SPECIAL REPORT: Entering the big leagues

When Colony Capital announced last month that it was entering a three-way merger with NorthStar Asset Management (NSAM) and NorthStar Realty Finance (NRF), chairman Thomas Barrack made it very clear why his firm was making the deal.

“The merger with NSAM and NRF is an exciting and dynastic moment for CLNY in a number of ways: tripling its size at a moment in time when scale truly matters and elevates the group to the highest echelon of real estate equity REITs,” he said, speaking during a June 3 analyst call.

Indeed, as highlighted in an investor presentation on the three firms’ websites, Colony would now be catapulted into the ranks of the top 10 largest global real estate managers (see page 12) as part of Colony NorthStar, with a combined $58 billion of assets under management (AUM). Currently, Colony on its own has $18 billion of AUM.

Barrack has made no secret of his desire to get his firm into the top tier of real estate managers. As one of the top 10 managers noted: “Barrack has ambitions to build a business [like ours]. We talk every so often and he asks me questions, ‘Why did you do this? Why did you do that?’ He’s wanted to get into this league.”

But while Barrack is fulfilling his dream through the merger, David Hamamoto, executive chairman of NSAM and chairman of NRF, is viewed by many as the greater beneficiary of the transaction. Although the deal is officially characterized as a ‘merger,’ effectively it is a sale of the two NorthStar companies. According to the deal’s announcement, Hamamoto, along with two other NorthStar executives, Al Tylis and Daniel Gilbert, are entitled to receive “cash severance payments and performance-based equity awards that would have been contractually owed to them upon consummation of the transaction.”

In lieu of $106 million in cash severance payments, the executives would receive equity in Colony NorthStar that would be equal to approximately 8.6 million shares, or about 1.4 percent, of Colony NorthStar common stock. Additionally, the three executives would each receive approximately 2.5 million shares, or about 0.4 percent, of Colony NorthStar common stock as performance-based equity awards.

Some onlookers go so far as to say the deal was vitally important for the NorthStar companies. “These businesses were in trouble,” said one real estate manager. “For them, it is a big payday.”

Stunning collapse’

“The story of NorthStar may be a tale of changing sentiments based on increasing complexity,” said Michael Coster, chief executive at Kimberlite, a New York-based boutique investment bank. “Eighteen months ago, everybody was saying, ‘I want NorthStar’s multiple.’ After NSAM spun out of NRF, they had 20x earnings. One year later, they’re exploring strategic options.”

In the words of one market observer: “Their stock fell off the cliff. It was a stunning collapse.” Opening at $17.75 a share on June 27, 2014, NSAM saw its stock price quickly rise, reaching a high of $24.75 in March 2015. During the second half of 2015, however, NSAM’s stock price began slipping precipitously, and closed the year at $12.14 a share. By the time NSAM announced that in January that it was exploring strategic alternatives for the company, including a possible sale, the share price had fallen to what was then an all-time low of $10.46 a share.

NRF, meanwhile, also has seen its stock price plummet, and in response, has been selling off assets in a bid to boost its long-term shareholder value, including its healthcare, manufactured housing, multifamily and net lease real estate properties; its commercial real estate loans, corporate debt investments and real estate securities; and its real estate private equity fund interests.

What went wrong? Some of it was bad timing, given the overall volatility of the stock market. Also, “threading the needle on the public market can be a real challenge,” said Coster. “On the one hand, they want you to be broad, on the other hand, they want you to be narrow and have expertise.”

Another industry observer noted that NSAM also suffered from market backlash against externally managed companies. In response, NRF announced in February that it was exploring a potential recombination with NSAM. “They caused their own problems by having an overly rich management contract,” he said. The 20-year management contract between NSAM and NRF called for an annual $90 million based management fee, along with other base management and incentive fees.

The evolution of a relationship

While the Colony NorthStar deal is new, the relationship between the firms’ top executives is not. Barrack and Hamamoto have known each other for 30 years, first meeting while the former was working at Bass Companies and the latter at Goldman Sachs in Los Angeles during the late 1980s.

Although he is now better known as the head of two public real estate companies, Hamamoto first made a name for himself in private equity real estate while at Goldman, as co-founder and co-head of the New York-based investment bank’s Real Estate Principal Investments Area business, which sponsored the Whitehall Funds opportunity fund series. Hamamoto was considered the architect of one of Whitehall’s defining deals, the 1994 acquisition of Westin Hotels & Resorts with Starwood Capital Group from Japan’s Aoki Corporation. Goldman exited the transaction four years later, giving Starwood full ownership of the company.

Like Barrack, who left Bass Companies to launch Colony in 1991, Hamamoto also went on to start his own firm, co-founding NorthStar Capital Investment Corp, the predecessor to NRF, in July 1997.

“A lot of institutional-type real estate players don’t know him that well,” said Ralph Rosenberg, private equity firm KKR's global head of real estate, who reported to Hamamoto at Goldman from 1990 to 1997 and remains a good friend. “He’s not a traditional asset manager. Tom Barrack grew up doing what we did when I was at Whitehall, running institutional capital, investing it in private partnerships to buy real estate. When David left Goldman, he figured out other ways to play in the real estate space, to do it with a combination of permanent capital and retail capital. He was an early mover in that concept, not just sticking with the model that the rest of the industry was comfortable with. In many respects, David was an innovator.”

Rosenberg noted that Barrack and Hamamoto’s personalities are more complementary than conflicting. “My impression of Tom is he is a larger-than-life character. He likes the spotlight,” he said. “David is a little bit of a chameleon. He can be the center of attention and dominate the room or he can be a team player. When David is in a meeting, he does not naturally overwhelm the room with charisma and personality in a way that I guess Tom might. David is more of an intellectual thinker, a man of fewer words, but when he speaks, everybody listens.”

In running a firm together, “they’ll be more compatible than you think,” he added. “People think, these must be two big personalities, both entrepreneurial, both successful, how can that ever work? If it’s going to work, it would be with a guy like David. He’s an incredibly unassuming, likable guy. You go to a golf outing, and everyone wants to play with David. That’s how he is. You can’t teach that.”

Apples and oranges

Both Barrack and Hamamoto declined to be interviewed for the story, as the transaction has not yet closed. But PERE understands that despite their decades-long relationship, their longstanding ties did not play much of a role in bringing the parties together. In fact, the backstory behind the deal was understood to be rather mundane. NorthStar “hired bankers who contacted everyone on earth,” said one source familiar with the transaction. “There was no magic.” The deal was highly complex to execute, given the tax and REIT structures of the numerous domestic and international entities involved, the person said.

Multiple real estate managers have also pointed out that while Barrack will be co-leading a much larger firm with Colony NorthStar, scale is not everything. “When Tom says they will have this large-scale business, that business is for the most part not an institutional business,” said one general partner. “This merger with NorthStar is giving Tom access to the retail channel. If you compare the AUM of this combined company and compare to it to the AUM of a Blackstone, you’re really comparing apples and oranges.”

Because of this, Barrack will need to consider how the new company operates within the retail channel, and how aggressive Colony NorthStar’s retail platform will be in terms of how it sell products to retail investors and how the retail distribution fee model will evolve over time, the GP said.

Another manager noted that much of the Colony NorthStar portfolio would not be of the same caliber as the real estate holdings of some of the industry’s other largest firms. “A lot of it is not high quality real estate,” the manager said. “It’s pretty unusual, quirky real estate.” In particular, the new combined company’s real estate holdings would lack marquee trophy assets, such as Brookfield Asset Management’s Canary Wharf Estate in London or The Blackstone Group’s Hilton Worldwide hotel chain.

Then there is the Townsend Group, which NSAM acquired in January. “One unusual piece of the puzzle that doesn’t fit is the Townsend piece,” said one Colony investor. “We view that as a potential conflict of interest. We’re curious as to how that is going to be managed going forward and how important of a role Townsend will have.” The conflict issue, however, could be avoided, provided that Townsend will continue to have an independent decision making process and have no obligation to put clients into Colony or NorthStar products, the investor said.

When asked about this very issue during the June 3 analyst call, Colony president Richard Saltzman responded: “Look, I think it’s a fair question. And I don’t know if we have the complete answer yet since even from NorthStar’s perspective, they only bought Townsend a few months ago. But I think we’re cautiously optimistic that it’s not going to be an issue.” Added Hamamoto: “The pipeline and the deal flow and the types of transactions that we could bring where we can invest alongside some of their clients, I think that creates more alignment rather than less.”

Embedded conflicts aside, others viewed Townsend as one of the most valuable assets in the Colony NorthStar portfolio. “A crown jewel that has been overlooked is Townsend,” said Coster. “They have a lock on the mindshare of public pensions. There’s a lot of enterprise value in those relationships.”

Meanwhile, many other questions remain. “We were a little surprised by the Colony NorthStar merger,” the Colony investor said. “We still need to understand exactly how Tom expects to get the scale that he wants and why he thinks the NorthStar team and assets will be a benefit to developing that scale.” The investor said he also needed to get a better understanding of how the management of the Colony organization may change and what new responsibilities Colony staff may have, including the people who managed the funds in which his group was invested. Other issues to be addressed include the compensation of the Colony funds team going forward and whether there will be any areas of excess capacity in the combined company, he said.

While Barrack and Hamamoto have overcome a major hurdle in striking a complicated transaction, such questions indicate that the hard work on the transaction is only beginning.