Third Avenue RE on Songbird Estates H/T Harvest
Songbird Estates, one of Third Avenue Real Estate Value Fund’s larger positions, remains a very attractive investment. The current price places minimal weight on the company’s entitlements and the profits embedded in existing development projects. In Third Avenue Management’s view, these entitlements will ultimately prove to be quite valuable as demand for commercial and residential space at the Canary Wharf Estate and surrounding area is poised to increase considerably once the Crossrail Project is completed in 2018. Third Avenue’s Real Estate Value Fund has owned Songbird since 2009, when we first recognized the value this investment represented. Five years later, the thesis largely remains the same. In fact, we see the recent price appreciation as only “part two” of a three part story.
The first part of the story was the opportunity. Songbird faced bankruptcy in 2009 as its balance sheet had difficulties weathering the global financial crisis. Songbird, itself, was not well-financed as its ownership stake in Canary Wharf was secured by a $1.5 billion holding company loan that matured in 2010. Due to the decline in commercial real estate values in the UK, Songbird’s stake in Canary Wharf, prior to its recapitalization, was determined to be worth only slightly more than the total amount outstanding on the company’s loan. Songbird negotiated a discounted payoff (95% of face amount) with the lender and then raised $1.8 billion of fresh capital by issuing common and preferred stock. The common stock was issued to existing shareholders through a highly-dilutive rights offering, and the preferred stock was taken up by China Investment Corporation. Post recapitalization Songbird remained positioned as a conservatively financed holding company. We purchased shares of Songbird Common in anticipation of participating in the company’s recapitalization efforts and fully subscribed to the rights offering, which allowed us to increase the investment in Songbird Common at a steep discount to our estimate of net asset value.
The second part of the story is currently playing out as the market is beginning to recognize the intrinsic value of the company. Songbird recently reported that its property holdings had jumped in value in 2013, reflecting robust demand for office space and endorsing its strategy to pursue residential development. The stock price increased by more than 35% on the heels of the earnings announcement. This came as no surprise to us at Third Avenue Management. As value investors we are on a permanent quest for companies that, like Songbird, have an intrinsic value that the market does not recognize. Value realization no doubt takes time, but for the patient investor it is a matter of “when” not “if”.
The third part of this story is yet to come. Our research shows that the market has not fully priced in Songbird’s growth potential. Songbird Common has increased by more than 80% since our initial investment, but is still at more than a 15% discount to its stated net assets per share. The price increase has come about with a 38% increase in NAV, from £2.10 to £2.90 in the six months between the end of June and December 2013. Furthermore, this value seems somewhat understated since it has limited weight on the company’s entitlements in the area or the potential boost that the Crossrail Project may have on their value. The high speed rail line is currently under construction and will meaningfully enhance the ease of transport from East to West London. Once complete, it will take less than 40 minutes to get from Canary Wharf to Heathrow, less than 15 minutes to Bond Street. More importantly, it is estimated to bring an additional 1.5 million people within a 45 minute commute to London. This should not only further accelerate the development in the Canary Wharf and surrounding area but could also lead the rents on existing properties to converge with rents in the City, which are more than 50% above rental rates on Canary Wharf.
With such a promising outlook… why are Songbird shares still trading at a discount? Some investors may worry about features such as the complexity of a holding company structure, the concentration of the shareholder base, the fact that as a real estate operating company (REOC)–unlike real estate investment trusts (REIT)–Songbird doesn’t pay a dividend, and that it is not widely covered by analysts or included in broader real estate market indexes. None of these features impact the underlying fundamentals of the company or the potential value of its assets. In fact, these features may have created the opportunity for those with a longer-term outlook to acquire shares in Songbird Estates at a discount to its underlying net asset value.
Investors focused on the fundamentals will see Songbird for what it really is: a company that owns high quality assets, is being financed with modest levels of non-recourse debt, has the ability to retain its cash flows and self-finance its future development projects, and is being run by a like-minded, accomplished control group, with interests that align with shareholders. Given these characteristics, it is Third Avenue’s view that the underlying value will ultimately be recognized by the public markets and Songbird will be rewarded with a share price that more closely reflects the underlying value of the company. If not, it is not inconceivable the private markets will capitalize on this price to value discrepancy. Until then, Songbird is likely to remain a core holding for the Third Avenue Real Estate Value Fund as it represents a real value in real estate.
See full PDF here: Songbird Estates Real Value in Real Estate
Via Third Avenue