Chrisfotolux
Investment case
Over the past few years, Equity Commonwealth (EQC) shareholders have patiently waited for management to deploy their significant cash reserves. For years, management has been looking for an M&A deal to turn the company around Office REIT to Industrial REIT. The company came close years ago when it tried to buy Monmouth Real Estate (MNR) in 2021 for About $3.4 billion. but, MNR contributors The deal was eventually dropped by voting against the takeover a few months later. Since then, EQC has not attempted to acquire another company, and shareholders have been left wondering whether management will finalize the deal. As such, shareholders have recently begun to consider whether it is in their best interest to seek a winding down of the business rather than reaching a transformative deal to free shareholders. value. Therefore, my investment case for EQC focuses on the potential winding down of the business and how investors can benefit from the liquidation.
So, one of the main reasons I made this investment case now is the fact that management has provided investors with a timeline for either a deal or potential divestiture of the business. Before the end of the year, the company plans to announce any of these scenarios to shareholders. Therefore, although I would not recommend investing today, this is something all investors should keep on their radar as we approach the end of the year. In my opinion, at the right price, investing in a company’s preferred stock (EQC.PR.D) provides a potential risk-free return opportunity if the company actually winds down its business. Although common stocks also have potential upside, I will focus only on preferred stocks because that is where I see the potential for guaranteed returns.
An activist investor pushes management to consider liquidation
On March 13, 2024, Land & Buildings Investment Management, LLC issued a letter to EQC’s Board of Directors urging the Company to consider selling the four remaining assets in its portfolio and liquidating the Company. This push from Land & Buildings Investment Management, LLC appears to have worked, as management included a business update section within its latest earnings release that outlined its plans for the business. In this section, management highlighted some of its accomplishments since acquiring the company, but the crux of the update lay in the final paragraph:
“Today, we continue our efforts to maximize shareholder value. We continue to focus on opportunities where we can create long-term value for our shareholders, while at the same time taking steps to facilitate the potential winding down of our business. Before the end of this year, we expect to either announce a transaction or move forward with a plan to wind down our business“.
The last sentence in the above excerpt is important because it now appears that management is open to the idea of winding down the business and returning remaining value to shareholders. I believe this is the most appropriate course of action for the company, as a transformative acquisition comes with many risks and shareholders have already been patient enough with management.
Investing in preferred stocks
In addition to the Company’s common stock, investors can also purchase EQC Series D Cumulative Convertible Preferred Stock that pays 6.5% per annum on the liquidation value of $25.00. If the company continues to operate as usual and does not liquidate, holders of preferred stock can convert their shares into common stock at a conversion rate of 0.8204 or they can continue to hold the shares and collect dividends. Thus, in this scenario, investors would be looking at a conversion price of $30.47 per common share but would still receive a healthy 6.5% return. However, in the event of a fundamental change, such as the termination of trading in its common stock, the Company has the right to repurchase Series D preferred stock with a liquidation preference of $25.00. Thus, if the company is liquidated, investors are practically guaranteed a liquidation value of $25.00.
EQC SEC 10-K
In my opinion, this last scenario has the opportunity to provide risk-free returns, as the company has enough cash to cover both the dividend and the total repurchase amount. For example, the total repurchase amount of preferred stock at $25.00 would equal $122.88 million (4,915,196 shares * $25.00). Since the company has over $2.0 billion in cash and cash equivalents, the company can easily cover the repurchase amount several times over. Therefore, I believe there is no downside to investing in their preferred stock when they purchase it at a discount from the liquidation value of $25.00.
Scenario analysis
For our analysis, assume that the company announces its plan to wind down its business at the end of the year. This announcement will likely occur after the fourth preferred stock dividend is paid in November. Thus, if an investor purchases shares before the July record date, he or she will receive two additional distributions totaling $0.8125. Given the current market price of the preferred stock of $24.80, this provides the investor with a return of 3.28% over the next six months (which equates to an annualized return of 6.67%). Additionally, because the preferred stock is trading at a discount, the investor will be able to earn an additional 0.8% return on his investment for a total return of 4.08%. Overall, this total return over the next 7 months isn’t bad, but when you compare this return against the 6-month Treasury yield of 5.36%, it looks like a poor investment.
Therefore, to provide some different investment return scenarios, I have compiled the table below that shows different returns based on the preferred stock’s trading price at the time of investment (all assuming the investment was made before the July record date). As you can see, if you are looking for a return equivalent to the 6-month Treasury yield, I would wait to buy preferred stock at a price of about $24.50 because that would provide you with a total return of 5.36%. For this reason, I recommend waiting to see how preferred stocks trade over the next month before making the investment if you are seeking a total return equal to the Treasury return. However, I will say that investing at any of the rates listed below is not a terrible option given the practically risk-free nature of this investment.
|
The investment price of preferred stock |
Dividend yield over the next six months |
Discount on liquidation value |
Full return |
|
$24.80 |
3.28% |
0.8% |
4.08% |
|
$24.70 |
3.29% |
1.2% |
4.50% |
|
$24.60 |
3.30% |
1.6% |
4.93% |
|
$24.50 |
3.32% |
2.0% |
5.36% |
|
$24.40 |
3.33% |
2.5% |
5.79% |
|
$24.30 |
3.34% |
2.9% |
6.22% |
Risks
The biggest risk I see for investing in preferred stock may involve management deciding to go ahead with a transformative deal that ultimately pays more for it than necessary. This is not something completely out of the question. The risk of overpaying for a trade is something everyone should consider, and for this reason alone I wouldn’t recommend investing in their common stock, despite the potential upside. With preferred stock investing, if a company overpays for an acquisition, the investor is still entitled to a 6.5% return on the stock. Additionally, dividends are cumulative, so any unpaid dividends accumulate overtime, providing little protection in the event that the company runs into trouble.
