The RMR Group Inc.

Q2 2023 Earnings Conference Call


spk01: Good morning and welcome to the RMR Group Fiscal Second Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Melissa McCarthy, Manager of Investor Relations. Please go ahead.
spk02: Good morning, and thank you for joining RMR's second quarter of fiscal 2023 conference call. With me on today's call are President and CEO Adam Portnoy and Chief Financial Officer Matt Jordan. In just a moment, they will provide details about our business and quarterly results, followed by a question and answer session. I would like to note that the recording and retransmission of today's conference call is prohibited without the prior written consent of the company. Today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws. These forward-looking statements are based on RMR's beliefs and expectations as of today, May 4th, 2023, and actual results may differ materially from those that we project. The company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's conference call. Additional information concerning factors that could cause those differences is contained in our filings with the Securities and Exchange Commission, which can be found on our website at Investors are cautioned not to place under reliance upon any forward-looking statements. In addition, we may discuss non-GAAP numbers during this call, including adjusted net income, adjusted earnings per share, adjusted EBITDA, and adjusted EBITDA margin. A reconciliation of net income determined in accordance with U.S. generally accepted accounting principles to adjusted net income adjusted earnings per share, adjusted EBITDA, and the calculation of adjusted EBITDA margin can be found in our financial results. On today's call, we will discuss the planned merger between OPI and DHC in our prepared remarks. OPI and DHC have not yet filed a preliminary joint proxy and registration statement with the SEC, and therefore we will not be taking questions about the merger. In addition, we will discuss the planned acquisition of TA by BP. As a special meeting of TA shareholders to approve the merger takes place on May 10th, we will not be taking questions on this transaction either. And now I'd like to turn the call over to Adam.
spk05: Thanks, Melissa, and thank you all for joining us this morning. In the second fiscal quarter of 2023, we continue to navigate a challenging economic environment for commercial real estate. Despite this turbulent backdrop, we are pleased to report solid financial results highlighted by adjusted earnings per share of 49 cents, adjusted EBITDA of $25.3 million, and an annual dividend of $1.60 per share that remains secure and well covered. Collectively, these results are a reflection of our diverse client base and durable business model. As it relates to operating fundamentals across our platform, We are proud of the tireless efforts of our employees to drive continued value at our managed assets, with RMR ranging almost 2 million square feet of leasing on behalf of our clients at a weighted average lease term of over nine years during the quarter. This leasing velocity across our managed portfolio resulted in a quarter-end consolidated occupancy rate of almost 96%. Count the year 2023, so far has been marked by three milestone events among RMR's client companies, all of which look to address the unique opportunities and challenges certain of our clients faced as we look to position them for long-term sustainable success. First, in February, TA announced that it entered into a definitive agreement to be acquired by BP for $1.3 billion. TA has been on a transformational journey over the last three years, and we are pleased with the 84% premium this transaction represents for TA shareholders. There is a special meeting of TA shareholders scheduled for May 10th to approve the transaction, and earlier this week, TA announced that both ISS and Glass-Lewis came out in support of the transaction. Assuming TA gets the requisite shareholder approval, the sale is expected to close on May 15th. Second, in March, Alaris Life announced that ABP Trust successfully completed a tender offer at an 85% premium to the prior 30-day average trading price. We believe that Alaris Life, now a private company, will be able to enhance its focus on operational excellence and best position the company to successfully deliver on its business plan. Lastly, in April, two of our perpetual capital clients, DHC, and OPI announced an agreement to merge and change the combined company's name to Diversified Properties Trust. The merger will create a diversified REIT with a broad portfolio, defensive tenant base, and strong growth potential. Financially, the merger is expected to be accretive to both entities' leverage and cash flow. The combined entity is expected to provide a sustainable annual dividend of $1 per share, with the potential for dividend growth in the future. As it relates to DHC, it is facing a number of serious near-term challenges driven largely by debt covenant restrictions that prevent it from issuing or refinancing debt. This problem is exacerbated by DHC having $700 million of debt coming due in early 2024, and DHC does not expect to be in debt covenant compliance before this debt comes due. As a result, one of the biggest benefits of this merger for DHC is that upon its completion, the combined company will be in debt covenant compliance and can access regular way refinancing of its debt maturities. In addition, while the shop recovery is underway and trending favorably, it is not happening fast enough and further capital is needed. In addition to debt refinancing capital, to fund investments in DHC's portfolio, to help drive the ongoing turnaround in the senior living properties. Finally, DHC also benefits from the merger with OPI by immediately providing a significant increase in its dividend for shareholders. Absent the merger, DHC does not anticipate reinstating its regular dividend until 2025. As it relates to OPI, they are facing a number of current and longer-term challenges. as office sector headwinds are likely to negatively affect office owners for the foreseeable future. More specifically, the financing environment for office properties is, and is expected to remain, very difficult for the foreseeable future. One of the biggest benefits of the merger for OPI is that it provides it with greater access to capital sources, including low-cost government and agency debt. OPI's office portfolio will also require increased capital investments in the coming years, and OPI was facing an unsustainable dividend rate prior to the merger announcement. By merging with DHC, OPI gains access to an attractive, unencumbered portfolio of medical office buildings and life science properties, and we expect OPI will benefit long-term from the expected eventual recovery in DHC's shop portfolio. Turning to other highlights of notes across our clients. During the quarter, SVC further enhanced its financial profile by redeeming its June 2023 senior notes using the proceeds from a $610 million issuance of net lease mortgage notes. In light of the challenging capital markets environment, we are pleased with this financing and believe it's attributable to the strength and positive outlook of SVC's retail portfolio. SVC is also expected to benefit from BP's acquisition of TA, as SVC will receive approximately $379 million in cash from the transaction. SVC also strengthens its tenant credit characteristics because the amended travel center leases will be guaranteed by BP's A-minus credit ratings. SVC's hotel portfolio also continues to experience positive operating fundamentals with robust increases in occupancy, ADR, and REVPAR. With all facets of SVC's business improving, we believe SVC is possibly on a path to generate incentive fees to RMR in the future. At Seven Hills Realty Trust, our publicly traded mortgagery, we believe there remain significant opportunities to grow this part of our business. Seven Hills portfolio remains default free a testament to our disciplined underwriting and asset management capabilities. In addition, with the recent pullback by many regional banks, Seven Hills has seen its pipeline swell to over $1 billion in possible transactions. Whether it be at Seven Hills or a new private capital vehicle, we believe our successful lending platform leaves us well positioned to possibly grow this type of AUM for RMR in the future. With almost $200 million in cash and no debt, We believe our durable business model affords us the benefit of patience to take advantage of strategic opportunities that we believe will result from the ongoing market volatility. I'll now turn the call over to Matt Jordan, our Chief Financial Officer.
spk00: Thanks, Adam, and good morning, everyone. For the second quarter, we reported adjusted net income of $8.1 million, or 49 cents per share, and adjusted EBITDA of $25.3 million, with both measures being in line with our quarterly guidance. This quarter's adjusted EBITDA margin of 50% yet again highlights the highly efficient and scalable platform RMR has in place. Total management and advisory service revenues were $48.2 million, which was down $1.4 million sequentially. This decrease was primarily attributable to seasonal declines at TA and Senesta, as well as a decrease in construction management fees as large redevelopment projects at OPI and DHC wound down. In regards to the financial impact to RMR from the TA transaction, TA currently represents approximately $4 million in quarterly revenues. The loss of this revenue will be offset over time by a number of factors, which includes the favorable impact to our management fees from the increase to SBC share price subsequent to the TA transaction announcement, as well as approximately $1 million in annual compensation savings, and the resulting interest income from the $100 million in cash RMR will receive in connection with the TA transaction. As it relates to next quarter, based upon the current average enterprise values of our managed equity REITs, projected construction volumes, and an expected closing date of May 15th for the TA transaction, we expect to generate between $45 and $47 million of management and advisory service revenues next quarter. This guidance excludes approximately $45 million in termination fees that we expect to receive upon completion of the TA transaction. Turning to expenses, recurring cash compensation was approximately $34.5 million, an increase of $1.3 million sequentially due primarily to payroll tax and 401 contributions resetting on January 1st. This quarter, we recovered approximately 43% of our cash compensation from our clients. Looking ahead to next quarter, we expect recurring cash compensation to be approximately $34 million, with a projected reimbursement rate closer to 44%. G&A expense of $9.5 million this quarter includes approximately $500,000 of costs related to annual Board of Director share grants, and approximately $600,000, or one cent per share, of technology transformation costs. On a normalized basis, G&A should be approximately $9 million next quarter, excluding technology investments. We closed the quarter with almost $200 million in cash. In connection with the TA transaction, we expect to receive approximately $100 million from the sale of the TA shares RMR owns and the termination fee I touched on earlier. As such, we expect to end next quarter with approximately $300 million in cash. Aggregating all the prospective assumptions I outlined earlier, Next quarter, we expect adjusted earnings per share to range from 46 to 48 cents per share, and adjusted EBITDA should range from 23 to $25 million. Before we begin the question and answer portion of the call, I would like to first acknowledge the publication of our annual sustainability report. The report highlights the many accomplishments and programs that drive our organization each and every day. As we've highlighted previously, RMR is publicly committed to reducing greenhouse gas emissions at assets we have operational control over by 50% by 2030 and to attain net zero emissions by 2050. Through calendar 2022, we've already achieved almost a 35% reduction in greenhouse gas emissions through energy efficiency measures, sustainable habits, and renewable energy programs. We encourage those listening to go to the sustainability section of RMR's website, where you can see a collective overview of our environmental programs, contributions to the communities we operate in, and the investments we make in our people. Secondly, as Melissa highlighted earlier, we cannot address questions regarding either the planned merger between OPI and DHC or the planned acquisition of TA by BP. Operator, would you please open the line to questions?
spk01: We will now begin the question and answer session. To ask a question, you may press star then 1 on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. Once again, that was star then 1 to ask a question, and at this time, we will pause momentarily to assemble the roster. And our first question will come from Brian Maher of B. Reilly Securities. Please go ahead.
spk04: Thank you, and good morning, Adam and Matt. I guess it's going to be a short Q&A session today for you with Adam talking about the deals. But kind of related to that, we noticed our G&A numbers were a little light relative to what you reported in the second fiscal quarter. Is any of that really being driven by legal or advisory fees, or is that being accounted for elsewhere?
spk00: No. G&A, when you back out the two large items this quarter, our run rate this quarter is actually $8.4 million. So we feel pretty good, actually, where G&A landed. But you've got to exclude the director share grants and the other half a million dollars or so of technology transformation costs, which we back out of adjusted EBITDA.
spk04: Yeah, but I got to believe you've had some pretty high legal and advisory costs. Where would those be going? Are they going into the actual managed REITs and OPCOs? Correct. The REITs would be absorbing those costs, not RMR. Got it. And then, you know, we hear what you're saying as it relates to, you know, office challenges on financing and DHCs, you know, and occurrence tests. But can you give us any color on on the appetite of some of the sovereign wealth funds that you've dealt with in the past as to, you know, stepping up to the plate should any of the managed REITs need, you know, further JV, you know, asset sales into, you know, those JVs or, you know, other type of capital where your deep-pocketed relationships, you know, could step up and help over the next six to 12 months if needed.
spk05: Sure, Brian. Yes, I think the relationships we currently have are very much open for business. As we've stated before, we have some very good relationships with some very large Asian sovereign wealth funds. I would say that the issue is that while they're very much open for business, their returns expectations have increased, and so therefore pricing around assets that could be put into a JV may not be very attractive for us. I think we could explore it, but based on our understanding and preliminary conversations with them about what they are doing and how they are looking at investments, I'm not sure it would be a very attractive alternative for our companies today. So it's not something I anticipate we see a lot of going forward. You also have to keep in mind that some of the assets that would be most attractive and available to go into those JVs good or bad, maybe some of the better assets that we have that are currently generating a lot of the cash flow that helps our companies, specifically DHC or OPI or any of the REITs. And by removing that very healthy cash flow, you know, yes, you get a near-term liquidity boost, but you lose out on the cash flow going forward. So, you know, you're sort of You're solving a short-term problem, but you may be not solving a longer-term problem because you've got to replace that cash flow. And that becomes exacerbated if the pricing for the asset into the JV or sale, regardless, isn't high. And today, the environment we're in, it's available. You can sell assets. And the sovereign wealth funds we're dealing with are open for business. But I don't think the pricing would be particularly attractive or really work to solve a lot of our problems. Now, in a pinch, if we really got against the wall and we didn't want to absolutely go into complete default on our debt, I suppose we could do it for a short term to pay off the debt maturity itself, but it won't solve the covenant issue because we'll lose cash flow.
spk04: Right. Now, would that be aside from, let's say, ILPT, where you had wanted to put you know, another 40% slug into the JV, I guess it was the mountain JV, and sell the sale of 30 assets. Aside from what you just talked about, you know, with respect to JVs and asset sales there, is the game plan still to move forward with deconsolidating, you know, those 90, 95 properties out of ILPT and giving that stock, you know, kind of new legs for life here?
spk05: That would definitely be the plan. Unfortunately, as ILPT discloses in its financial package, and I think as they talked about on their call, you know, that joint venture does not currently cash flow because of the rapid rise in interest rates and the floating rate debt that we put in place to finance the Mountain JV. So while we do not anticipate there being a need for capital calls into the joint venture, it is not throwing off significant, it's not throwing off any cash flow. And therefore, for a core or core plus investment, which most investors when they invest in a core or core plus portfolio, it's not as particularly high return, but they're looking for stability. Part of that stability is a current income. We are not in a position that we can offer a current income in that portfolio, so we do not believe it would be attractive to any potential other additional joint venture partner. So, yes, we'd love to sell an interest in that to somebody and deconsolidate it. We don't believe, and I think ILPT addressed this on their call as well, as we try to highlight in some of the materials that ILPT puts out, and it's supplemental. It's not practical to believe that's going to happen.
spk04: Right. But, you know, with the industrial reach that we track, it seems like everybody's having a lot of success with driving renewal rates pretty impressively higher still in the 20% zip code. So it seems like it's only maybe a matter of time that organically ILPT should be able to raise NOI to kind of get you out of that scenario, especially if one were to believe the 10-year rates where they're trading currently, if interest rates were to kind of backtrack, you know, 12 to 18 months from now, it seems like there's a clear sign of, you know, light out of this situation. It's just going to take time. Is that correct?
spk05: There is. It's a question of time. We're blessed with the fact that we have a very high, very well-occupied, very high credit quality tenant base, you know, roughly 99% lease to very, you know, majority investment grade rated tenants, well-located properties, Newer properties. The average lease term is nine years. So the issue is that we don't, in every lease that does come up for renewal, we are rolling up and we're rolling them up significantly. The problem is we don't, if there's a problem, it's just that there's not a lot that's renewing every year. And so we're sort of blessed and cursed with that portfolio because we just don't have enough leases rolling. I agree with your conclusion and what you're saying, Brian, that eventually it will grow out of it. But we're talking, unfortunately, years, not months or quarters for it to grow out of it because it's going to take that much time for the leases to roll, enough leases to roll to create enough increase in NOI to really move the needle.
spk04: Got it. Just last for me, I don't think I've seen anywhere, and maybe you're yet to disclose it, But when OPI and DHC do merge, have you identified what the new benchmark index would be for that combined entity?
spk05: We have not. It's an interesting, nuanced question, and we have discussed it preliminarily at the board level. I will tell you that on a combined basis, the majority of the assets would be office, office including medical office and life science. That all being said, I think that's something that the board of the combined company will likely take up after the completion of the merger. We'll consider that more seriously.
spk04: Got it. Thank you.
spk01: Once again, if you would like to ask a question, please press star, then 1. And our next question will come from Ronald Camden of Morgan Stanley. Please go ahead.
spk03: Hey, good morning, guys. This is Tim Iman for Ronald Camden. Yeah, maybe just following up on the previous question, you know, I talked about higher return hurdles in the private markets. Just, you know, understand, you know, asset sales and whatnot may help, you know, may not help the covenants. But just in terms of, you know, expectations for pricing relative to maybe where the stocks trade on the public market, could you guys comment on that at all?
spk05: So... Based on, you know, implied cap rates that the stocks are currently trading at, they do seem quite a bit wider than where even at the higher cap rate environment we're living in the private market. You know, I'm not talking about the merger itself, but one of the things that we've certainly been quite negatively affected by in the OPI-DHC merger is the is the drop in the stocks at OPI and DHC. That's had a direct impact on RMR's cash flow and perhaps a significant direct negative impact. And so I do believe they're trading quite a bit wide of where you would see private valuations be for some of those assets. The issue is in the private markets is it's very hard to determine value, especially around the office, because there's very little trading activity going on in the marketplace. Generally speaking, anything that has the word office today feels like, whether it is good office or bad office or well-located and newer buildings or older buildings, is just negatively viewed across the board. And so everything gets thrown out. I believe, and I hope this to be true over the coming quarters or years, that what happened, I think, in analogy in the retail sector over the last decade will start to happen in the office sector where investors, lenders, finance providers will start bifurcating between good office assets and bad office assets. And, you know, I think the good office assets, which, frankly, we have a portfolio that is majority A-class buildings and we happen to have a portfolio that's not heavily located in gateway markets, which used to be where everybody wanted to be, and I'm not sure that's the right place to have a large portfolio today in office in gateway markets. I think you're maybe better served having a diverse portfolio in class A office buildings in suburban markets across the country, especially in the southeast and southwest, which we have a large portion of properties. So, it's a long way of answering your question that, yes, I think our stocks are not reflecting sort of intrinsic value, but I think a lot of stocks today are not reflective of intrinsic value because there's not a lot of transactions that people can point to to come up with real value, and even in the private marketplace.
spk03: Great. That makes sense. And then, you know, obviously without getting into detail about the, you know, RMR or the OPI and DHC transaction, you know, just in terms of access to GSC financing, I understand that was one of the, you know, the impetus for the transaction in general are one of it, just, you know, in terms of some of the underwriting, um, you know, standards and whatnot that, that will be looked at just because, you know, from my understanding, you know, the shop portfolio isn't fully stabilized, you know, will that be looked at kind of on a pro forma basis or just on, on, on trailing results? How are you thinking about that?
spk05: So. Just to make sure I understand your question, how does, in the shop portfolio, how does, let's say, the agencies look at financing those assets?
spk04: Yeah, exactly.
spk05: Yeah, so they've revised their financing criteria over the last few years. And the good news is we have a large portfolio of senior living assets. And although they are struggling but improving, Obviously, you know, with over 200 and roughly 30 assets, roughly senior living assets, we obviously have many assets that are performing fine. Unfortunately, we have more assets not performing fine. So you don't have to take the entire portfolio. You can take a group of assets based on historical, and the agencies have become a little bit more more forgiving in the way they do the underwriting, where they may, they will just look at maybe the most recent quarter and then annualize that, keeping in mind your projections. They won't take the last 12 months. And so there's an opportunity, and the agencies have been doing this largely because they, this is largely something that came out of the pandemic because they recognized that in the recovery for a lot of senior living assets, you know, if you look back 12 months, you're going to have a pretty low underwriting, ability to underwrite. Now they're more willing to look at just one quarter back, which might, you know, obviously if things have been improving over many quarters, the most recent quarter hopefully is the best quarter, and then you annualize that, and that's what you use for the underwriting. We're optimistic that there is a portfolio of assets within the DHC portfolio that that will provide for significant capital or financing to be able to be put on those assets that we are not able to access today at DHC. And that, again, I said in my prepared remarks, I'm just repeating it, is one of the benefits of the transaction is on a combined basis you're in debt covenant compliance. That's a huge thing that I think a lot of investors sort of brush aside about the covenants. It's very onerous. We're not allowed to finance new debt. We're not allowed to finance refinance expiring debt. You just can't issue any debt. And by being in compliance, we can then access that what I think very, very liquid, open, and cost-competitive financing. And if you're, especially if you're in the office sector, if you have access to that funding window, I think you are at a competitive advantage in the marketplace.
spk03: Right. And maybe just to follow up, you know, if the underwriting is based on, you know, quarterly results, I guess, you know, the logical thing to do would be, you know, to wait until maybe the second half of 24, you know, before you actually access the GSC financing just to show kind of stabilized results. Is that kind of the right way to think about it or?
spk05: I think we have to wait. Yeah, this is getting a little ahead of ourselves. It's planning a little bit too far out. I think we could be in a position to put financing in place if we chose to in early 24. We could be in a position to do so. The question you're asking is, would you do so? And the answer is, I don't know, but I do know that we could, by early 24, in my belief, do so and do so in a sizable way if we had to. So it's there for us whether we choose to do it, it's a different question that you're asking, but we can.
spk03: Great. Thanks for all the help, guys.
spk05: Yep.
spk01: The next question is a follow-up from Brian Mayher of B. Reilly Securities. Please go ahead.
spk04: Great. Thanks. So, Adam, you opened up that door for me on the shop financing question, which I think we understand here pretty well. When we look at, you know, roughly $4 billion in unencumbered shop assets within DHC, you know, we were thinking something along the lines of, you know, maybe you cherry pick out $1.4 billion, $1.5 billion of the better performing NOI accelerated from renovations last year, properties, to do, you know, a tranche in early 2024. take out the 2024 debts for OPI and DHC, and then maybe you do another one a year later after other shop NOI assets, you know, have, you know, moved northward and can support, you know, that debt. Is that unrealistic to be thinking in that way?
spk05: No, you're actually in the right thinking about things correctly, Brian. Those are all things we can do. I will just put some markers out there for you to rethink about. Obviously, you know, we want to be very careful in terms of if we access that market, picking the most mature properties that we aren't financing them too early in their recovery. We want properties that are, you know, largely recovered, and we're not leaving some financing on the table. A billion four, billion five in 24 sounds a little heavy to me, to be honest, but, you know, If we did something that large, I think we'd be taking some assets that were not fully recovered and leaving financing on the table. The other benchmark to keep in mind is there are limits to how much secure debt we can ultimately put on the portfolio. Because remember, we do not want to... Because every time we put secure debt on, we're removing those assets from the unencumbered asset pool. And we still have... unsecured bonds that have unsecured debt covenants. Yes, we have significant room to add secured financing well past the billion dollars, but there's a limit to how much we can put on. Think about that. I'm not sure you could say something like a billion five and then there's another billion five. I think you'd start really stressing covenants for the unencumbered bonds that will still be in place. So that's, those are just some sort of reactions and markers for you to think about.
spk04: Right. But I got to believe that if you just did, you know, in the first half of 2024, you know, a pledge of, and when I say a billion, four billion, five, I mean, pledge a billion, four billion, five to take out, you know, a billion cash, your other debt will trade more favorably, and one would have to believe that the bank groups associated with OPI and DHC combined company would, you know, have a sigh of relief and be, you know, much more agreeable to just simply refinance debt that comes due on a go-forward basis after you've maybe tapped, I don't know, the first half a billion or billion of agency debt. Is that correct thinking?
spk05: Brian, that is correct thinking. Yes, I think in the near term, we have a bias towards thinking about putting agency debt on sometime in 24. You know, the timing is a little open. It's a little ways away, so we're not quite sure exactly when, but sometime in 24. And that's right. You know, our hope is that we would then have more regular way access to the unsecured market going forward after that. That would be the sort of base business plan. But, you know, that has a lot of assumptions in that base business plan that we have to see come true.
spk04: Perfect. Thank you. That's helpful.
spk05: Yep.
spk01: This concludes our question and answer session. I would like to turn the conference back over to Adam Portnoy, President and Chief Executive Officer, for any closing remarks.
spk05: Thank you all for joining us on today's call. We look forward to speaking with you again in the future.
spk01: The conference has now concluded. Thank you for attending today's presentation and you may now disconnect.

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