Another Chance To Buy Power REIT On The Cheap

Tom Konrad CFA

An earlier
version of this article appeared on the author’s Forbes blog
on June 3rd.

An article

about Power REIT (NYSE:PW)
that came out on Seeking Alpha on May 30th has sent some investors
running for the hills. 

The article has since been removed from Seeking Alpha.
 According to PW’s CEO, David Lesser,  Seeking Alpha’s
editorial staff concluded that it had reached unsupported and
erroneous conclusions after discussions with him and Ryan Griffin,
the article’s author.  Ryan Griffin told me that he did not
have time to respond to the information Lesser sent Seeking Alpha
challenging his conclusions.  He was confident that, when he
has time to respond, the article will be reinstated.  However,
he also told me that his goal was to get the article to be
reinstated by “Monday or Tuesday” (6/10 or 6/11) and that had not
happened.

Even if the article is reinstated, I disagree with its
conclusions, and I doubt the opportunity to buy this speculative
Rail/Renewable Energy REIT in the $9 range will last long.
 The stock is very illiquid, so even a few investors bailing
or buying can send the stock for great swings. 

Here, I’m going to try to address the main points of the article,
without going into details.  

The core of Griffin’s argument was that
investors are not considering the risks inherent in the civil
action brought by Norfolk Southern Corp (NYSE:NSC) and Wheeling
and Lake Erie Railroad (WLE) against Power REIT to prevent the
latter from foreclosing on the lease of 112 miles of track it
owns, and which are leased to NSC and subleased to WLE.

I am probably the main person Griffin is referring to here, since
I wrote in December how the lawsuit would be good

for Power REIT even if they lose the case.  The reason
for a “lose” being good is that, even in a loss, Power REIT will
be able to write off $16 million or more in the form of debt from
NSC and WLE that they are trying to collect, and this will allow
them to distribute future dividends to shareholders in the form of
tax-free return of capital for decades to come.

I also believe that in a “loss” WLE and PW will be liable for
Power REIT’s legal expenses, because of a clause in the lease
saying that the lessee is responsible of any legal expenses
incurred to protect its interests in the the leased property.
 Griffin thinks this is not so clear.

I think that, at the $10-$11 range PW was trading at, the
benefits of a “loss” were fully priced in to a stock.  Those
of us who still think PW is worth holding at those prices are
indeed valuing the hope that PW will win on at least some of the
points they have made against the lessees.  Before Griffin’s
article, PW was actually gaining ground because some recent
revelations about WLE selling oil and gas leases on PW’s land and
not providing records to PW as required by the lease which seem to
strengthen PW’s case.

Griffin also felt that the first solar deal was “uneconomic,”
citing a “70x multiple” and claimed that this deal could drive PW
into bankruptcy.  His numbers don’t seem to add up.

By my calculations, the deal would only be uneconomic under the
bridge loan currently used to finance it if significant SG&A
expenses are charged against it.  When the bridge loan is
refinanced, I expect it to be modestly accretive to
earnings.  Griffin’s statement that the project had a “70x
multiple” does not agree with my
calculations at all: The $1.04 million purchase came with a
$80,800 annual rent (with a 1% annual escalation.)  After
accounting for the assumption of a 5%, $122,000 sewer financing
which was taken on as part of the purchase price, I get a price to
net revenue multiple of 12.25x.

I, like Griffin, don’t like PW’s CEO David Lesser loaning money
to the company at 8.5% interest, which was the step-up rate on the
bridge loan he used to finance the deal.  However, according
to Lesser, the bridge loan has been revised to remove the step-up
in interest rate (leaving the initial 5% interest rate), and PW
has recently signed a term sheet to replace the loan with bank
financing. I expect more details on this financing soon. Future
solar deals should be larger, and bank financing easier to obtain
when the legal mess is wound up.  Even if PW were paying 8.5%
on the bridge loan after the first six months, there would still
be a net profit (before SG&A expenses) of $26,794 in the first
year on the $115,000 cash PW put into the deal.  In the
second year, profit would fall to $6,700 because of the step up in
interest in the bridge loan, slightly offset by the 1% annual rent
increase, but future profit would trend upward even in the event
PW is not able to obtain more attractive financing.  To me,
it seems unlikely that PW will have to pay 8.5% to refinance the
deal, and the difference from a lower interest rate would go
directly to profit.

If the whole deal were to be financed at a 5% interest rate, PW’s
annual net profit would be $29,100, and this would increase in
subsequent years.

I don’t see how this deal, which looks marginally profitable even
under an 8.5% bridge loan, could drive PW into bankruptcy, as
Griffin claims.

Griffin made a number of other points which I consider less core
to the argument, but I will attempt to respond to them briefly:

• PW cut its dividend to $0.  Griffin
  thinks this is a bad thing, but I think it is a good thing.
   I, and at least one other professional investor I have
  been in contact with, suggested the cut to Lesser.  We felt
  that as long as the lawsuit was using most of PW’s cash flow, PW
  should not be issuing stock and diluting current shareholders
  just to pay a dividend.
• The civil case could last for years of appeals during
  which time PW will have to issue stock to pay legal bills. 

  While this is possible, and NSC can fund the lawsuit forever
  without even really noticing the cash flow drain, WLE does not
  have NSC’s financial strength.  The fear of having to pay
  PW’s legal bills as well as its own will be a strong incentive
  on WLE to settle, especially if the initial rulings are not in
  its favor.  If the initial ruling is in WLE and NSC’s favor
  (and a Summary Judgement could be handed down as soon as August
  or September,) PW will not drag things out.  The costs of
  the case are also likely to fall after the end of the discovery
  and expert witness phases, currently scheduled for the start of
  July.  See PW’s recent litigation update [PDF].

• WLE can pay for the lawsuit longer than PW can, but
  can’t afford to pay if PW wins. These two
  statements seem to contradict each other, and NSC is on the hook
  for at least $7M of the settlement account, and possibly for the
  entire sum of any award, since NSC is the lessee, and WLE is
  only a sub-lessee.
• Shareholder trying to remove Lesser in previous years. 

  Griffin seems unaware that while a shareholder group
  unsuccessfully challenged Lesser for control of the company in
  2011 and 2012, there was no such attempt this year.   He
  did not mention that the lead shareholder of this group had a
  tiny holding of stock, and was trying to get WLE’s President on
  PW’s board – a clear and undisclosed conflict of interest.

• Griffin says PW is suing WLE and NSC. 
  This is false: WLE and NSC brought the civil action against PW
  to prevent PW from foclosing on the lease.  This makes a
  difference since Griffin’s worst-case scenario revolves around
  PW having to pay their legal bill because it brought a lawsuit
  that might be found spurious.  But PW did not bring the
  lawsuit, and given WLE’s apparent multiple violations of the
  lease, PW’s claims and grounds for foreclosure seem far from
  spurious to me.

Conclusion

PW is a very illiquid stock that was driven down 25% by panic
selling.  Although Griffin points to very real risks, his
price target is laughable.  Lesser seems to agree with me,
and he is putting his money where his mouth is.  He has been
adding to his position all along, but has made much larger
purchases since the Griffin article came out.

By the way, Lesser is very accessible to investors.  As I
said, I have very little time this week, but if you want more
details, I suggest you contact

him directly.  I’ve been trying to persuade him to make
all the public filings in the civil case available on PW’s
website.  He’s been helpful at emailing it to investors who
do not have a PACER account (or don’t want to pay $1 a page.)
 If readers inundate him with requests for documents, I bet
he will get on this sooner rather than later.

Disclosure: Long PW.  I have added a
little to my position recently in the around $8.42 for short
term trading purposes, and may sell these shares at any time; I
have GTC limit orders in place to do so.  My much larger
long term stake remains intact. 

DISCLAIMER: Past performance is
not a guarantee or a reliable indicator of future results. 
This article contains the current opinions of the author and
such opinions are subject to change without notice.  This
article has been distributed for informational purposes only.
Forecasts, estimates, and certain information contained herein
should not be considered as investment advice or a
recommendation of any particular security, strategy or
investment product.  Information contained herein has been
obtained from sources believed to be reliable, but not
guaranteed.