Small-Cap Office REIT First Potomac Downgraded - A Potential M&A Silver Lining?
On Thursday, BMO Capital Markets analyst Paul Adornato published a note "Downtown Funk…" detailing why First Potomac Realty Trust (NYSE: FPO) shares were being downgraded and its BMO target price reduced by over 21 percent.
However, there could be a silver lining due to $615 million cap First Potomac's potential to be acquired or be a candidate to be taken private, in order to realize the full value potential of its portfolio over time.
Notably, BMO is projecting a potential 26 percent, 12-month total return for high-yielding FPO shares, even at its lowered price target.
Tale Of The Tape: Shares Under Pressure
During the past year, First Potomac shares have lost just over 20 percent of their value, and YTD they are down almost 16 percent.
During the past 52-weeks, First Potomac has traded in a range of $10.21 to $12.95 per share and currently pays out a dividend yielding 5.7 percent.
First Potomac's Strategic Pivot
Since 2010, First Potomac has acquired $1.1 billion of office assets located in various metro-Washington, D.C. markets.
During the same time period, First Potomac has shed $450 million of assets, including the sale of the majority of its 4.3 million San Francisco industrial portfolio to Blackstone Group LP (NYSE: BX) for approximately $215 million in 2013.
Unfortunately, the Washington, D.C. office market – heavily dependent upon Federal spending – contracted severely in 2014, as shown in the slides below.
First Potomac At A Glance
- 1. Double-Down On Washington, D.C. Office
- 2. Shrinking Economy
- 3. Job Loss Slams D.C. Office Market
- 4. First Potomac Portfolio Occupancy Trends
5. High Quality Assets/Long-Term Value Creation
BMO–First Potomac: Downgrade Outperform To Market Perform, PT Lowered $16 To $12.50
BMO's new $12.50 target price represents a potential approximated 20.3 percent upside based upon Thursday's closing price of $10.43 per share, for a total return of approximately 26 percent, including the 5.7 percent dividend yield.
- The BMO $12.50 PT is based upon 16.7x revised 2016E AFFO of $0.75 per share.
- First Potomac currently "is trading at 14.0x [BMO's] 2016 AFFO estimate, which represents a 31 percent discount to the 20.2 REIT universe average," the report stated.
- Adornato's rationale included the statement that the "D.C. office recovery has been slower than expected, and FPO's leverage, redevelopment pipeline and market cap make it less compelling to public investors."
First Potomac's Consensus Analyst Estimates
The revised BMO 2016 estimated AFFO for First Potomac is still considerably above the consensus estimate of $0.68 per share posted by First Potomac on its website.
Source: FPO - IR website May 28, 2015
Silver Lining Playbook?
While Adornato does not recommend buying REIT shares due to M&A speculation, First Potomac is currently trading at a significant discount to NAV, as noted in the chart below.
The FPO Debt + Preferred to EV appears to be towards the middle of this group, although not nearly as high as some of the REITs in this group; the FPO leverage is still relatively high compared with REIT averages.
BMO: Private Equity A Possibility
According to Adornato: "With three recently announced deals in the Apartment REIT sector (Associated Estates, Trade Street Residential, potentially Home Properties) and various private firms such as Blackstone eyeing such REITs as privatization candidates, we think the environment for transactions – fueled by the spread between best and worst – is likely to become more friendly to M&A activity."
The fact remains that REITs that are geographically concentrated can be riskier for investors.
However, if the bad news is already priced into the First Potomac shares, investors are being paid a 5.7 percent dividend to wait for the D.C. "job pendulum" to swing in the favor of office landlords.
Additionally, First Potomac has several major office redevelopment projects in various stages, which will likely help to increase returns when the local economy improves.
Latest Ratings for FPO
|Sep 2016||Stifel Nicolaus||Upgrades||Hold||Buy|
|Sep 2016||SunTrust Robinson Humphrey||Upgrades||Neutral||Buy|
|Aug 2016||Stifel Nicolaus||Maintains||Sell|
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