Tom Konrad CFA
An earlier version of this article appeared on the author’s Forbes blog on June 3rd.
An article about Power REIT (NYSE:PW) that came out on Seeking Alpha on May 30th has sent some investors running for the hills.
The article has since been removed from Seeking Alpha. According to PW’s CEO, David Lesser, Seeking Alpha’s editorial staff concluded that it had reached unsupported and erroneous conclusions after discussions with him and Ryan Griffin, the article’s author. Ryan Griffin told me that he did not have time to respond to the information Lesser sent Seeking Alpha challenging his conclusions. He was confident that, when he has time to respond, the article will be reinstated. However, he also told me that his goal was to get the article to be reinstated by “Monday or Tuesday” (6/10 or 6/11) and that had not happened.
Even if the article is reinstated, I disagree with its conclusions, and I doubt the opportunity to buy this speculative Rail/Renewable Energy REIT in the $9 range will last long. The stock is very illiquid, so even a few investors bailing or buying can send the stock for great swings.
Here, I’m going to try to address the main points of the article, without going into details.
The core of Griffin’s argument was that investors are not considering the risks inherent in the civil action brought by Norfolk Southern Corp (NYSE:NSC) and Wheeling and Lake Erie Railroad (WLE) against Power REIT to prevent the latter from foreclosing on the lease of 112 miles of track it owns, and which are leased to NSC and subleased to WLE.
I am probably the main person Griffin is referring to here, since I wrote in December how the lawsuit would be good for Power REIT even if they lose the case. The reason for a “lose” being good is that, even in a loss, Power REIT will be able to write off $16 million or more in the form of debt from NSC and WLE that they are trying to collect, and this will allow them to distribute future dividends to shareholders in the form of tax-free return of capital for decades to come.
I also believe that in a “loss” WLE and PW will be liable for Power REIT’s legal expenses, because of a clause in the lease saying that the lessee is responsible of any legal expenses incurred to protect its interests in the the leased property. Griffin thinks this is not so clear.
I think that, at the $10-$11 range PW was trading at, the benefits of a “loss” were fully priced in to a stock. Those of us who still think PW is worth holding at those prices are indeed valuing the hope that PW will win on at least some of the points they have made against the lessees. Before Griffin’s article, PW was actually gaining ground because some recent revelations about WLE selling oil and gas leases on PW’s land and not providing records to PW as required by the lease which seem to strengthen PW’s case.
Griffin also felt that the first solar deal was “uneconomic,” citing a “70x multiple” and claimed that this deal could drive PW into bankruptcy. His numbers don’t seem to add up.
By my calculations, the deal would only be uneconomic under the bridge loan currently used to finance it if significant SG&A expenses are charged against it. When the bridge loan is refinanced, I expect it to be modestly accretive to earnings. Griffin’s statement that the project had a “70x multiple” does not agree with my calculations at all: The $1.04 million purchase came with a $80,800 annual rent (with a 1% annual escalation.) After accounting for the assumption of a 5%, $122,000 sewer financing which was taken on as part of the purchase price, I get a price to net revenue multiple of 12.25x.
I, like Griffin, don’t like PW’s CEO David Lesser loaning money to the company at 8.5% interest, which was the step-up rate on the bridge loan he used to finance the deal. However, according to Lesser, the bridge loan has been revised to remove the step-up in interest rate (leaving the initial 5% interest rate), and PW has recently signed a term sheet to replace the loan with bank financing. I expect more details on this financing soon. Future solar deals should be larger, and bank financing easier to obtain when the legal mess is wound up. Even if PW were paying 8.5% on the bridge loan after the first six months, there would still be a net profit (before SG&A expenses) of $26,794 in the first year on the $115,000 cash PW put into the deal. In the second year, profit would fall to $6,700 because of the step up in interest in the bridge loan, slightly offset by the 1% annual rent increase, but future profit would trend upward even in the event PW is not able to obtain more attractive financing. To me, it seems unlikely that PW will have to pay 8.5% to refinance the deal, and the difference from a lower interest rate would go directly to profit.
If the whole deal were to be financed at a 5% interest rate, PW’s annual net profit would be $29,100, and this would increase in subsequent years.
I don’t see how this deal, which looks marginally profitable even under an 8.5% bridge loan, could drive PW into bankruptcy, as Griffin claims.
Griffin made a number of other points which I consider less core to the argument, but I will attempt to respond to them briefly:
- PW cut its dividend to $0. Griffin thinks this is a bad thing, but I think it is a good thing. I, and at least one other professional investor I have been in contact with, suggested the cut to Lesser. We felt that as long as the lawsuit was using most of PW’s cash flow, PW should not be issuing stock and diluting current shareholders just to pay a dividend.
- The civil case could last for years of appeals during which time PW will have to issue stock to pay legal bills. While this is possible, and NSC can fund the lawsuit forever without even really noticing the cash flow drain, WLE does not have NSC’s financial strength. The fear of having to pay PW’s legal bills as well as its own will be a strong incentive on WLE to settle, especially if the initial rulings are not in its favor. If the initial ruling is in WLE and NSC’s favor (and a Summary Judgement could be handed down as soon as August or September,) PW will not drag things out. The costs of the case are also likely to fall after the end of the discovery and expert witness phases, currently scheduled for the start of July. See PW’s recent litigation update [PDF].
- WLE can pay for the lawsuit longer than PW can, but can’t afford to pay if PW wins. These two statements seem to contradict each other, and NSC is on the hook for at least $7M of the settlement account, and possibly for the entire sum of any award, since NSC is the lessee, and WLE is only a sub-lessee.
- Shareholder trying to remove Lesser in previous years. Griffin seems unaware that while a shareholder group unsuccessfully challenged Lesser for control of the com
pany in 2011 and 2012, there was no such attempt this year. He did not mention that the lead shareholder of this group had a tiny holding of stock, and was trying to get WLE’s President on PW’s board – a clear and undisclosed conflict of interest. - Griffin says PW is suing WLE and NSC. This is false: WLE and NSC brought the civil action against PW to prevent PW from foclosing on the lease. This makes a difference since Griffin’s worst-case scenario revolves around PW having to pay their legal bill because it brought a lawsuit that might be found spurious. But PW did not bring the lawsuit, and given WLE’s apparent multiple violations of the lease, PW’s claims and grounds for foreclosure seem far from spurious to me.
Conclusion
PW is a very illiquid stock that was driven down 25% by panic selling. Although Griffin points to very real risks, his price target is laughable. Lesser seems to agree with me, and he is putting his money where his mouth is. He has been adding to his position all along, but has made much larger purchases since the Griffin article came out.
By the way, Lesser is very accessible to investors. As I said, I have very little time this week, but if you want more details, I suggest you contact him directly. I’ve been trying to persuade him to make all the public filings in the civil case available on PW’s website. He’s been helpful at emailing it to investors who do not have a PACER account (or don’t want to pay $1 a page.) If readers inundate him with requests for documents, I bet he will get on this sooner rather than later.
Disclosure: Long PW. I have added a little to my position recently in the around $8.42 for short term trading purposes, and may sell these shares at any time; I have GTC limit orders in place to do so. My much larger long term stake remains intact.
DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results. This article contains the current opinions of the author and such opinions are subject to change without notice. This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.
