Prepared by: Broyhill Asset Management, LLC
Kennedy Wilson Holdings
(NYSE: KW)
Who is Kennedy Wilson?
Founded in 1977, Kennedy Wilson (KW) has grown from a small auction business into a vertically integrated real estate operating company headquartered in Beverly Hills under the leadership of William McMorrow. Starting from a net worth of $50,000, McMorrow paid $1,000,000 for KW in 1988, which has a market capitalization in excess of $2 billion today. The value of his initial investment is now worth $300 million, based upon the chairman’s 15% ownership stake. Insiders, in aggregate, own nearly 20% of the company.
Kennedy Wilson went public in 2009 and remains underfollowed and misunderstood despite incredible investment success. Management has a demonstrated nose for value and a proven track record of identifying and capitalizing on shark-infested waters.
In other words, they are excellent swimmers with the experience to follow the current of distress across global real estate markets and position the portfolio to benefit from central bank super powers of money and credit. Previous investments have systematically exploited the historical cycle of boom and bust.
Our thesis on KW is straightforward, although the accounting may be somewhat more complex given that investments are held at depreciated cost basis and only marked to market when sold. Simply put, this means that the company’s current earnings power is vastly understated as gains on investments are only recognized at the time of sale. As a result, we believe that shares trade at a healthy discount to current net asset value and expect that gap to close as investments mature and gains are crystalized. More importantly, we see a long runway for growth in European real estate investments as banks have just begun shedding real estate loans and related assets. In other words, we expect significant growth inNAV over our time horizon. KW’s recent investments in Spain could be its most profitable venture yet.
In this report, we review the company’s operating segments, describe the Opportunity in Europe and outline our estimates of Net Asset Value.
A Proven Model for Capital Allocation
Kennedy Wilson’s operations are comprised of two complimentary business segments, which together, create off-market sourcing opportunities and deal-flow from various financial institutions:
KW Services provides real estate services to property owners and lenders, with a focus on financial institutions. This operating segment has five main lines of business – investment management, property services, research, brokerage, and auction and conventional sales – which generate revenue through recurring fees and commissions. Since inception, KW has sold more than $10 billion of real estate and currently manages 69 million square feet of commercial property and 20,000 multi-family units in the U.S., Europe and Japan. Importantly, KW Services provides management with market insight and creates opportunities for investment.
KW Investments includes fund management and advisory services for portfolio investments, property acquisitions and note purchases. Since 1999, the company has invested in 371 deals, deploying $16.4 billion of capital. While early investments were often wholly owned, recent growth has been driven by investments in joint ventures, whereas KW is typically the general partner. This arrangement provides exceptional returns on capital as the company benefits from gains on the original investment as well as a promoted interest in the profits beyond its ownership interest.
The following illustration, presented by Chris Mayer of Agora Financial, provides a good overview of the economics behind this business. We think the assumptions here are quite reasonable given the existing opportunity set (which we will discuss in detail) and management’s track record.
Housing the service business and the investment platform under one roof provides KW with significant competitive advantages over other real estate buyers operating stand-alone firms. Rather than participate in a competitive bidding process, the majority of KW’s deals are sourced through the company’s services platform and often provide exclusivity in negotiations.
Management’s local expertise and established reputation in targeted markets have enabled KW to cultivate key relationships with major holders of property inventory. These relationships provide the company with access to deal flow, which in turn, generates highly attractive returns for KW shareholders as illustrated below.
The services business effectively gets the investment business in the door while providing ongoing market intelligence which is leveraged to allocate the company’s capital. Management has developed a reputation for being able to quickly execute, originate and creatively structure transactions with a hands-on approach to real estate investing and local expertise in regions within its circle of competence.
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Last Stop? The European Distress Spigot
At Broyhill, investments are sourced through multiple channels. Sometimes our best ideas are found among the lonely shares trading on the 52 week low list. More often than not, they are sourced from our universe of high quality businesses when one encounters the occasional hiccup. And of course we always enjoy the intermittent opportunities provided by corporate actions. But KW just sort of fell in our lap . . . after years of diligence. We just didn’t know we were looking for it.
In 2009, we published our first letter on the European Sovereign Debt Crisis.Since then, we have been waiting for the right opportunity to capitalize on distressed deals from forced sellers in the region. Unfortunately, banks in the region have been slow to unload assets because of accounting rules, political pressure and to avoid selling at steep discounts.
It’s been a long waiting game, while the banks provision more and more each quarter, until they can afford to sell loans at discounted levels. As a result, the disorderly liquidation we’ve been waiting for has been more like a slow drip. The more time that passes, the more capital accumulates on the sidelines. The longer the wait, the more impatient investors become. Of course, the more impatient they become the higher price they are willing to pay. Consequently, the amount of money looking for a home in the region is eye-popping.
There are about 40 distressed debt specialists targeting Europe. They include Apollo, Strategic Value Partners, Cerberus, Angelo Gordon, Avenue Capital as well as Fortress, Lone Star and Oaktree Capital. Private equity groups such as Blackstone and KKR are also active. Blackstone raised more than $4 billion in 2009 to buy European property anticipating that cash-strapped banks would be forced to sell. It sat idle for two years. This year, private equity has raised $1.7 billion for European distressed funds, while hedge funds focused on European distressed debt manage a total of $57.2 billion of assets, according to data from Preqin.
After years of waiting – while European banks “pretend and extend” – the distress opportunity in Europe is finally emerging. European lenders are expected to sell loans with €80bn of combined face value this year, after disposing of about €60bn last year, according to data compiled by PwC. This compares with €46bn in 2012 and €36bn in 2011. The ECB’s asset quality review and stress tests should act as an important catalyst for future sales. We’re five years into the crisis, but the investment opportunity is just beginning.
Our own diligence naturally started with the most prominent managers in the industry, all of which have announced major deals in European assets. But long term allocators of capital should recognize that the longer the lock-up, the greater the odds that a manager overbids the competition. Particularly when those managers have been sitting on the sidelines for five years! Consequently, our attention quickly shifted towards niche, lesser-known firms with boots on the ground in Europe. These deals rarely make the headlines, but by focusing on smaller tickets, which don’t move the needle for most institutions, they are in the sweet spot and should be compensated accordingly. Which brings us back to Kennedy Wilson.
Kennedy Wilson Does Europe
After scooping up distressed assets in the wake of the US housing crisis, KW made their first trip to Dublin in 2010, amidst a highly distressed European banking system, and subsequently purchased the Bank of Ireland’s real estate investment management division, with £1.3 billion of real estate assets under management at the time of acquisition. One year later, KW raised $1.5 billion to recapitalize the Bank of Ireland and purchased $2.2 billion of performing real estate secured loans for $1.8 billion. Once again, Bill had some good company. Here’s what Prem had to say in his 2012 and 2013 Annual Letters:
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Source Broyhill Asset Management
Broyhill Asset Management
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