TCI's value has been unmasked
But is it a tightly held value trap?
TCI was written up by LEO11 on ValueInvestors.com in November: They correctly described how the balance sheet was going to be transformed by completion of the sale of the TCI joint venture with Macquarie (VAA). It surfaced the hidden value of a large number of properties being held at historic valuations that were a fraction of their market value. Selling (most of) them nearly doubled book value to $95 at end of Q1, but the market so far has not responded. In fact, TCI has traded down nearly 20% since then to a range around $37.
I’m not going to go deep into financials in this writeup, I think the potential value is very clear in a $37 stock with a $95 tangible book value. My focus will be the key question, what is the catalyst to unlock this value trap?
But just for clarity lets first review how obvious the value is. As of Q1 TCI has $1.13B in assets and only $284M in liabilities, so very little leverage. $1.04B (96%) of assets are real estate, cash, restricted cash, short term investments, and receivables. Deducting $502M in real estate leaves $540M in liquid assets (50%). I estimate liquidation value of TCI is roughly book value ($95), offering a potential upside return of 160%.
TCIs book value is a good proxy for liquidation value because the balance sheet value for their real estate seem reasonable. A rough calculation for Q1 FFO is $8M (operating earnings + D&A) which works out to a 6% annual yield on its Real Estate’s carrying value. And this is with their commercial office space only operating at 67% occupancy. About half of their multi-family properties have been recently revalued to market, but referring back to LEO11’s writeup, additional properties and land are likely still held well below fair market value.
So what is the catalyst?
The biggest cloud hanging over TCI is ownership. It was created by the notorious self dealer Gene Phillips and is now majority controlled by his children.
The corporate structure is convoluted. The properties are managed by Pillar Income Asset Management, which is essentially owned by a trust known as the May Trust. The beneficiaries of the May Trust are Gene’s children. It owns 90.8% of American Realty Investors, Inc (ticker: ARL), which owns 78.4% of TCI. TCI itself owns 81.1% of Income Opportunity Realty Investors (Ticker: IOR), which manages its mortgage note receivables. ARL, TCI and IOR basically have the same board. Finally, TCI sold bonds on the Israeli exchange through a wholly owned subsidiary called Southern Properties Capital Ltd. (“SPC”). This structure allows Pillar to earn at least $10M a year in fees for managing the properties.
The potential catalyst is the death of Gene Philips which occured in 2019. He left 80% of TCI (and 90% of ARL) in the Gene E. Phillips Childrens' Trust for his seven children. My thesis is this is a Succession like scenario, where it's likely that the children will have conflicting interests and objectives that will make it difficult to continue operating TCI together instead of selling/liquidating or paying out substantial distributions. Right now the Phillips children’s ownership of TCI would be worth about $600M in net liquidation value, but is trading in the market for only $200M. Closing that gap should be easily worth giving up $10M in annual fees.
What evidence is there that the family will break up TCI?
What started me thinking about this as a possibility is the substantial deleveraging since Gene’s death. Over the last few years, TCI has sold a substantial amount of properties without replacement, transforming their balance sheet to be much more cash rich than before.
Specifically, the VAA transaction has reduced total apartment units the company owned from 6,500 (when assigning 49% of the VAA units to TCI) in 2021 to 2,300 today. Also their commercial real estate properties have been reduced from 1.6M square feet in 2020 to 1.1M today and land has been slightly reduced from 1,961 to 1,858 acres. Finally, even if valuing VAA at its 2022 sale price in 2020, real estate has declined from 67% of assets to 47%, and liquid assets (cash/AR) has increased from 27% to 47%.
And most recently on May 4, 2023 TCI prepaid all of its remaining $43M in bonds and exited the Israeli exchange. This is despite $29M not maturing until mid-2025 at an interest rate of 6.8%.
The key child is the eldest son Bradford Phillips. As far as i have been able to determine he is the only Phillips with an active participation in ARL/TCI (with exception that Ryan Phillips appears to handle leasing out their office properties). Gene’s will was filed with the Dallas County courts. It appointed Bradford Phillips executor of the estate and all trusts. He is given the ability to control distributions but each beneficiary's trust is to be distributed to them at age 25. It's unclear if similar conditions also apply to the joint children's trust.
Bradford’s full time job is as CEO of Liberty Bankers Insurance Group. He is also President of Midland Securities while running the Gene E. Phillips Children's Trust and is the only Phillips on the TCI/ARL boards. So our outcome here is heavily dependent upon how he treats outside shareholders. So what do we know about him?
Beyond being a very successful businessman in his own right, Bradford also appears to not be greatly enamored with his fathers business practices. In a lawsuit he filed against Gene’s former mistress Bradford’s lawyer wrote about Gene in one filing “While Mr. Phillips was very successful, he was also a controversial figure” and that in Bradford’s career he, “has had to overcome his father’s reputation with the companies’ regulators and others.”
So what will be done with the capital accumulating within TCI? There are six likely options:
Conserve cash and capital until prices in real estate become attractive again, and then start buying properties again.
Pay out a large cash distribution to help keep the family happy, and run TCI in a smaller footprint going forward. I estimate up to $26/share could be available for a dividend without touching AR/Notes receivable.
Liquidate so every beneficiary can manage their own inheritances.
Go private in a “take under” paying minority shareholders well under book.
Sell TCI/ARL, presumably at near book value. This might be the most tax efficient method for the family to exit from the investment.
Distribute the families shares to each beneficiary. This may hurt the share price in the short run, but by eliminating the majority control discount it should be very positive over time.
None of these are terrible options for holders at these prices, and most would be extremely positive. If they want to continue to run the business Pillar would manage acquisitions as well as operations but it would seem likely that Bradford would need to provide oversight. Given he should have his hands very full with his own businesses, the last thing I think he should want is a bunch of work trying to please his siblings managing their portfolio, one that he only has a 14% economic interest in.
Finally a take-under is always a risk with a large majority shareholder. But in this case the time for a take-under was before the VAA transaction, where book value was roughly $43. Now it should be very hard to get a fairness opinion to justify a buyout anywhere near current prices while tangible book is $95.
Contraindications
There are some significant contraindications to the idea the family will dissolve TCI or pay out a large distribution. On March 15th TCI greenlit development of a $55M multifamily property in Lake Wales, Florida for completion in 2025. This is on top of acquiring $219M in apartments from the VAA partnership at the end of 2022 when it was broken up and sold. It’s possible that they just thought the properties were worth significantly more than offered, or that the buyer didn’t want them so TCI took them to ensure the sale closed.
In combination these transactions suggest they have no plans to leave the real estate business any time soon. The deleveraging could have been just an intelligent response to increasing interest rates, and they plan to re-invest when prices become attractive again. But if so that says we are in business with a very smart strategic operator, which is not a bad thing.
Estimated Returns
Obviously there is no smoking gun here that can make one highly confident that a liquidation, sale or large distribution is coming any time soon. We have no useful information to handicap how likely it is the family will decide to break up or sell TCI, or even to understand their decision making process. But we can estimate how often a sale/liquidation event needs to occur to make TCI a worthwhile investment. Modeling two most divergent possible outcomes, either continuing as a value trap with a zero return or a liquidation/company sale at $95, we reach an annualized return goal of 30% if liquidation/sale happens 18% of the time within the next year.
This simple calculation doesn’t give any benefit for a take-under at prices significantly above current trading price, or paying a large distribution, or the market shrinking that huge discount to tangible book value over time. Essentially the reason I currently own TCI is that at current prices I view it as a low risk option for the opportunity at a very high return if any transaction occurs.