03/22/22 07:05 AM EDT

REITS DAILY BRIEF | PGRE REJECTS MONARCH OFFER | 3.22.22 | (PGRE)

Rob Simone, CFA

@HedgeyeREITs

Takeaway: Where do we go from here?

Hedgeye Cartoon of the Day: HYPERINFLATED BLOOD PRESSURE

Ticker: PGRE

Subsector: CBD Office

Headline: Would Monarch launch a proxy fight?

Yesterday afternoon Long Bench name Paramount Group (PGRE) rejected its second unsolicited buyout offer in two years (this time from Monarch Alternative Capital @ $12/share, last time Bow Street @ $9.50-10/share in 2020) without subsequently running a full process to explore strategic alternatives/a sale of the company. At least this time the Board took about a month to reject, which we expected to happen all else the same, versus a little over a week on the last go around. They did not, however, find the time to write a new rejection form letter, or to at least add a sentence or two (see Figure 1 below), but did forget to drop the next-to-last sentence down into the new paragraph. Attention to detail!
In all seriousness, though, this is becoming a complete joke, as every player in the public market (except for company, apparently) knows and understands that PGRE should not be a public company any longer, and that its portfolio of assets is most valuable in a private market context. The management team (really the CEO working on behalf of the Otto family, in our view) and Board (1) once again demonstrated an exceptional level of entrenchment by not yet doing the right thing by shareholders and hiring an advisor (other than BAML) and putting the company up for sale (to the best of our knowledge), (2) has demonstrated an exceptionally poor track record of capital allocation, and (3) overseen a significant amount of value destruction since coming public in 2014, both pre- and post-COVID.
The question now turns to whether Monarch, on its own or in conjunction with a more traditional activist investor, launches a campaign and/or proxy fight for the May 2023 meeting. Our understanding from our own research and conversation with investors is that (1) Monarch is a SERIOUS group, and is likely committed to this effort, (2) there are possibly other interested firms lurking in the background with a history of formal shareholder activism, and (3) the non-passive shareholder basis is frustrated and supportive of PGRE going private. In fact, we have strong indications that >50% of the non-Otto, non-passive shareholder base would support and vote for a deal at $12/share or higher.
We continue to believe that an offer in the range of ~$12 to $14/share is both appropriate and fair (this company is not worth a mid-to-high teens price anymore) - for example at ~$14/share, a buyer would effectively be paying a ~3.6% forward cash cap rate inclusive of capex (~30% of NOI) and a buyer's own underwritten overhead burden (assumed ~3% of NOI here), for an eventual stabilization in the ~6% unlevered yield range. Valuation is subjective, but contrary to what was said in the rejection press release last night, an equity purchase price in the above range WOULD effectively be giving credit today for any future NOI growth/value creation.
We are moving PGRE higher on our Long Bench priority list on signal strength.