How 'Serial Issuers' Of Debt And Equity Win: Morgan Stanley, Darden And Triple-Net REITs
When companies such as Darden Restaurants, Inc. (NYSE: DRI) that own restaurant locations spin the real estate out as REITs, how does that add value for shareholders?
On Thursday, Morgan Stanley analyst John Glass and his team published "Restaurants and REITs" to help investors understand the rationale behind the June 23 announcement by Darden of its "OpCo/PropCo" REIT strategy.
Darden is contributing 430 store locations (almost entirely Olive Garden) to a PropCo, which will then lease the locations back to Darden under triple-net leases. In addition to monthly rent, the OpCo will be responsible for paying the operating expenses, including taxes, insurance and almost all maintenance costs.
Net-Lease REIT Portfolio Diversity
Most triple-net REITs are diversified by tenant, industry type and across multiple geographies in an attempt to protect against changes in consumer preferences and maintain high occupancy during all economic cycles.
The Darden REIT Is A Choice
The REIT spin and sale-leaseback of 75 more individual stores is calculated to generate approximately $1 billion to Darden, which it intends to use to deleverage its balance sheet.
However, this is a very different scenario than retailer Sears Holdings Corp (NASDAQ: SHLD), which is cash-strapped and continues to hemorrhage huge sums on a quarterly basis. Tapping into the real estate assets on the Sears balance sheet through its Seritage Growth Properties (NYSE: SRG) REIT was essentially a matter of survival.
Notably, Darden shares already pay investors a very competitive dividend, currently yielding 3.1 percent.
Red Lobster Haunts Darden
In May 2014, the former board approved the sale of Darden's Red Lobster chain to Golden Gate Capital who funded the majority of the purchase by entering into a sale-leaseback of approximately 500 properties to net-lease REIT American Realty Capital Properties Inc (NASDAQ: ARCP).
Darden activist hedge fund Starboard Value was vehemently against the transaction, as not being in the best interest of Darden shareholders, and successfully spearheaded the election of an entirely new board of directors.
The current Darden Opco/PropCo REIT strategy is an attempt to create additional shareholder value, since net-lease REITs trade at higher EV/EBITDA multiples than most restaurants.
Net-Lease REITs: Tenant Concentration Risk
However, many ARCP shareholders were not pleased with the high concentration of Red Lobster assets, the increase in exposure to restaurants in general and the reduction in percentage of investment grade tenants.
All shareholders in REITs created through an OpCo/PropCo spin, or IPO, share a similar dilemma – single tenant and single industry concentration risk.
One plus for the Darden REIT is that its OpCo tenant has an investment grade rating, which is not the case with Sears or Red Lobster.
Morgan Stanley Trims Darden Valuation
Morgan Stanley expects the Darden REIT shares "to trade at a 10–20 percent discount to the group on an FFO multiple basis. This would translate to 11–13x FFO or 12–14x EV/EBITDA."
This is a reduction from initial estimates in the 13x–17x EV/EBITDA range, resulting in a new Darden price target range of $63&ndash$77, down from $63–$79 for the combined OpCo/PropCo.
Darden REIT Questions
There are major investor questions that have yet to be addressed:
- Lease Terms: So far, Darden management has mentioned very conservative rent coverage levels of approximately 3x, but that remains to be seen.
- Growth Strategy: Darden has indicated that it may pursue 1031 exchanges in an attempt to diversify, but Glass feels this would also require acquisitions and strategic dispositions.
- REIT Management: In order for net-lease REITs to grow, they are "serial issuers" of debt and equity, which in turn requires investor confidence to be successful.
Restaurant REIT Possibilities
Morgan Stanley noted that Bob Evans Farms Inc (NASDAQ: BOBE) has recently announced its intention to pursue a REIT spin or sale-leaseback of its real estate.
McDonald's Corporation (NYSE: MCD) has the largest portfolio of owned real estate worldwide and was the subject of a hedge fund presentation back in March, which suggested that its real estate was potentially worth $25 per share. However, McDonald's current management is not keen on the idea.
Morgan Stanley's Valuation Takeaway
"A combination of factors drive valuation in the Triple-Net REIT sector. On a relative basis, valuation is typically determined by a combination of the (1) external growth outlook, (2) perceived portfolio quality, (3) portfolio diversification and (4) leverage. On an absolute basis, interest rates and expectations are also an important valuation driver," Glass concluded.
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|Dec 2016||Deutsche Bank||Downgrades||Buy||Hold|
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