RMR Group
Cheap + Good business metrics + Something doesn't sit right in my head = No Go
Business RMR is an interesting business >> It manages five publicly listed REITs as below.
$DHC: Medical office and life sciences REIT, focused on District of Columbia
$ILPT: Industrial & logistics REIT with a focus on Oahu, Hawaii and a diverse set of assets across 38 states
$OPI: Office properties, primarily single tenants, focused on District of Columbia
$SVC: Hotels and retail net lease properties, focused on District of Columbia and Puerto Rico
$SEVN: Mortgage REIT
$DHC, $ILPT, $OPI, and $SVC (Managed REITs): these are referred to as perpetual clients. Additionally, provides management services to private clients that include ABP Trust (RMR's controlling shareholder), Aleris Life which is 100% owned by ABP Trust and operates senior living communities many of which are owned by $DHC, and Sonesta International Hotels Corp which is a franchisor & operator of hotels, resorts, and cruise ships and many of its hotels are owned by $SVC.
Acquired Carroll earlier in December 2023 which adds a portfolio of multi-family properties.
Business Model
The Managed REITs accounted for about three-fourth of its revenues. These revenues represent a very long run stream of cash flows >> subject to 20-year evergreen contracts that renews every year for another 20 years. Subject to significant termination fee. If terminated by the REITs for convenience, termination fee amounting to NPV of 20-years of management fee. If terminated for performance reasons, termination fee amounting to NPV of 10-years of management fee. Only termination for cause results in no termination fee.
The Private Clients revenues are subject to 1 year contract terms and can be terminated by either party.
$SEVN is subject to an advisory contract with termination without cause resulting in termination fee amounting to 3 years of fee + $1.6 mln.
Revenue Model
Managed REITs
Management Fee: 0.7% of the AUM or market capitalization (actually EV as it includes the principal value of debt) up to $250 mln and 0.5% on >$250 mln
Incentive: 12% of the excess per share TSR over a 3-year measurement period
Property management fees: 3% of gross rents excluding properties leased to Aleris and Sonesta
Construction management fees: 5% of the construction value
Expense reimbursements. Compensation and other expenses that are allocable to the client. Significant parts of these costs are passed on to tenants of the clients.
Private Clients Management fee of 0.6% of gross revenues of Aleris and Sonesta Advisory
$SEVN: Advisory fee of 1.5% of SEVN's equity and incentive fee of 20% of profits in excess of 7%
While the revenue model above protects RMR's interests rather well, the same cannot be said of the interests of its clients. There is some incentive for RMR to engage in empire building at each one of these REITs even if that means saddening their balance sheet with significant debt as RMR will earn a fee on such debt capitalization.
Ownership/control.
Mr. Adam D. Portnoy, RMR's MD, President, and CEO is the controlling shareholder of ABP Trust which is the controlling shareholder of RMR. ABP owns all of class B1 and class B2 shares and about 200K class A shares. Gives Mr. Portnoy about a 51% economic interest and a 91% voting control.
Profitability
Two modifications that I made at my end.
One, revenue are gross of expense reimbursements. I have instead focused on net revenues, i.e., ex-reimbursements. For example, 2023 gross revenues of $962 million while net revenues of $236 million.
Two, the Class B2 shares carry Class A units that are redeemable in cash or class A shares equivalent to 15 million shares. For the purposes of my work, i have assumed that these shares will fully redeem in Class A shares. Accordingly, i have adjusted the taxes and one incomes to represent the full capitalization.
As the charts below show, this is a business with very healthy profitability on as reported basis as well as on core basis.
Return on capital is very healthy as well with RoE hovering around the 20% mark and a fantastic cash conversion which is around 100% of earnings and is representative of the capital light nature of the business.
Valuations
RMR is trading at very reasonable valuations. I estimate that the company will end FY 2024 (September) with about $6 per share in net cash, i.e., about 25% of the share price. FCF generation ability of about $2 to 3 per share, i.e., FCF yield on the EV of about 15%. Chart below shows a simplified valuation multiple of EV/Tangible Assets.
Summary
On the face of the it, $RMR comes across as a reasonably good business that is priced for a deep discount to what is its likely business value. However, for some reason, it doesn't sit right with me. Anyways, DYOD. Will be happy to hear any thoughts.