Not Dead - Unlike Inland American

My blogging hiatus is over.  There was no reason for the lack of posts other than more pressing work.  I won't predict the frequency of future posts, but I expect more posts than there have been recently.

Here is Bruce Kelly's article on Inland American's new Net Asset Value of $4.00 per share.  I need to dive further into this calculation.  My quick takeaway is that despite plenty of asset sales over the past two years, the new, lower NAV per share primarily reflects this year's spin-off of Inland American's remaining hotel assets. 

In 2014, Inland American sold $1.1 billion of hotel properties to NorthStar and $2 billion of properties overall, but didn't return any capital to investors.  In 2013, Inland American closed a portion of a $2.2 billion property sale to various American Realty Capital entities, the balance of which closed in 2014.  I figure Inland American sold over $3 billion of properties from the middle of 2013 through the end of 2014. 

In February 2015, in a separate transaction from the sales in 2013 and 2014, Inland American completed the spin-off and listing of Xenia Hotels and Resorts (XHR), which Inland American formed in 2014. (Inland American retained 5% of XHR.)  Inland American investors received shares in the new hotel company, and I estimate that the XHR transaction was worth the equivalent of approximately $2.60 per share to an original $10.00 per share Inland American investment.

Inland American's new Net Asset Value (NAV) per share is $4.00, as of February 5, 2014.  Its previous NAV (December 31, 2013) was $6.94 per share.   The drop in NAV reflects - mainly - the XHR spin-off.   The XHR transaction was Inland American's first return of capital event - through the distribution of fully liquid XHR shares to Inland American investors -  with Inland American retaining and retiring debt with the net proceeds from the $3 billion in property sales in 2013 and 2014.  An investor that originally purchased Inland American shares at $10.00 per share have $7.40 per share remaining, based on the estimated listing value $2.60 per share for XHR.  The new $4.00 per share NAV needs to be viewed in relation to the $7.40 per share of remaining offer contribution.

Inland American announced a lower distribution with its new NAV.   The new distribution is $.13 per share, a drop from the previous $.50 per share.  The lower yield partially reflects the XHR spin-off, but it is also a cut in yield.  The yield on the new $4.00 per share NAV is 3.25%, but based on original investment amount, this represents a yield of 1.76% on the $7.40 of remaining original contribution value ($.13 / $7.40).  This should be compared to the previous 5.0% yield ($.50 / $10.00 per share).

I'm no revisionist and won't feign shock that the current $4.00 per share NAV - which is net of the XHR transaction - is less than the original $7.40 per share, or the remaining original offer price.  Inland American acquired the bulk of its properites before real estate prices dropped in the late 2000s.  A drop in value below the original offer price is expected.  Its disingenuous to think that Inland American could have somehow missed the decline in real estate values.  That being said, the cut in annual distribution yield from 5.0% to 1.75% is sharp.

I encourage you to read Inland American's September 22, 2014, 8-K.  It details new incentive compensation for Inland American executives, among other items.  I guess the executives realized that the original compensation, which was subordinate to investors getting a full return of capital plus a preferred return, was unobtainable.  Here is some of the language from the filing:

On September 17, 2014, the board of directors of the Company adopted the following three incentive compensation plans (the “Share Unit Plans”): (1) the Inland American Real Estate Trust, Inc. 2014 Share Unit Plan (the “Retail Plan”), with respect to the Company’s retail business; (2) the Xenia Hotels & Resorts, Inc. 2014 Share Unit Plan (the “Lodging Plan”), with respect to the Company’s lodging business; and (3) the Inland American Communities Group, Inc. 2014 Share Unit Plan (the “Student Housing Plan”), with respect to the Company’s student housing business. Each Share Unit Plan provides for the grant of notional “share unit” awards to eligible participants.

Share Units. Subject to applicable vesting conditions, each share unit represents the right to receive a cash payment, or, to the extent provided in the applicable award agreement, shares of common stock of the Company, Xenia Hotels & Resorts, Inc. (“Xenia”) or Inland American Communities Group, Inc. (“IA Communities”), as applicable, in an amount equal to the fair market value of the share unit on a specified date. Share unit awards will vest and become payable on terms and conditions determined by the plan administrator and set forth in the applicable award agreement, including by reference to certain change in control transactions or specified events resulting in a listing of the applicable entity’s shares on a national securities exchange (including an initial public offering) (“Listing Events”). A “change in control” under the Lodging Plan and the Student Housing Plan includes a change in control of the Company, in addition to a change in control of Xenia or IA Communities, as applicable. A “change in control” under the Retail Plan includes only a change in control of the Company.

For purposes of each Share Unit Plan, the “fair market value” of a share unit will be determined by the board of directors in good faith, and prior to a Listing Event, will be determined by reference to the valuation performed as of December 31, 2013, or such other subsequent similar third party valuation performed to estimate the value of a share unit on a fully diluted basis, using methodologies and assumptions substantially similar to those used in prior valuations.

At the time of the September 2014 filing, the Xenia assets, retail properties, and student housing were the main property types left in Inland American's property portfolio.  It is my opinion that Inland American investors will never get a full return of capital.   Inland American executives, therefore, won't get their originally planned revenue sharing (15% of profits after a return of investor capital plus a 10% annual return), and is the reason for the new incentive compensation plans.   The drop in the REIT's share value and performance of the REIT made the original incentive hurdles unachievable.   I am sure Inland American's executives know this better than anyone and have have created a salve to ease their financial hardship - by which I mean a plan to pay themselves despite investors losing capital.  It is a salve that excludes Inland American investors.