One study completed at Penn State, covering a twenty-five-year period ending in 1988, found that stocks of spinoff companies outperformed their industry peers and the Standard & Poor’s 500 by about 10 percent per year in the first three years of independence… Insider participation is one of the key areas to look for when picking and choosing between spinoffs — for me, the most important area. -Joel Greenblatt, “You Can Be A Stock Market Genius“
I first came across NexPoint Residential Trust (NXRT) when I noticed the CEO, James Dondero, had bought a few shares. As usually happens with these things, it took him buying a number of shares over the course of a few weeks to really slap me across the face and take notice. All told, Dondero, the founder of Highland Capital, has now personally bought over 560,000 shares at about $14 each for a total investment of almost $8 million.
So I decided to do a little digging to find out what this company was all about. NexPoint is a fairly small real estate investment trust that currently owns 38 multifamily buildings in the Southeast part of the country encompassing nearly 12,000 apartments. They are looking to grow the portfolio by looking for “value add” plays. This just means they’re looking for properties that can be fixed up to generate better rental rates.
What I like about the stock is that it comes with a built-in “value add.” It currently trades at a significant discount to its larger peers like Equity Residential (EQR), Apartment Investment and Management Company (AIV) and others. It’s price-to-FFO multiple is roughly 12 compared to an average of 24 for its 5 largest competitors. Price-to-book value is 1.23 compared to 3.26 and at 5.9%, the dividend yield is nearly double the 3% average of its competitors. So if NXRT were to simply trade in line with its peers it would have to roughly double in price.
What’s more, because the company is so much smaller than its peers, its growth prospects are also that much more attractive. It can look at properties that its larger competitors ignore because they’re just not big enough to move the needle for them. I imagine that the company could also make for an attractive takeover target for the larger competitors once it manages to establish itself and prove its growth potential over the next few years.
The company is being spun out of a closed-end fund, NexPoint Credit Strategies (NHF) as a way to unlock shareholder value. The REIT deserves a much better multiple than the fund does based upon the fact that its income is much steadier and also avoids double taxation through the REIT structure. Like many spinoffs, it’s come under some selling pressure as NHF shareholders have indiscriminately dumped their shares. This creates an opportunity for new shareholders willing to take a real look at the business.
I believe this is a classic spinoff trade along the lines of what Greenblatt wrote about in his excellent book. The fact that Dondero is personally buying so much stock adds to the veracity of this belief. I’m adding a 2% position to the model portfolio today and may look to add to it in the future.
Disclosure: I own NXRT personally and for a few other accounts I manage.