Colony Capital Stock Investment Thesis

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May 19, 2016

Colony Capital, Inc. (Colony) is a REIT focused on commercial real estate. In 2009, the company came public as Colony Financial and was a permanent capital vehicle managed by Colony Capital. The company invested in distressed real estate debt and equity. Over time, this opportunistic strategy led Colony to invest in a portfolio of industrial properties and another portfolio of single-family homes. Colony also originates first and mezzanine mortgages for commercial properties. The company is regarded as a sophisticated commercial real estate investor.

We became interested in Colony’s stock in 2015 after the company acquired its external investment manager. The external investment manager advised a series of private equity real estate funds in addition to Colony Financial. Colony Financial was renamed Colony Capital and the combined company has improved economics because the investment manager is an asset-light business that earns a high return on equity and does not require capital to grow. The company can reinvest the earnings generated by this business back into the core real estate portfolio or increase dividends paid to shareholders.

The investment management business has the potential to grow. With the balance sheet of the REIT, the investment management business can seed new funds which will accelerate growth. We have seen evidence of this with the new launch of a global credit fund. Colony’s investment management business at $9.9 billion in assets is large enough that it is at scale and small enough that it can grow at an attractive rate.

We believe there are a few catalysts on the horizon for Colony to drive its stock higher. First, we believe Colony will sell or spin-off to shareholders its stake in Colony Starwood Homes in late 2016 or early 2017. Next, we think Colony will recycle capital from other low yielding investments into higher return opportunities. Another possibility is the company announcing a significant stock repurchase. Lastly, we believe each earnings report is an opportunity for the company to show improved fund raising in its investment management business and/or improved results in its real estate portfolio.

A new potential catalyst for Colony shares appeared in early May. Colony confirmed that it was in talks to acquire NorthStar Asset Management (NSAM). NSAM is the external manager for NorthStar Realty (NRF). NSAM also raises capital and manages several other non-public investment vehicles. We’ll have to wait to see if Colony and NSAM are able to agree to a deal, but we think the potential combination is an interesting transformational opportunity for Colony.

Colony’s stock has underperformed over the last 10 months. We believe this is due to several reasons: yield-oriented Mortgage REITs have underperformed, there has been volatility in the CMBS markets, and Colony’s largest investor may have had redemptions from their fund and may have had to sell down their stake in Colony. At its recent price of $18, Colony’s stock trades near tangible book value, so we are getting their real estate private equity business for free along with a free option on a potential deal with NSAM.

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