RMR Group Inc (RMR) 2019 Q1 法說會逐字稿

Good day, and welcome to the RMR Group's First Quarter 2019 Financial Results Conference Call. (Operator Instructions) Please note, today's event is being recorded.

I would now like to turn the conference over to Tim Bonang, Senior Vice President. Please go ahead, sir.

Good afternoon, and thank you for joining us today. With me on the call are President and CEO, Adam Portnoy; and Chief Financial Officer, Matt Jordan. Just in a moment, they'll provide details about our business and our performance for the first quarter of fiscal 2019. They will then take questions.

I would like to note that the recording and retransmission of today's conference call is prohibited without the prior written consent of the company. Also, note that today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws. These forward-looking statements are based on RMR's beliefs and expectations as of today, February 7, 2019, and actual results may differ materially from those we project. The company undertakes no obligation to revise or publicly release the results of any revisions that are forward-looking statements made in today's conference call.

Additional information concerning factors that could cause any differences contained in our filings with the Securities and Exchange Commission or SEC, which can be accessed from our website, rmrgroup.com or the SEC's website. Investors are cautioned not to place undue reliance upon any forward-looking statements.

In addition, we may be discussing non-GAAP numbers during this call, including adjusted net income, adjusted EBITDA and adjusted EBITDA margin. A reconciliation of net income determined in accordance with U.S. generally accepted accounting principles, or GAAP, to adjusted net income, adjusted EBITDA and a calculation of adjusted EBITDA margin can be found in the news release we issued this morning.

And now, I would like to turn the call over to Adam Portnoy to begin our quarterly review. Adam?

Thanks, Tim, and thank you, everyone, for joining us this afternoon. Before I begin, I just want to apologize in advance. I'm getting over a cold and I may sound a bit congested and cough a couple of times. For the quarter ended -- for the first quarter of fiscal 2019, which ended on December 31, we reported net income attributable to RMR of $52.2 million or $3.22 per share. Our earnings this quarter include $120.1 million or $2.82 per share in incentive business management fees from HPT, SIR and SNH. Each of these managed equity REITs outperformed their respective industry benchmarks over the last 3 years by at least 10%.

At this point of the call, I usually talk about our client companies results in some detail. However, because RMR has a September 30 year-end and most of our client companies have December 31 year-ends, we are reporting RMR's quarterly results in advance of our client companies.

That said, I can talk about some overarching themes across our client companies as well as leasing results in activities that have been publicly announced. On a combined basis, RMR ranged over 2.5 million square feet of leases during the quarter on behalf of our client companies. These leases resulted in average rental rates that were approximately 2% higher than prior rents at the same space, and the average terms of these leases were over 12 years.

We also supervised approximately $40 million in capital improvements at our client companies during the quarter. One of the most significant events at our client companies this quarter was the merger of Government Properties Income Trust and Select Income REIT to form Office Properties Income Trust or OPI. This merger received significant shareholder support, and we look forward to advancing OPI's investment strategy of owning buildings primarily leased to single tenant and tenants with high credit-quality characteristics such as government entities.

During the quarter, we also helped facilitate the amendment of OPI's $750 million unsecured credit facility, which extended the term through January 2023 and resulted in a 15 basis points reduction in the facility's annual interest rate.

Last week, ILPT executed a 10-year mortgage on its Hawaiian assets for $650 million with the loan-to-value ratio of less than 50%. We think this transaction highlights to the market a significant and underappreciated value of ILPT's industrial assets in Hawaii. We further believe that the ILPT story is one that investors continue to underestimate.

In January, TA agreed to purchase 20 TravelCenters from HPT for $308 million, resulting in a reduction in annual rent to TA of $43 million. HPT also extended the term of their leases with TA by 3 years, and TA will repay $150 million of deferred rent at a discount over 16 quarterly installments, beginning in April 2019. This transaction is beneficial to both companies and provides increased stability to the overall relationship.

In terms of RMR's newer platforms and growth initiatives, this quarter, we had some significant updates. At Tremont, management has continued to build on recent momentum. This quarter, Tremont issued approximately $66 million in new loans with another $47.5 million in new loans closing after quarter-end. At this time, Tremont has fully deployed its IPO proceeds and will pay its first dividend later this month.

In order to maintain Tremont's business momentum, this week, RMR entered a $25 million credit facility with Tremont at a fixed rate of 6.5% per annum. This facility is intended to be a bridge until we can arrange additional third-party capital for the company, at which time a portion of any monies raised will be used to repay RMR. This facility ultimately provides Tremont with almost $100 million of investing capacity on a leverage basis and will provide Tremont greater flexibility to execute their business strategy and keep its origination network engage.

As it relates to the RMR Office Property Fund, on January 31, the fund announced its first acquisition. A $56 million multi-tenant Class A office building in Richmond, Virginia at a 7.2% cap rate. Depending on the pace of future acquisition opportunities, we would expect RMR's $100 million commitment to this fund to be called in the latter half of calendar 2019.

This quarter, we also officially launched our marketing efforts for the fund in conjunction with our third-party sales team, and initial feedback across all potential sales channels has been positive. As I've highlighted in previous calls, the fundraising process will be lengthy, and we don't expect to have any news around capital raising until later this year at the earliest.

Beyond these updates, we remain focused on seeking out strategic opportunities to diversify our platform. We ended the quarter with almost $285 million in cash and no debt. In January, we collected the incentive business management fees, providing us additional capacity to pursue possible growth opportunities. While I cannot speak to specific opportunities, consistent with what I've communicated in the past, we continue to assess the acquisition opportunities to possibly further diversify our revenue sources.

I'll now turn the call over to Matt Jordan, our CFO, who will review our financial results for the quarter.

Thanks, Adam. As Adam highlighted earlier, net income attributable to RMR was $52.2 million or $3.22 per share this quarter. After excluding incentive fees, separation costs and unrealized losses on equity method investments, adjusted net income attributable to RMR was $10 million or $0.62 per share.

Management services revenues, excluding incentive fees, were $47.5 million this quarter, which represents a $1.1 million decrease on a year-over-year basis and a $1.6 million decrease sequentially. These decreases were primarily the result of lower business management fees due to declines in the average market capitalization of certain of our managed equity REITs. With the decline in REIT share prices in the latter portion of 2018, all of our managed equity REITs, except for ILPT, are currently paying their monthly base business management fees on a market-capitalization basis. The impact of being on this lower measure for calculating our monthly base business management fees results in our revenue for the quarter being approximately $5 million lower than it otherwise would have been, had the managed equity REITs than paying on invested-capital basis.

Based on the current share prices of our managed equity REITs, along with OPI's strategic dispositions and the fact that there are 2 fewer days on a sequential quarter basis, we expect total management and advisory services revenues to be approximately $45 million next quarter.

It's also worth noting, this quarter, we adopted ASC 606, the new revenue accounting standard. As a result, we are required to present any client company operating in capital costs we help source on a gross basis with an equal and offsetting amount in operating expenses. This is a consistent application of ASC 606 with other large publicly traded property managers and one we will apply prospectively. This quarter, the resulting gross up of our income statement was $98.1 million, which again has no impact to net income or cash flows.

Turning to expenses for the quarter. Total compensation and benefits expense was $36.2 million, which includes cash compensation of $28 million, $1.8 million in equity-based compensation and $6.4 million in separation costs related to former executives. Cash compensation of $28 million is an increase of $1.8 million on a year-over-year basis and $2.1 million on a sequential quarter basis. These increases are primarily attributable to headcount additions to support growth as well as standard merit increases.

Looking ahead to next quarter. We would expect normalized cash compensation to be approximately $29 million after considering payroll tax and 401(k) expenses that both reset on January 1 each year.

Lastly, in October 2018, we exercised our right of first refusal under the provisions of the retirement agreement in place with the former President and CEO of TA and purchased approximately 1.5 million TA shares he held for $8.4 million. These TA shares will be mark-to-market each quarter, and in this period we recorded an unrealized loss of $2.8 million. In future quarters, we will continue to recognize gains or losses based on the changes in the price of TA's common shares.

That concludes our formal remarks. Operator, would you please open the line to questions?

(Operator Instructions) Today's first question comes from Owen Lau at Oppenheimer.

I have a few related questions for the Office Property Fund. Would you use any of that for that $56 million acquisition? Or is it all cash? Also, it's $56 million the average size that you are looking for going forward? And finally, how should we think about the earnings impact for 2019 after these transactions?

I'll take the first 2 parts, and then let Matt pick up the second part. In terms of debt, the fund itself has a working line of credit, and we grew on the working line of credit to actually fund the acquisition itself. As we think longer term with that whole vehicle, we imagine it to be about 40%, 45% levered. And so not all the assets will have property-level debt, but a good amount of them will. We haven't made a determination, whether that specific asset itself will have long-term debt on it. In terms of the average size, I think that's a pretty good size investment in terms of -- a pretty good average size. I mean, we've been saying less than $100 million would be what we'd be looking to invest in. I see -- I think around $50 million, $60 million is a pretty good average size investment for us. Now I say that, and we'll probably do some stuff smaller, and we'll do some stuff bigger, but it's a pretty good average size investment. Matt?

Yes. No, I think we're consistent with where we've been guiding, $2 million or $2.5 million of incremental revenue with about $0.05 of incremental earnings. The Richmond acquisition was something we had baked into our forecast in that guidance.

Okay. That's perfect. One follow-up from me. Looking at the balance sheet, cash and deal combined was about $475 million. So a good question -- a good problem to have. How should we think about your cash management strategy in the shorter term? Would you be investing more cash into securities to generate more income? Would you be putting more money into the Office Property Fund if it goes well? Any color would be very helpful.

Sure. It's a great question. You're right. We ended the quarter with about $285 million of cash, and we've got about $120 million of incentive fees. So that's about $400 million.

Correct.

And it's a great question about what we're going to do with that capital. Of the $400 million, we do have a $100 million committed to the fund, which will probably be spent some time in the second half of calendar 2019. We also announced today that we've made a $25 million loan or will be making $25 million loan to Tremont to help that business. And that's about $125 million of the capital that still leaves a good chunk of capital as you can quickly do the math. I think our preference is to continue to try to deploy our capital in ways that will increase the revenues for the business, specifically revenues in and around new opportunities. So if we were to start a new business line, we would look to maybe help start that business line by investing in that business line with some of our excess cash. I think we also are and we have been, for several quarters, acquisitive in the sense that we're very opportunistic and looking every quarter, which we think is our job to do, at opportunities to make an acquisition. We haven't pulled the trigger on anything of significance since we've been a public company, but that's obviously something we could use the capital for if we found the right opportunity.

I don't think we -- what I don't think we'll spend the money on is likely investing in, let's say, some of our well-established businesses. That's -- we've been asked that many times, would we invest in our well-established client companies? And I don't see that is highly likely. But if we get to the end of, let's say, get to the second half of 2019 or get closer to the end of the year and we continue to build up cash, we were not as -- be able to put it to work in growth initiatives. And again, growth initiatives around new business lines that will expand the platform and diversify our revenues. If we're unable to do that, then I think the board would come back, and we would consider whether or not we distribute some return of that capital to shareholders. And the way I think we have a bias is towards a dividend, meaning, we might think about increasing our regular dividend in some matter if that was -- if that's where we were at the second half of the year or near the end of the year.

And our next question today comes from Mitch Germain of JMP Securities.

Adam, the Tremont loan, is that going right to them today or now? Or is that as drawn over time?

Yes, they -- it's to be drawn. They have 6 months to draw on it. So it'll be as they need it. So we didn't want them to -- they didn't want -- Tremont didn't want to have to have the negative carry of whole mix sitting on the cash. But they -- but there is a 6-month window they have to draw the money.

Got you. Okay. And then with regards to the office fund, just trying to figure out cadence. I mean, I know you guys have that $100 million commitment. You said that's probably a back-half-of-the-year funding. Is that a reflection of the fund -- initial fundraising or deal pipeline? Was that in line with kind of what you expected? How is the -- how are deals materializing there?

So I think it's in line with regard -- it has nothing to do, really, with fundraising expectations, I mean, just so you know. We're -- for planning purposes, we haven't assumed we raised nothing this year in terms of third-party capital. We hope we raise some. But I'm just letting you know for planning purposes, we're planning that we're not very successful in the first year, meaning, it takes time to get the money, get the -- the sales lead takes time and that we get -- it takes us over a year to really start raising money there. And I just think that's the nature of the fact that for the first time, we have a private fund. It's the first time we are talking to a whole group of investors that we have historically not talked to. So it's introducing us as a platform to that whole new universe of investors, and that takes time. But the reason -- I don't think our timing has changed since the last quarter. Last quarter, we also thought it was going to be in the second half of '19. And that's just a reflection of putting the money to work in terms of deal opportunities. And we have a very robust pipeline of many deals that we're looking at for the fund. And I'm confident we will get the money out in the second half of '19.

And looking at your business, right now, you obviously have the office fund, which is more of a multi-tenant type of a property. You've got OPI, you've got lodging, you've got health care, you've got industrial. Could you be looking at the private fund business for other alternative sectors that you're not involved with in the public markets?

Yes, we could. The obvious one that we had asked about is residential and multifamily. It's the biggest -- it's a giant sector in the marketplace that we do not play in. That's a sector that we could someday enter, either in a public format or a private format. I'm not sure which -- if we were to do it which way we would lean. I think a lot of the effort on the private side right now, as we're trying to not get too distracted or trying to pitch too many things at once. Remember, again, it's our first time out there, talking to these investors. We're trying to be very focused on what we have, which is this multi-tenant office fund, core-plus fund. We want to gain traction there. If we're successful with that, I think you're right, there are opportunities that present themselves to then raise additional private capital around other strategies. But we've got to walk before we run. We've got to raise the capital first for this strategy to do it successfully, and then I think that opens up opportunities for us to think about doing it in other sectors, which -- and the obvious one for us is -- obviously multifamily.

Got you. My last question, Matt. I think you've provided some guidance of $45 million for revenues. Just want to make sure I kind of understand that. So you've got the OPI potential sales in that number. You've got HPT TA transaction. And then does that reflect kind of where stock prices are currently? Is that your anticipated -- where you think stock prices, kind of, well, average for the quarter? What are the underlying assumptions in -- that create that number?

That is looking at share price activity through the month of January and assuming that they're static. Obviously, we'd like to see that not to be the case and see those share prices improve. But if nothing were to change and the OPI dispositions were to move forward or execute, the $45 million would be your number.

And our next question comes from Bryan Maher of B. Riley FBR.

So we've had a pretty volatile market till last 3 or 4 months. And when you're out there sourcing acquisitions, whether it's for the new fund or as it relates to any of the funds that you manage, are you seeing any movement or skittishness on the part of owners that could free up assets? And what are you seeing, if anything, as it relates to cap rates for those assets?

We are in a period right now being early February that we have not seen a lot of transactions come to market, meaning, the pricing or the call-free offers are all starting to come due. The brokerage community has really got into a cycle where they try -- a lot of deals try to get closed by the fourth quarter before year-end, and then no one likes to have calls for offers in January for whatever reason. So we haven't -- I have not seen or we have not seen a lot of transactions calls for offers yet. I will tell you, though, there's a lot that's coming up in the next few weeks. And I think we're going to know a lot more in the -- within a month or so if there's been any movement in the market. I guess, that's -- we just haven't seen a lot transact -- there is a pipeline, it's just that nobody set call for offer dates or not many set call for offer dates in January. They sent out their books the first, second week of January and are calling for offers in February. And so that's where -- I'm sorry, I'm not giving you a great answer because I don't think there's been a lot of data points for us to point to since the beginning of the year to really say what's going on. I will tell you, I mean, the one area we have some insight as we have been seeing a little bit is on the loan side because we did close on the Tremont side some loans. And I would say that spreads, at the very least, to have bottomed and maybe even have started to move up. And so if that's happening on the debt side, that's going to have an impact on cap rates eventually. But again, of course, it depends what the benchmarks is doing as well. But we are seeing that. That I have -- we have seen in the last since the beginning of the year there may be a little bit of widening out on the spreads. But that's sort of an indirect way to get the cap rates.

All right. That's helpful. And then when you look across your various platforms, which do you think would be -- will be the most active or aggressive as we move through 2019?

I think the company will probably be the most acquisitive is ILPT. And then followed by the fund. ILPT has a tremendous amount of capacity right now. We talked about it on our call -- on this call but we've just put $650 million of debt on an asset that we bought, have invested $500 million on. So we bought and then invested $500 million -- total dollars in $500 million, we just took $650 million out, and then spent less than 50% loan-to-value. So you can do the math what the value of those properties are compared to what we bought them for. So -- and that then frees up that company, ILPT. The ILPT has its revolvers completely undrawn and is sitting on cash. And so it's in a position where it can really go up and be acquisitive right now. And I think we're in a good fortune that, that's a space in the industrial market that is seeing a lot of calls for offers coming up and a lot of product coming to market. So -- and that's the continuation of what we saw in '18. It's just continuing into '19. And so I do think ILPT will be very -- will be our -- probably our most acquisitive in 2019. Then followed by the fund, we have a few hundred million dollars we can put to work there. I think we'll do that. And then probably right behind that would be Tremont. With the loan, we're making some more and more into Tremont. They've got $100 million of lending capacity that they can put to work in the next 6 months. So I think they'll also be fairly.

active. So I think those 3 vehicles will probably be our most active on the growth side, certainly in the first half of this year.

And just as a follow-up here, your comment on ILPT. You made a comment that you see a lot of product coming to market, is that new build stuff? Or is that secondary transactions? And what are you seeing in some of those really low cap-rate markets like New York, New Jersey, San Francisco, L.A.? Is anything getting there? Or are you just planning to kind of staying away from those very low cap-rate areas?

Yes, there's both new and secondary product coming to market. In terms of cap rates, again, not much is transactioned -- transacted yet. But our expectation is that cap rates have not moved much for, certainly, in those top 5 markets in the country that you referenced. And so I don't expect that we'll be very acquisitive in those sort of top 5 markets or not very much so on those top 5 markets just because you're right, cap rates have really dipped below 5%. And just -- if you do the math very quick, ILPT put 10-year debt on it, less than 50% loan to value at 4.3% fixed rate for 10 years. So we've got a whole bunch -- you could say we have at least $650 million of capacity. Anything over 4.3% should be accretive. And in some of the markets you mentioned, unfortunately, deals are being done at 4.3%. So we probably can't buy much, if anything there. But I think if you get outside the top 3, 4, 5 markets in the country, there are opportunities to buy new product. There's opportunities to buy a functionally modern product with good credit tenants, long-term lease at 5% in higher cap rates. And so I think we'll be able to put the money to work very accretively in very high-quality real estate.

Right. And just lastly, on the TA stock, you guys bought from Tom O'Brien. Is the plan to hold that? Just tuck it away and forget about it? Or is there a point at which you would sell it as in it's not strategic to be owned by RMR and you just fulfilled an obligation, but you're getting rid of it at some point?

I don't think we've discussed it at length yet, but I think if you push beyond it, I'd say, my gut says we'll probably hold it for quite some time. I don't -- I mean, nothing is for sure. It depends on a lot of different factors. But I think that -- my gut reaction is we'll likely hold on to that stock for a good period of time.

And our next question is a follow-up from Mitch Germain with JMP Securities.

Adam, a bunch of C-suite changes announced, obviously, in the last couple of months. Just curious about how everything seemed to be transitioning there.

Great question, Mitch. We anticipated this one. So yes, there has been quite a bit of a movement in the senior ranks. None of this was, I would say, acrimonious. All of this was really folks retiring. They've had a good fortune of being with our company for a long time, and our company has been successful, and they have benefited from that success. And they had decided that it was time for them to retire. I also think there was a natural -- it coincide, there was a change in leadership over the last year with myself assuming more of day to day -- I guess, more responsibility with the organization, with the passing of my father about a year ago. And so I think there was some correlation to that because people said, well, it's just the right time to think about retiring, simply because Adam is probably -- he doesn't look like he's low on energy, probably he's going to be running this business for quite some time. And so people had to put that all in the mixing bowl and decide what it is they wanted to do. And so I think that's what led to those retirements. I think it's -- at largely, it's a good story. It's a especially good story internally. These are folks that were well accomplished, did well and were very successful here and were successful, both in what they accomplished and -- but also financially. So I think it's a very good -- it's a great story. And no, I don't think it's a trend that we're going to see continue much into '19. At least, I don't foresee it trending much into '19.

Got you. One more from me. Try to be a little more original on this one. No, but I am sure you can't provide that much of an update with what's going on in Five Star. But maybe some sort of -- is there maybe a time line that's emerging? Or any sort of color that you can provide, I'd be grateful.

Sure. It's a great question. Obviously, the market is aware that Five Star is -- issued a, what was called, the going concern when it announced earnings for its third quarter in November. I think it was -- or around November when they did it. And that has led to discussions with SNH, between Five Star and SNH. Those discussions are ongoing. I anticipate that something will be announced around it, certainly in the -- closer to the first -- in the first half of this year versus the second half of this year. And the sooner the better. Basically. I think you can just do the math on -- with Five Star, and I think something needs to give in the next few months here. And so I'm sure something can be announced. I think we hope to announce it. And I can tell you it is an enormous focus for both SNH and Five Star and RMR, what's going on at Five Star right now.

And ladies and gentlemen, this concludes our question-and-answer session. I'd like to turn the conference back over to Adam Portnoy for any closing remarks.

Thank you for joining us this afternoon. And we look forward to updating you on our progress during our second quarter conference call. Operator, that concludes our call.

Thank you, sir. Today's conference has now concluded, and we thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day.