An Update On My "Risky" High-Yield Turnaround Pick

Back in August, I mentioned that Colony Capital (Nasdaq: CLNY) was exploring the sale of its industrial unit. The company owns 465 warehouses from Texas to California that are 92% leased, mostly for ecommerce fulfillment.

For those who may not remember, CLNY is a High-Yield Investing portfolio holding. It's been a rare disappointment for us so far, but as I explained back then, there's reason for hope. That turned out to be prescient, as shares have since rallied by about 24%.

CLNY chart

But back to the sale...

At the time, these properties were expected to fetch about $5 billion on the open market. But management hinted that the final price tag could be "significantly higher" based on preliminary demand from interested parties.

It turns out they were right. On September 30, Colony officially announced the sale of its industrial division to Blackstone Group (NYSE: BX) for $5.9 billion.

I'm quite bullish on industrial real estate. In fact, that was the primary motivation behind my initial recommendation of CLNY.

It's no secret that a growing percentage of retail spending is migrating online. When you buy a new pair of shoes or a television from an online retailer like (Nasdaq: AMZN), those goods don't just ship straight from an assembly line to your front door. Odds are, they spend some time in a warehouse first.

With e-commerce booming, the absorption of empty warehouse space has been exceeding new supply for seven straight years. In turn, vacancy rates in the industrial real estate sector fell to historic lows of 5.2% last year -- driving average rental rates to record highs.

So-called "last mile" space is the most coveted. As the name implies, these are smaller facilities (relative to bulk distribution hubs) located near major population centers, thus allowing for speedy delivery to homes and stores.

Not surprisingly, there has been a wave of M&A activity in recent months. Blackstone has now gobbled up nearly $25 billion in warehouse assets this year and may intend to spin them off into a publicly-traded unit.

If so, I will likely be a buyer.

As for Colony, this sale marks a major reversal in strategy. As recently as March, the company was still in expansion mode and had just inked a deal to purchase 48 last-mile warehouses. Now, it is exiting this sub-sector entirely as part of a broader transformation.

When the dust settles, Colony will be more of an asset manager than a landlord. The company currently manages nearly $30 billion in real estate on behalf of third-party owners. This business model requires less maintenance capital. It's also less susceptible to economic downturns (fee-based as opposed to rental income).

On one hand, I hate to see Colony part ways with these valuable properties. But monetizing assets is one of the surest ways to unlock shareholder value. The $1.2 billion in net proceeds from this transaction amount to $2.46 per share. Colony also has a large collection of various debt and equity positions with a book value (even after write-downs) of $2.40 per share.

That's a total of $4.86 per share. The stock is currently trading at $5.72 as I write this. That means the market is valuing the rest of the company at less than $1 per share.

We're talking about 170 hotels that generate over $80 million in net operating income each quarter, as well as 400 healthcare facilities (senior housing communities, medical offices and hospitals).

The sum of the parts is worth far more than the whole -- as this latest sale confirms. At least one competent independent appraisal from Blackwells Capital suggests a fair value of $11 per share, implying triple-digit upside potential.

Action to Take
Colony's warehouse unit fetched almost $1 billion more than anticipated. The stock jumped 14% to $6.72 before the opening bell on the day of the announcement, but gains moderated later in the day.
CLNY remains a "buy" for risk-tolerant income investors.

It will take time to win back investor support following the ill-fated Northstar merger. But Colony has fresh leadership and is making progress. I like the recent leap into cell towers, data centers and other communications infrastructure. Fueled by the explosive growth of mobile data traffic (and the nationwide rollout of 5G service on the horizon), this has been one of the hottest corners of the real estate sector.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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