BRSP - BrightSpire Capital And An Overhang Called DigitalBridge

Summary

• On March 1, BrightSpire Capital saw one of its largest single-day declines since April 2020 ending 16.6% below its previous close.
• The impetus for this was a new stock offering prospectus being filed -- though the offering is non-dilutive and represents DigitalBridge selling their BRSP stake.
• In this article, we'll review recent earnings performance and analyze the context of DigitalBridge's disposition.
• And ultimately, we'll tell you why we think this is a buying opportunity.

On March 1, BrightSpire Capital ( BRSP ) filed a prospectus to sell up to 30.358 million of their shares at $6.00 per share. The day before this the stock closed at $7.39 meaning the offering valued the shares about 23% below what the market valued them at.

So the market reacted with one of the largest percentage decreases in the stock price since April 2020. The stock closed at $6.34 representing a single-day decline of 16.6%.

This price action comes on the heels of BrightSpire reporting earnings on February 21 where they beat expectations with non-GAAP EPS of $0.27 covering the $0.20 quarterly dividend by 135%. Whatever slight jump there was with the positive earnings report has been kneecapped by this offering.

In this article we'll take a second to review where things stand in the wake of both earnings and the offering as follow up to my coverage from September 2022 . We'll start with an earnings review to feed a valuation update. From there we will attempt to interpret the offering from an established perspective of business value.

BrightSpire Capital Q4 & 2022 Earnings Review

Adjusted distributable earnings were reported at $0.27 per share for Q4 and $0.98 per share for the full year. Earnings have grown sequentially each quarter this year starting from $0.22 in q1 - this represents 22.73% growth. The quarterly dividend was raised slightly this year from $0.19 to $0.20 per share (5.26%) which seems sustainable. What's of note is that while their earnings have been increasing, their debt profile risk has been decreasing also. Debt-to-equity sits at the lowest point this year at 2.0x - and below the peer group average of 3.04x.

With a lower leverage than peers and about 9.16% of their total undepreciated assets in liquidity they remain well positioned to navigate this credit cycle. Their unrestricted cash pile has also increased 6% this year to $284 million allowing more flexibility for management.

With an overall shrinking portfolio at the moment, there is still stress on the company. The trick moving forward will be managing credit losses in the portfolio while opportunistically making new loans in a tenuous environment. Over the last year they were able to deploy $1.0 billion across 30 new loans which represents ~29% of their total loan portfolio. This outpaced their $897 million of repayments in 2022.

Despite the shrinking portfolio, earnings grew as a result of the rise in interest rates. A full 100% of their senior loans are at floating rates and the benefit to the portfolio can be seen in the weighted average unlevered yield jumping 70% this year.

If we do the math here, that means that their $3.5 billion loan portfolio yields $297.5 million annually. Blended all-in cost of financing was reported at 5.85% and with $3.2 billion in total outstanding debt we can estimate financing costs to be $187.2 million. These calculations suggest they can capture around $110 million annually in net interest margin here.

With the stock trading at $6.34 currently and with 128.872 million shares outstanding we get a market capitalization of $817 million. This $110 million in estimated net interest income suggests the company is trading at a P/E of 7.42x - and this is without considering any income from their $722 million in net lease assets. Net operating income for these properties in 2022 came out to be around $65 million.

If we add these two together then estimated income is $175 million for a company with an $817 million market cap. Consider as well that $284 million is held in cash. If we back that out of the market cap then the operating business of BrightSpire Capital is trading for 3.04x estimated earnings. This is well below peer average P/E of 11.48x.

It's an interesting thing to see a company trading below book value and at a single digit P/E multiple, simultaneously growing earnings 22% over a year. We can also see that the company is trading below the peer group P/B multiple of 0.64x - and it's third lowest amongst this group. Both of these things suggest to me that BRSP remains undervalued.

The company's five year average P/B is 0.71x and reflects a number of years formerly run by Colony Capital. With the move to internal management in 2021 under the helm of Mike Mazzei (former President of LADR ), BrightSpire is not the same company it was years ago. It seems more reasonable to me that their P/B should be near to the 0.8x mark or $8.62 per share - that represents about a 36% premium to current prices.

If we look at it from the P/E angle I think it's reasonable to apply a 7x multiple to their earnings. To be conservative we'll estimate annual income to be $150 million which translates to a valuation of $1,050 million. If we add the $284 million in cash back to this we get a total valuation of $1,334 million or $10.35 per share. If BRSP stock saw prices at this level then that represents a 63% increase.

Averaging these two price targets so far gets us to a valuation of $9.49 or ~50% higher than today's prices.

The stock trades with a 12.6% annual dividend yield as well which is well supported by last year's earnings performance as well as cash on hand.

The Stock Offering: An Overhang Named DigitalBridge

With a rough gauge on value we can now turn back to the offering . It's actually an offering of 30.358 million shares owned by DigitalBridge ( DBRG ) with up to an additional 4.553 million up for purchase at the option of the underwriters. These shares are being bought by five different underwriters: J.P. Morgan Securities, Barclays Capital, Bank of America Securities, B. Riley Securities, and Raymond James & Associates, Inc.

If the underwriters execute their options for additional shares then a total of 34.911 million shares will be sold by DigitalBridge. Prior to the offering they were beneficial owners of approximately 34.911 million shares representing full liquidation of their position.

So first off we can acknowledge that this offering is not dilutive to current owners and simply reflects a former 27% owner liquidating their position. But we are left with the obvious question: why would a 27% owner sell out their position in the shares at $6.00 per share when book value is reported at $10.77 per share?

To understand this we should first contextualize when this position began. BrightSpire Capital was formerly Colony Credit Real Estate, Inc. or CNLC and was externally managed by DigitalBridge. When the move was made to internalize management of BrightSpire in April 2021 DBRG was paid a one-time termination payment of $102.3 million and they ended up with 29% equity ownership of BRSP. Here are some other details from their 2021 10-K :

"The Company also entered into a stockholders agreement with BRSP, pursuant to which the Company agreed, for so long as the Company owns at least 10% of BRSP's outstanding common shares, to vote in BRSP director elections as recommended by BRSP's board of directors at any stockholders' meeting that occurs prior to BRSP's 2023 annual stockholders' meeting. In addition, the Company is subject to customary standstill restrictions, including an obligation not to initiate or make stockholder proposals, nominate directors or participate in proxy solicitations, until the beginning of the advance notice window for BRSP's 2023 annual meeting. Except as aforementioned, the Company may vote its shares in its sole discretion in any votes of BRSP's stockholders. The Company is prohibited from acquiring additional BRSP shares and currently holds a 29% equity ownership in BRSP following the sale of a portion of its BRSP shares in August 2021."

DigitalBridge owns over 20% of BRSP's shares outstanding and thus are considered to have significant influence over BrightSpire's operations. That's why in their financial statements we see them using the equity method of investment to account for BRSP which is really the only investment the company has to account for this way. This created an operational outlier for DigitalBridge and resulted in a $60 million other-than-temporary impairment in 2022 for their BRSP holdings.

Since August 2022 management at DigitalBridge has been focused on a turnaround effort rotating from legacy real estate to a digital investment management platform.

Most recently CEO Marc Ganzi has indicated that they are entering the final stage of this transformation. In none of this transformation did it seem like BRSP was a part of their future. They actually began selling shares in August 2021 disposing of ~9.5 million shares at $9.00 per share. Some familiar buyers were involved in that offering as well.

It's not altogether surprising to see them selling more shares. BrightSpire reflects an anomaly in their financial statements and a distraction from their business model moving forward. Divesting of the rest of the shares will allow them to more appropriately reflect their business in financial statements without the impact of BrightSpire.

And we can look at their Q4'22 earnings call from February 24 for an even clearer explanation from management as they discussed BrightSpire directly. Ganzi referred to BrightSpire in the prepared remarks when discussing balance sheet liquidity:

"Additionally, we have further potential sources of capital, including BrightSpire shares and remaining legacy asset sales, which can be utilized to offset medium-term obligations such as the upcoming 2023 convertible note repayment, which we expect to retire with readily available cash on hand. Throughout 2023, we expect to remain well positioned to deploy capital for accretive uses."

When asked further about BRSP in the Q&A. Ganzi reiterated that "we've been pretty clear about that as well that this would be the year that we'd finish divesting of all the non-core assets." BrightSpire being chief among them Ganzi handed it to CFO Jacky Wu who stated further about the BRSP shares that their "focus this year is to be opportunistic with selling - to divesting those to the degree it makes sense for our shareholders and the price that we're going to get for it."

My read on this is that DigitalBridge is a near-equivalent of a forced seller here. The shares they owned in BRSP were non-core to their business and strategy moving forward yet there was no way to reflect this in the financial statements while they had to maintain an equity method of accounting for their ownership. Owning nearly 35 million shares would make it hard to dispose of quickly in a stock that just before this announcement had a 50-day average volume between 400k - 600k shares.

Against those measures it would take 58 days of selling 600k shares to liquidate their position. That kind of selling pressure would have caused a decline in price one way or the other. I think the secondary offering at $6.00 reflects more of an urgency on the part of the seller than anything as they look to retire their upcoming 2023 convertible note. This note is due in April 2023 for a repayment of $200 million.

Proceeds for the selling of their shares in BRSP are expected to generate $175 million.

In Conclusion

At the end of February BrightSpire reported strong quarterly earnings and full year earnings. Earnings have improved dramatically this year in part to rising interest rates driving the yield on the portfolio. My estimates suggest the stock is trading at a single-digit multiple to its potential earnings if rates remain elevated. It also continues to trade at a meaningful discount to book value.

When news of the DigitalBridge secondary offering hit the markets it caused immediate fear and selling. While some may have interpreted the offering as dilutive to current owners, another layer of fear was in whether DigitalBridge knows something that perhaps we do not about BRSP. From my analysis it seems clear that DBRG is merely continuing along their strategic path of becoming something new with no connection to BRSP. And it helped that they needed some cash for a $200 million bill coming up in April.

So to me the recent downturn in price represents another opportunity to enter a position here. From what I've seen of the company since I first wrote them up in September, they seem on track to navigate this credit cycle opportunistically. And at the very least we can acknowledge that DBRG doesn't seem to be selling with regard to any valuation of BrightSpire in mind.

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