Quick idea today: I am looking at Service Properties Trust (SVC). I think the idea is interesting and there is a catalyst. Here’s the situation:

• Company Overview: SVC is an externally managed REIT (managed by RMR – more on this later), owning 304 hotels and nearly 800 “service-oriented properties” which are net lease
• Glance at the Opportunity:
  • $1.4BN market cap, $913MM in cash*, $7.14BN in Debt = $7.7BN EV
  • Tangible book $10.62 vs. stock at $8.61 = 19% discount to book value
    • Book value likely underestimates the net lease portfolio value
    • Book value is also depreciated – i.e. the assets bought many years ago likely didn’t go down in price from the price paid, but accounting is accounting. Depreciation is $3.5BN of value – think about that in the context of the market cap.
    • See Value Build table below. You could arrive at $40 implied stock price depending on what you want to believe. I used 7% cap rate for the net lease portfolio which is a decent discount to a recent comp.
  • You can also get to ~$12 stock using 12x EBITDA, which is 37% upside, and ignores a lot of other things I’ll mention. True value likely is somewhere in between these data points.
  • The cap structure is overlevered, they have a $500MM of bonds due Aug 2022 and the $1BN revolver is technically due as well.
    • *They have $1BN drawn on revolver. The rest of the debt is unsecured bonds.
    • The revolver draw isn’t all bad – they transitioned ~200 hotels to Sonesta in 2020/2021 and thought it had a chance of being disruptive, so they did it out of abundance of caution. It *was* disruptive when you add in COVID lock-downs, but both are looking like they are in the rear view mirror.
    • In some ways, this reminds me of CPLG, but sketchier – CPLG owned hotels and leverage got a bit too high. But CPLG sold poor-quality hotels at amazing levels, delevered and create value. Eventually they sold the whole business.
  • Bottom line: Given this is a levered equity, if you think the enterprise value is too low, that likely means the equity stub could have A LOT of upside. But also means A LOT of risk!
• The Assets – Hotels and Service Properties:
  • The hotels are managed or operated by franchisees of Sonesta (261 hotels), Hyatt (17 hotels) or Marriott (16 hotels), etc.
    • About half of these are extended stay hotels, with the other being a mix of mid-level to some luxury. But luxury is in the eye of the hotel-er.
    • The hotels are recovering from COVID nicely, but no where near peak. The company did provide monthly operating stats in their deck which is nice.

• • The Service Properties / net lease portfolio came from the SMTA acquisition, which was a special situation if anyone followed it
    • The largest tenant in the net lease portfolio is TravelCenter of America (45% of minimum rent owed, but larger on a $ value basis – likely 60%)
    • TravelCenter is public (ticker: TA) and is a full-service truck stop.
    • TA is doing quite well fundamentally. Looks like EBITDA has doubled LTM 9/30/21 vs. 2018. Haven’t fully dug in, but seems like if trucking in America is doing well, TA is doing well.
    • Other tenants in the net lease portfolio include Shopping Centers (20%) AMC (2%), The Great Escape (2%), Life Time Fitness (~2%), and a tail of others. You can imagine many of these were battered by COVID, but mattered less compared to TA and Shopping Centers.
    • Either way, the company is collecting 100% of rents now and the portfolio is 98% occupied with well staggered maturities. I encourage you to check out the investor deck for more.
• What else makes this interesting?
  • The situation is hairy: RMR involvement (I’ll get to it) and a levered equity. The latter tends to produce high returns if you get the entry point right and you think the B/S is fixable
  • Abandoned REIT: SVC had to cut its dividend during COVID. Went from 54 cents to a penny.
  • Catalyst: Currently marketing 68 hotels for sale ($579MM of carrying value). Mgmt stated they expect to get at least carrying value in Q1’22.
    • Mgmt said they have term sheets on all properties, though one is a bit more complicated. I suspect we will see staggered announcements to multiple buyers
    • Sales proceeds will first go to refi the bonds and likely downsize and extend the revolver
    • These assets for sale lag the rest of the portfolio in earnings or had deferred capex (read: bottom tier). It also reduces hotels vs. net lease portfolio. Net / net RemainCo should be valued higher.
    • Selling these assets and taking out the impending maturity can act as a cleansing event for investors to come back to the stock
  • REIT M&A remains hot, provides comps:
    • iStar recently sold its net lease portfolio to Carlyle credit for ~6% cap rate.
    • Taking SVC’s annualized net lease rents of $396, 6% cap rate = $6.6BN. That’s 86% of the EV right there. 7% cap = ~75% of EV.
• Other Value:
  • SVC owns 8% of TA equity and 34% of Sonesta Holdco. The former is worth about $51MM, the latter I am not sure as they are not public.
    • RMR earns fee on managing Sonesta. We can infer Sonesta makes about $750MM in revenue (0.6% fee on all revenue per RMR 10k)
    • We just saw CPLG get acquired for 2.8x revenue, which would imply $2.1BN EV here.
    • Assume 60% debt / cap (total guess) = $1.26BN of debt and $840MM of equity, implies about $285MM of value for SVC. This is all a wet finger in the air and the carrying value of the investment is $62MM. I use carrying value.
• Value Build
  • Here is the value build of what I have so far

• • There’s only one thing I haven’t talked about so far and that is the remaining 236 hotels.
  • The table below is how I got that number and it goes back to that depreciated book value discussion.
  • SVC’s lodging-REIT roots trace back to 1995. It isn’t out of the realm of possibility that many of those assets are depreciated considerably.

• RMR / Intercompany Relationships:
  • RMR manages SVC. SVC owns a lot of Sonesta hotels and owns 34% of Sonesta. SVC owns a lot of TA properties and owns 8% of TA. RMR provides management services for Sonesta and TA!
  • Let me be clearer: RMR manages both sides.
  • I should also mention people have a lot of misgivings about RMR and the Portnoy’s who manage it.
  • Let me copy the statement straight from RMR’s 10-k:

• • Perhaps you can see the risk here. RMR might try to rob Peter to pay Paul. RMR makes more money from managing SVC than it does from Sonesta (like… a lot more. 10x more. $45MM vs. $4-5MM).
  • That said, the web of inter-ownership perversely provides some comfort (admittedly not a ton). Screwing part of the chain should ripple back through and solve nothing. And again, RMR makes more from SVC. If there is a transaction, it is to preserve value at SVC.
  • On the other hand, I will admit an outright sale of SVC isn’t likely. I doubt RMR does that.
• Are there any signal of what RMR could do?
  • RMR also manages Diversified Healthcare Trust (DHC) which had some liquidity and covenant issues
  • RMR went out and found institutional investors for some assets, from my understanding not all core, which DHC contributed to a JV.
  • They did this recently in Jan-22 at a 5% cap rate but also at the end of 2021. Net / net, it looks to be about a $1BN of value realized.
  • It allowed DHC to get some liquidity, get a real bid on the assets, but not lose all economics
  • Why does this matter?
    • I think if your one hang-up is leverage, I think there are many solutions in addition to selling these non-core hotels in Q1.
    • If your one hang-up is RMR, then I think they’ve shown they are acting in the best interest of the company. RMR is aligned as they earn management fees on the enterprise values of the companies. They also manage the JVs in DHC’s case (lol)
  • Did RMR tip there hand to this??

That’s all for now – stay tuned for the asset sale announcements!