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Sometimes, assets are worth more than the market is willing to value them at. When that occurs, you may see a company announce that it has engaged an investment bank to “explore strategic alternatives” so that the true value of the company can be monetized.
Disconnects in valuation happen for many reasons. Sometimes there is no rational reason why the values of assets in the private market are higher or lower than those in the public markets. But it happens, and when it does, management should look into maximizing shareholder value.
The market got just such an announcement recently from Ashford Hospitality Prime (NYSE: AHP), when the company indicated that it’s considering making itself available for a corporate buyout.
“We do not believe Ashford Prime’s current share price accurately reflects the Company’s intrinsic value,” CEO Monty Bennett stated in an Aug. 28 press release. “While we are confident in our strategic plan, we have concluded that we should consider all other opportunities to maximize shareholder value.”
Prime is a spinoff from Ashford Hospitality Trust (NYSE: AHT), and as a hotel-specific REIT it has a different approach than Ashford Hospitality Trust, which has a generalized hospitality focus.
Prime’s strategy, according to its website, is to invest “primarily in high RevPAR (revenue per available room), full-service and urban select-service hotels and resorts located predominantly in domestic and international gateway markets.”
At present, Prime owns 11 hotels across the country which have delivered strong RevPAR growth versus its peers. Fiscal year 2014 saw RevPAR growth of 8.3%, with several large REITs underperforming in comparison. Meanwhile, Q1 RevPAR was up 10.8%, hotel EBITDA (earnings before interest, taxes, depreciation and amortization) was up an impressive 16.4%, and EBITDA flow-through was an equally impressive 44%. Prime doubled its dividend in May.
Despite all this, however, comparable assets are trading at much higher valuations in the private market. One way to measure this is by referring to capitalization rates. That is defined as the ratio of net operating income to property asset value.
In the private market, we are seeing cap rates of 6.5%. Ashford Prime’s cap rate is about 9.5%. Thus, the denominator of the ratio – property asset value – is higher in the private market than in the public market.
This may change. Or it may not. One way it could change is if the company does a financial transaction that valued it at this rate. For example, say management tells me that it believes it could obtain debt at terms which would value the assets above $20 in the public markets. But it’s a catch-22, because the assets are presently valued, as AHP stock, at $15.47.
That takes us back to strategic alternatives. If these assets are indeed worth more in the private market, then Ashford Prime may want to try and find a private buyer.
When the announcement was made on Aug. 28, the stock ran up a bit, and has since added slightly to those gains. The reason is that all the event-driven mutual funds and hedge funds rushed in to buy the stock, eventually settling on a price that is reflective of their view of the probability of a transaction.
Thus, if one chooses to value Ashford Prime’s assets at $20 or higher, based on something like the cap rate, then there’s 30% upside to be had with Ashford Prime’s stock. I was already long the stock, because I believe in the company and management. I added slightly to my position, seeing that I think the stock is undervalued.
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