Friday Letter Colonising Grubb & Ellis

The current predicament of US property services firm Grubb & Ellis set against improving market conditions makes it an ideal investment for private equity. 

Investing in property services firms makes real sense, and LA-based Colony Capital knows it. That’s why this week Tom Barrack’s firm carved out a 60-day exclusivity period with one of the oldest and most recognisable brands in US real estate advisory, Grubb & Ellis.

Colony agreed to an $18 million lifeline loan with the troubled, 5,200 staff, 100 office firm, which has seen its share price tumble 95 percent in the last five years following expensive expansions and a global economic downturn that brought its US stomping ground to its knees.

For the next two months, Colony will weigh the benefits of meeting Grubb & Ellis’ liabilities (and there are a few) with improving market fundamentals (such as increasing transactions, liquidity and rents). Should it determine to make a “larger strategic investment”, we could see a competitive tender for the following 25 days, during which time rival bidders can lodge competitive offers.

The fact Colony would invest via its funds rather than corporately shows that it sees Grubb & Ellis as a turnaround opportunity, and that is a good stance. There’s real potential for expanding Grubb & Ellis’ share price from its current lowly position of 77 cents and, judging by all the hedge fund activity in the firm’s stock this past week, others believe that too. A check of Grubb & Ellis’ SEC filings shows Cohanzick Management, Zazove Associates, Pine River Capital Management and Stonerise Capital Management have each found themselves declaring ownership positions of more than 5 percent, as per the regulatory requirement.

Colony and these hedge funds surely must see the potential for significantly increasing its top line revenue, which had been depressed in recent years as a result of crippled deal volumes. Jones Lang LaSalle, for example, predicted in a recent report that US deal volumes would increase 40 percent to $135 billion, and that sort of positivity is not isolated.

Grubb & Ellis’ annual report published only yesterday adds further fuel to that fire, revealing annual revenues of $575.5 million, up about 9 percent on 2009, as well as transactional services activity up 36 percent. Better management could see EBITDA look far healthier than the negative $19.6 million too (although this also is showing signs of improvement already – $23.99 million was recorded in 2009).

The other, perhaps obvious, buy point for Grubb & Ellis is its brand. Established in 1958, the firm, led by chief executive and president Thomas D’Arcy, is one of the stalwarts of the sector and has for years punched its weight alongside global rivals Richard Ellis, Jones Lang LaSalle and Cushman & Wakefield in areas such as investment, leasing, capital markets and asset, construction and project management. It also manages REITs, although that accounts for a minority of its revenue.

However, further scouring of Grubb & Ellis’ annual report reveals a potentially off-putting set of company risks. Most importantly, without securing Colony’s $18 million, “it could create substantial doubt about its ability to continue as a going concern,” Grubb & Ellis admitted. Just how far the 12-month loan, which incidentally will earn Colony interest at a rate of 11 percent per year, will meet its various potential liabilities – such as outstanding payments owed from its 2007 merger with real estate advisor NNN Realty Advisors or a lingering lawsuit against it and its ‘tenant-in-common’ affiliate Daymark – remains to be seen. The requirement of further financing seems a decent bet.

Then again, an injection of capital and better management is exactly what firms like Colony Capital are all about. In that respect, this deal is just as much private equity as it is real estate.

For certain, the future of Grubb & Ellis is going to be fascinating and most likely profitable for whomever turns the firm around. Whether that will be Colony or another investor has yet to be determined.