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Tower Properties Ticker: TPRP
Price: $12,500
The investment thesis for Tower Properties is similar in structure to that of various infomercials we’ve all seen. “You can buy premium apartments at a steep discount…but wait, there’s more!! We’ll also throw in office buildings and land for the same price. Act now and we’ll also give you shares of a bank and a well respected management team. All for the low, low price of $12,500 per share!!” Interested? If so, keep reading! Come on, it’s either this or the Slap Chop! Tower Properties is the epitome of an oddball stock. On the back of a napkin the company could be summarized as simply a property developer and manager. But, a quick peek at their financial statements leads one deep into oddball territory. The company started as a complicated merger/spin-off transaction in 1989. Tower Properties merged with Commerce Bancshares and during the process formed another company called Tower Acquisition Corp. The merged Tower Properties and Commerce Bancshares entity contributed $17.5m worth of assets into Tower Acquisition Corp upon creation. Tower Properties shareholders received Commerce Banchares shares upon the merger. Following the merger, Tower Acquisition Corp shares were distributed to shareholders as a stock dividend. The company decided to then confuse everyone even more by naming the merged entity Commerce Bancshares and then changing the name of Tower Acquisition Corp to Tower Properties, which was the same name as the pre-merger Tower entity. The newly created Tower Properties continued to operate in the real estate area. Currently, it owns a number of office buildings, apartment complexes and land in the Kansas City area. Unlike many property companies that operate on the principle of secrecy, Tower Properties is transparent about what they own. Details about the properties, including occupancy details and financing, are readily available. In the game of who can perform the most exhaustive due diligence, some investors might make an effort to visit all of Tower’s apartment properties They might further visit comparable properties and even pose as a potential tenant to get leasing or other details. If one were looking to buy the entire company I think due diligence of this magnitude could be merited, but as an outside shareholder living in the age of the internet, I think research like that has diminishing returns. Now, if an investor lives in or near Kansas City and finds apartment hunting to be enjoyable it might be a different story. I spent some time researching the company’s apartment properties (online of course). From pictures and reviews they appear to have a quality portfolio. The company’s apartment complexes could be considered luxury apartments with a community clubhouse and pool. The complexes appear updated and modern. Reviews on rental sites are generally favorable. While there are always at least a few that are loud and proud in their negativity, most negative reviews had more to do with loud Copyright Red River Research Inc. 2016
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neighbors rather than poor facilities conditions. Without visiting and professionally inspecting every unit it’s impossible to know the absolute quality of the portfolio, but based on some sample research it seems that Tower Properties owns high caliber apartment complexes in desirable locations. Including the aforementioned apartment complexes, the company’s portfolio includes, among other things (as discussed later): • • • •
10 multi-story office buildings ranging from two to six stories; A 120,000 square foot warehouse facility; 10 apartment complexes with 2,231 total units; and 30 acres of residential and commercial land in Kansas City.
All of this is for sale at a market price of $59.8m, but the question is whether this is a reasonable valuation or not. If the company’s assets are low quality, then the market’s $59.8m valuation might be fair or even overly generous. But, I don’t think that’s the case. It’s easy to take a real estate company and scream from the rooftops that it’s undervalued because IF the company liquidated it would be worth more dead than alive. There are a number of problems with this approach, however. Company management is unlikely to be satisfied with a one-time gain for the company when they have what amounts to an annuity which can continue paying their salaries (ah, self-interest, where would we be without you?). This is the case even if the annuity value is less than the amount of the onetime gain. Secondly, if investors in the local real estate market heard a company was liquidating it’s unlikely it could obtain top value, or perhaps even fair value, per property. Because of this, real estate is usually valued based on the earnings it generates. This value is typically determined on a yield basis, which is known in the industry as the “cap rate” (i.e. the amount of earnings divided by the price or market cap, if a public company). When one looks at Tower Properties on a strict cap rate basis the company doesn’t appear cheap at first sight. What seems amazing is that for a company with high occupancy they have somehow managed to lose some money in most years on a GAAP basis. For investors focused on P/E ratios and earnings growth this is a negative. However, it’s actually a feature and benefit of the investment. It’s true! Keep reading! The company is able to generate slightly negative earnings that eliminates their tax liability, all while generating significant positive operating cash flow. The company earned $13m in operating cash flow in 2015 and $9m in both 2014 and 2013. On a cap rate basis utilizing operating cash flow as opposed to GAAP earnings, the company is trading with a 21% yield based on 2015 results (16% for each of 2014 and 2013). This might not seem significant, but when most property companies are trading at a 5-6% yield it demonstrates that the market has significantly discounted the value of Tower’s cash flow. While the company currently pays no taxes because of their GAAP losses, they could permanently avoid (most) taxes by restructuring as a REIT. A REIT is a real estate
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investment trust, which is a corporate entity in the US with no entity level taxation. In return, REITs are required to distribute 90% of their taxable income to shareholders each year who then pay tax on these amounts at their personal income tax rate. The most likely reason the company doesn’t want to convert to a REIT is they would be required to distribute any accumulated earnings and profits in a special distribution to shareholders, thus causing them a potentially significant tax event. If the company was to trade like a REIT based on its yield, at a 6% yield it would be worth $216m or about 4x its current price. Of course, in the current low rate environment a 6% yield has the potential to cause a mass stampede as investors chase anything with yield. As a point of reference, the NAREIT index currently yields 4.2% and if Tower Properties were to trade at that level investors would see roughly a 5.2x gain. While these are considerable gains, I don’t think investors should expect the market to ever value Tower in line with peers. In addition to the portfolio of properties, the company also owns $11m in Commerce Bancshares stock and has $11m in cash held at Commerce Bank. The company’s bank investment is a legacy ownership position related to the original merger and spin-off, but the bank stock isn’t the only tie between the two companies. Commerce Bank also employs tower’s executive management in similar executive roles. While not ideal to have the executives work at both companies, they don’t seem to be using this arrangement as a way to take advantage of shareholders. For example, the Tower Chairman recently reduced his salary in light of the reduced time he has available for Tower. This is in contrast to many small companies where executives view their position as a way to milk things as much as possible with large salaries and a lot of perks. Tower’s balance sheet isn’t pristine. As a real estate company they have mortgages outstanding on every property. Due to the special relationship between Tower and Commerce, the bank is the source of all of Tower’s funding needs. This is a very unique arrangement that benefits both parties. It provides Tower with a ready source of loans on good terms and provides Commerce a steady stream of interest income on known properties. The special relationship between Tower and Commerce extends beyond shared executives and favorable financing. Tower’s commercial properties and related parking lots are leased to Commerce, for which Commerce paid $968k in rent and management fees in 2015. So suffice it to say that there’s a lot going on between the two companies. In addition to being undervalued based on its yield (determined based on cash flow), the company is most likely trading at a substantial discount to the fair market value of its assets. Many of the company’s properties were purchased in the 1980s and 1990s and have appreciated since their purchase. Unlike many real estate companies, Tower does sell some of their properties occasionally. As an example, in 2013 the company sold a warehouse for $4.7m that had been purchased for $2.6m. They also sold surface lots in Kansas City, as well as various other properties over the past decade. A simple metric of valuation is that the company’s apartments alone are trading for $29k per unit when the build price for a typical apartment in the same area costs anywhere
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between $60k and $90k per unit. This valuation approach doesn’t take into account any of their other properties or assets. An argument could be made that this simple metric doesn’t take into account the debt on each property, which is true, but their apartments generate significant cash flow and are high quality assets. If the company were to sell any of these complexes it’d be highly unusual to sell them for less than half of their replacement cost (which is the value the market is placing on them), especially considering their cash flow supports a value of replacement cost or higher. While it’s been established that Tower Properties is trading at a substantial discount to their assets and earnings, there is a slight wrinkle to acquiring a position. The company’s shares trade for the high price of $12,500 per share and there are only 4,786 shares outstanding. Shares do trade and when they do it isn’t unusual to see volume in the $100,000 or greater range, but investors need to be patient. The company’s high share price is a result of a going dark transaction in 2008 when they executed a 1 for 30 reverse split. At the time of the transaction shares traded for around $300 or $9,000 adjusted for the reverse split. Due to the high share price and limited liquidity the price has been extremely volatile. Some lucky investors paid as little as $6,130 in 2013 for shares, while some less lucky ones paid as high as $13,000 this past year. While the company is dark they do file news releases and quarterly and annual financial reports on OTCMarkets.com. Tower Properties gives investors an unusual opportunity to purchase high quality assets at a considerable discount to their fair market value. But it’s not only about the asset value as these assets generate considerable cash flow that management has continued to reinvest in new properties. If the market ever begins to recognize the value of Tower then investors could realize a substantial gain. Investors interested in Tower should place limit orders at a price they’re willing to pay for shares. And just for good measure, it might not hurt to place a low ball limit order as well because you never know when you’ll get lucky. Hey, it happens sometimes!
Copyright Red River Research Inc. 2016
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