LAACO, LTD - CASE STUDY
Eric Schleien, Portfolio Manager
Here at Granite State Capital Management (GSCM), we love to buy ultra cheap companies and assets that are safe and they also preferably produce a lot of profits and cash, and return capital to shareholders in a prudent manner.
As of March 2018, one of our largest positions is just like this. This particular company owns ultra valuable real estate assets mostly on the West Coast that produce a ton of cash flow. We believe we have the opportunity to purchase this company at 54 to 72 cents on the dollar compared to its true value. It pays us a ~3.5% dividend while we wait.
And it’s far less levered than their other public company competition. These are the perfect kinds of investments we love to buy and we’re going to share a bit about our thinking behind our purchase…
When it comes to our investments in real estate we like to buy assets at significant discounts to what we deem as their private value market.
This is what happened when we bought LAACO, Ltd (LAACZ).
LAACO is a West Coast based self storage and real estate investment holding company.
It owns self storage centers, a marina, an athletic club and other cash flow producing real estate assets mostly on the West Coast of the United States. LAACO’s self storage units are located in Southern California, Houston Texas, Las Vegas Nevada, and Phoenix Arizona.
And its athletic club, marina, and various other real estate assets are owned mostly in the Southern California/Los Angeles area.
When evaluating this company we broke it up into two distinct segments.
ALL storage unit facilities – LA, Houston, Phoenix, and Vegas specifically
Los Angeles Club/Parking Lot Assets
Because these are two distinct operational units that we need to value and evaluate separately to find the true value of the entire company.
First let’s take a look at the storage unit side of the business.
So How Cheap Is The Business? - Worst Case Scenario
As of this writing (March 2018), the company has 52 operating self storage facilities running under the Storage West brand. These 52 centers have a combined 4,296,000 operating square feet worth of space. And are currently 88% occupied. In 2016 these 52 facilities produced $52.6 million in revenue. And on this revenue it produced net operating income – NOI – of an estimated $29 million. NOI is after all expenses which we estimate to be ~45% just to be on the conservative side of things. Typical commercial real estate expenses amount to an average of 30% to 50% depending on how well they’re run.
And while we think LAACO’s management is doing a fantastic job running the company, we still wanted to be conservative with these estimates so we have a significant margin of safety.
If we apply an ultra conservative 7.5% cap rate, we get a value of $387 million or $2,283 per share
We’re okay buying cheap assets at cheap prices and high quality assets at moderate valuations. But here we can buy ultra high quality assets at extremely low prices.
Plus, the company has another 525,000 square feet of storage space currently under construction that will be operational soon that will add another ~11% to the company’s value.
This increases the entire value of ALL the self storage facilities soon to be operational to $430 million. Or a total per share price value of $2,537 per share.
This is the conservative estimate using a 7.5% cap rate.
This means with the company’s market cap as of this writing at $374 million, we can buy the entire company by paying for JUST its current self storage operations. And we get the future self storage operations, AND its club, marina, and parking lot assets for FREE.
So what value do we give to their club and other real estate assets so we can find an estimated true value for the entire company?
Valuation Overview of Non-Self Storage Real Estate Assets – Worst Case Continued...
LAACO’s other main real estate assets outside its self storage facilities are the LA Athletic Club and its parking lots.
And the California Yacht Club.
We can’t currently give any value to the California Yacht Club because none of its financials are released. But we can get to an estimated value for the LA Athletic Club and its parking lots.
The LA Athletic Club consists of an 184,000 square foot building with retail, hotel, and office space. Its parking lots make up 124,600 square feet of space in a covered parking garage. And it has another 21,000 square feet of space in a surface parking lot.
Based on our estimates of cash flow, operational improvements, and future best case uses of the property we estimate this entire property and its operations to be worth between $108 million conservatively.
This means the LA Athletic Club adds another $637/unit to the company’s valuation.
Giving ZERO value to the California Yacht Club we conservatively estimate the value of all of LAACO’s assets of $538 million, or $3,174 per share respectively.
As of this writing, that means we can buy LAACO for 69 cents on the dollar to what we estimate as its true value in a worst case scenario.
And again this is an ultra conservative valuation because we give ZERO value to the California Yacht Club. And we put a much lower multiple on its self storage operations than its public competition has.
Plus, we can own ALL these assets for an adjusted cap rate of over 9% when we adjust for the Downtown LA assets. For these types of assets, this massive undervaluation is incredible. And this cap rate is used for subpar assets, not great assets like these.
This means the valuation of the LA Athletic club assets are low estimates of value. In a sale of some kind, they would get far more than this, but that is speculation at this point so we’re being conservative.
In other words it would be impossible to purchase these assets in the private market at the current valuations the stock market is giving us today.
Remember, we also get paid a ~3.5% dividend while we wait for the market to realize this company’s true value and raise its share price.
And this is all a worst case scenario.
What about a more realistic valuation for the company?
Base Case Valuation of LAACO
The more realistic number using the 5.7% cap rate for JUST its storage assets gets us a value of $565 million or $3,333 per share.
If we value LAACO’s storage operations like its public company peers using a 5.7% cap rate and then add in the value from the Athletic Club, ALL of LAACO is worth $673 million. Or $3,971 per share while still giving zero value to the Yacht Club.
This is a much more realistic valuation in my opinion and means LAACO is currently selling at only 55 cents on the dollar compared to its real value.
This is a massive margin of safety.
Even when taking out its $52 million in debt, this gives us a value of $621 million or $3,664 per share.
This means that net of ALL its debt we can buy LAACO for only 60 cents on the dollar compared to its true value.
And today - due to far higher regulations, property prices, and land values - you would never be able to buy these kinds of high quality real estate assets in LA at even moderate prices let alone these massively discounted prices.
But we also love LAACO’s conservatism…
So how does their balance sheet look?
In short, fantastic… Especially when compared to its competition.
Its net assets make up $182.7 million. Or at current rates 54.2% of its current market cap is in net assets.This not only means its balance sheet is healthy. But this also provides a massive margin of safety.
LAACO also as has far less debt than its other public competition. Its debt to Enterprise Value (Debt/EV) ratio is only 12% while the average public competitor’s ratio is 29.6%. This means it’s a far safer investment than its competition because it’s far less likely to go out of business.
This also means interest rates rising will affect LAACO far less than its public competition. And with interest rates around the world raising this could lead to trouble for LAACO’s more highly levered public competition.
And as LAACO’s revenues rose from $41.3 million in 2002 to $77 million in 2016 or a rise of 86% during that time - and alongside them profits - distributions to shareholders rose even faster from $34 per share in 2002 to $80 per share in 2016 or a rise of 135% in that time.
As a percentage of revenues, LAACO shareholders are getting a higher and higher percentage of distributions as time goes on and the company grows.
This all illustrates the beauty of GSCM, we can invest in these kinds of small, obscure, and a little bit confusing companies that are safer and more undervalued than their bigger public competition because other firms can’t or won’t evaluate them.
We’ll take advantage of this by doing more due diligence and taking advantage of these opportunities into the future.
So why is LAACO so cheap?
Why is it so Cheap?
First off, LAACO is an OTC company which doesn’t get much coverage from analysts. And few investors are willing to search for companies in this arena due to the generally smaller sizes and low liquidity of these companies.
This brings us to point two…
LAACO has extremely low liquidity in it shares to insiders and funds owning 70%+ of its outstanding shares.
Its units are so illiquid it requires trading by appointment and there are currently only 105 shareholders in the entire world!
Another reason it's so cheap is because of its structure as a partnership.
This is an inefficient structure for most people that requires investors to get K-1’s and file their own taxes on their distributions.
None of these affect the underlying economics, valuation, or operations of this company. As long-term oriented investors we’re fine with these mostly perceptual risks.