Rich Howe thinks $NXDT could be the next $NXRT (podcast #93)

Rich Howe, founder of stock spinoff investing, walks through the bull case for NXDT. NXDT is a closed end fund trading at a huge discount to NAV; the fund is planning to transition to a REIT and Rich thinks that makes the stock very catalyst rich. A related company, NXRT, pursued a similar move ~6 years ago and their stock has gone up ~6x since. You can find my thread on NXDT here.

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Transcript begins below

Andrew Walker: Hello and welcome to Yet Another Value Podcast. I'm your host, Andrew Walker. And with me today, I'm happy to have Rich Howe. Rich is the founder of stockspinoffinvesting.com. Rich, how's it going?

Rich Howe: Hey, doing well. Thanks for having me on, Andrew, I'm a big fan. So this is fun.

Andrew: Hey, I'm a big fan of yours. I'll get to that in a second but let me start this podcast the way I do every podcast. First, a disclaimer to remind everyone that nothing on this podcast is investing advice. Please consult a financial advisor. Do your own work. This isn't financial advice. The second way started your podcast is with a pitch for you, my guest. This is actually going to be the easiest pitch I've ever done. Spin-offs are always an interesting area of the market. If you're looking into spin-offs, the only spin-off subscription service I do is stockspinoffinvesting.com. I'm a very happy sub, does great work. I say every spin-off that comes out, you've got a write-up, you got a thesis. You've got a model on, some you'll say are interesting, some of you won't but every spin-off you cover it and I think you do fantastic work. What are the prices of subscription these days?

Rich: So let's see. It is $629 for an annual subscription and it's $67 bucks, kind of random numbers for a monthly subscription.

Andrew: I've been a subscriber for a year and a half I would say, and I love it. So hopefully that's as good a recommendation as I can give. But all that out the way, let's turn to the stock we're going to talk about today. It's funny we're having you on for the first time for this one because this is not a spin-off though there are event spin-off E-Type qualities here. The stock is NexPoint Diversified. The ticker is NXDT and all that out the way, Rich, I'll turn it over to you. Why are we so interested in NXDT?

Rich: Yeah. Thanks so much, Andrew. So yeah, it's funny. So my site is named stockspinoffinvesting.com. I cover all the spin-offs. That's my primary hunting ground but at the end of the day, I'm just looking like everybody else for good opportunities. More often than not, it's going to be in a spin-off or in a special situation. So, NXDT is a good example of a special situation that I think is obviously pretty interesting.

So just to take a step back at a high level, one of the reasons why spin-offs are so interesting is because, essentially, you have a chance to be buying something that is being indiscriminately sold. If you do your work ahead of time, you can value the spin-off and you come up with a fair value, you can determine what you think is a good price to buy at. You're oftentimes buying from shareholders who have just received a tiny spin-off, didn't choose to invest in that spin-off, and are more likely they're not going to be sellers at the end of the day.

It's a really kind of interesting setup. Not all spin-offs work, many don't work, and some go bankrupt. It's usually kind of been an interesting inefficient area of the market to look at. The reason why NXDT is also interesting is because it has kind of a similar dynamic, and that it's really right now it's orphan security. So currently, it's a closed-end fund even though actually the name is Diversified REIT. Currently, right now it's a closed-end fund.

There aren't many natural investors for closed-end funds. Closed-end funds are generally sold, they're not bought. It's kind of maybe like an annuity when a closed-end fund has an IPO. Usually, the brokers whoever sell the IPO get a big 5% commission because it is so profitable for the underlying manager. Long story short, NXDT is a closed-end fund that was launched way back in 2006. It has been basically managing kind of primarily focused on real estate assets. But if you look at its portfolio, there's a bunch of weird stuff, random equities, post-equity, reorg, some distressed debt. It's kind of like a weird bit of a portfolio.

As a result of that, there are not many people that are interested in owning basically, almost a micro-cap closed-end fund. It has a market cap of about 500 million dollars. The thing that's interesting to me is that it's going to go transition from being an orphan security to nonorphan security. So I love these setups. So you have a cheap asset and it's going to go from something that basically nobody has an interest in owning to a lot of people potentially having an interest in owning.

Basically, NexPoint has changed their name. It's not a closed-end fund anymore by name, they're Diversified REIT and they are in the process and it's taking a while. It's taken a while, I'm sure we'll talk about that, but they're basically going to be transitioning from being a closed-end fund to being
a REIT. Basically, transition from a closed-end fund to a REIT makes all the sense in the world. Usually, closed-end funds trade at some sort of discount. NXDT is trading at a 40% discount. Usually, most REITs don't trade at a discount to NAV. They typically traded a multiple of funds from operation or from EBITDA.

So it's basically by essentially changing from a closed-end fund to a REIT, the security will be open to a whole other class of potential investors that can basically invest. There's a whole other host of reasons why I think it's potentially interesting. The biggest one is its trading at a big discount to NAV right now about a 40% discount. So if it worked to revert to NAV, that could be a very nice 50% plus return there.

The other interesting thing is the CEO of the company, James Dondero. It's almost like he's been buying indiscriminately. It's like every day he's in the market buying more shares. He owns about 14% of the company so that's a very sizable investment for him. So at a high level, I'm happy to obviously dive into questions but the situation seems like a low-risk setup. You have about a four and a half percent current dividend yield. It's trading at a big discount to NAV and it has been growing and they have some pretty nice assets in there. And then you have the potential catalyst, which I'm guessing will happen within the next six months. We're by they transition to a REIT and open up a whole swath of other investors, whether their passive index funds or individual investors who are interested in investing in the REIT. So that's kind of the pitch in a nutshell and that's why I own it.

Andrew: That is perfect pitch, perfect pitch. Let's start with some of the more bull cases and then I'll provide, not that it's huge pushback but there are some concerns here. So I guess the first thing, you mentioned persistent and started buying and I just want to clean up with something that I think actually makes more bullet. It's not that he's in the market every day, I believe if you look since June, every day that the insider trading window is open, he's in the market. I don't know if that's different than being in the market every day. Maybe that's more bullish. Maybe that's less bullish. But I just think that's interesting. Like, window open the dude is in there. And this is not a super liquid stock, and I guess he's probably buying like the max that he's allowed to buy. Would you disagree with everything I just said there?

Rich: No. No, that's a really good point. I didn't even realize that he's just waiting till the insider trading window is open for him to participate but that's exactly right. Yeah, he's not buying, it's in liquid stock but he's buying good chunks of stock. It's not like he's buying 10 grand here and there as kind of a window dressing event. I think at the beginning of the year, he owned about 10% of the company and throughout 2021, he's increased his stake to closer to 15%. So he's been doing some meaningful buying.

Andrew: I think, again, you can you tell me if I'm wrong. I don't want to put words in your mouth or be too much of a softball host here but I think a lot of the concerns and red flags around the company that we're going to talk about and we're certainly going to address throughout the podcast, I think the answer to a lot of them can be, "Hey the man who knows the valuations, the man who has the most insidery info into the company, every chance he has a chance to buy shares, it seems like he's doing so." Now, inside there's no you can play by a little bit token buying game, get people interested, but it doesn't seem to be that too.

I do think people should keep it in the back of their heads because there will be some red flags we address. But I think that is like the overarching answer to a lot of those questions where you lean one way or the other. Again, don't want to put words in your mouth but you tell me how you think about that.

Rich: Exactly right. And I think that's the biggest thing that's really given me comfort here because the assets there, I think this is part of the reason why there's a big discount and why it's been trading at a big discount to NAV, it's because there isn't a tremendous amount of granularity into what those assets are valued. When you were prepping for the podcast, you mentioned that 80% of the assets are basically kind of valued independently using kind of comps and DCF and other metrics. I'm sure they're doing a fine job doing that but it's not like they own a hundred different shares of publicly traded stock and they're updating the NAV every day. So what gives me a lot of confidence is I'm not a professional real estate investor but the fact is it looks like it's turning it a big discount to NAV. It looks like the cash flows are real and then a presumably pretty sophisticated individual is, as you said, pretty much buying at any chance he gets.

Andrew: Great. I want to dive into the asset concern you talked about in a second, but I do think there's one other area on the bull side that I think is worth addressing. Because for event investors, this is a little bit before my time but it's not that long ago. In 2014 or 2015, there was a company called NXRT that went from closed-end fund to REIT, since then it's up about 6X whereas the Russell 2000 is up maybe 80%. Probably REIT indexes around something like this stock has been a screaming home run. I know a lot of event investors who maybe not made their careers but made a lot on this trade. So NXRT has a lot of similarities to NXDT, the stock we're talking about. So I just wanted to give it over to you if you want to talk about those similarities and why that might have a lot to do with the situation.

Rich:Yes, so essentially, it's kind of weird, but this was a closed-end fund and it's the only time that I've seen it but essentially, this fund which had a different ticker at the time, actually...

Andrew: This fund being NXRT is what you're referring to?

Rich: NXRT or NXDT previously, its ticker was NHF, I believe. It actually spun out. It basically incubated this multi-family REIT and then that became NXRT which was spun out and as you've said has gone to be a 5X. So yeah, that's kind of in the background too that NexPoint controls that REIT as well. So, clearly, they do have some expertise in the real estate market. They do know how to add value, they've done it before. It's a little different in this case, NXDT, the company that we're talking about today, essentially is the parent of NXRT which was the spinoff that performed incredibly well.

We can kind of get into the strategy, and what the strategy is going to be once this reconversion actually takes place. But from talking with investor relations and there's not much that they can really share, but their strategy really is to continue to be an incubator and to kind of reading between the lines, spin out additional assets like NXRT which I think would help to close the gap to NAV.

Andrew: Perfect. Let's use that to talk about as you and I are talking into the stock is between 14 and 14-50. This is a little bit on the e-liquid side but it's liquid enough unless you're managing real big boy money, you can get a position here. But at 14 to 14-50, where's NAV, and then we'll dive into assets and if you can trust NAV if that makes sense.

Rich: Yes. So the market cap right now is they're about 37 million shares outstanding. So the market caps about a little bit over 500 million dollars and I can't do the math in my head. I know the NAV per share is about 23-50 but the shares are trading a little bit about 14. So, it's about a 40% discount to NAV on a per-share basis.

Andrew: Perfect. Perfect. I think there are two big questions here that bring us to probably the first in most pressing of the concerns. Can you trust NAV? I'll put my tweet thread in here as well as a link to Stock Spinoff Investing in the show notes. People can go look at my thread, I included a screenshot from the semi annual report, or maybe it was from the Q3 fact sheet.

Let's call it a billion in assets is roughly what it rounds to. Of the billion in assets, a little over 800 million if that's number we're using of the assets would be level three assets. Level three assets, so a level one asset would be GE stock. Super liquid, every day you can go point to a price, right? A level two asset would be an e-liquid stock that you can point to a price but maybe you wouldn't actually be able to get that price but a level 3 asset is, it's a private equity money. It's not traded. You can go model it. You can say, "Hey, we own a cable company." Cable companies in the public market trade for 10x bil or slap at NXT bit on multiple on it. Maybe we give it an e-liquidity discount.

But there is no liquid comp for it. You are trusting a model for the valuation. So, of the ability and assets about 80% of them are marked, our modeled valuation assets, what I call them. So the first question to you, the most important question I think for is that 80% of assets, do you trust that number? How do you gain comfort in that number?

Rich: Yeah. So first, they do own a REIT which they kind of IPO, they incubated in an IPO out of NXDT called NexPoint Real Estate Finance. And that accounts for about 16% of NAV. And so, that is the part of the portfolio, the part of the NAV that is valued on a day-to-day basis. Essentially, what they do is they basically, the NAV of NXDT fluctuates based on the price changes in that security.

So you can do research on that part of the portfolio. The market is kind of valuing that independently. The rest of the portfolio, we do not have much granularity into. In terms of the biggest parts of the portfolio, you have Vinebrooke Holmes, which is basically a single-family rent-to-own operation. So they are single-family. They own a portfolio of about 14,000 single-family rentals, which they rent out across the Mideast. They're very similar to kind of like an Invitation Homes at a much lower scale than Invitation Homes. Invitation Homes is a lot bigger. This is the blackstone entity that does the same thing. They buy a bunch of homes and they rent it up.

Historically, this has been a very good place to be. Vinebrooke Homes is a trust. It does file financials with the SEC so you can go in and try to get a sense of what you think this thing is worth. They also publish a monthly NAV. Again, it's done I think by Green Street Advisors or with input from Green Street advisor. Theoretically, it's done by experts but again, it isn't a market price.

I guess I don't have tremendous confidence in or I guess, I don't have a lack of confidence. I don't have complete confidence in whether that asset is necessarily marked correctly, historically, or at least in the past year or two. The single-family rental market has been a good place to be as has most residential investments other than office or maybe retail.

So I am comforted by the fact that it's been a good place be over the past couple of years and you do have a good comp in terms of Invitation Homes. The other big asset which represents about 12...

Andrew: Just before you go to the other big asset, if I can just pause you on Vinebrook. So I noticed they were not publicly traded but they had public financials. You can look it up buying Brooks homes trust, their SEC Filer and everything. Feel free to say, "I don't know," to this question, but one thing that jumped out to me just glancing at the rate case is they actually do issue stock pretty frequently. So I'm looking from December, they filed an 8K from
December 2nd to January 14th, we issued 1.1 million shares for about 60 million dollars. They issued it right around NAV. NAV is 53-54. They issued at about 53-54. My question is, do you know who they're issuing stock to? Is NXDT participating pro rata, taking all this down? Are they issuing it only through the brokers who are selling into retail shareholders? I'm just wondering, 60 million dollars, is not nothing. Who's taking all of this that they're selling?

Rich: Totally, yeah. Great question and I don't know. Yeah, it's a great question. I'll definitely look into that but it's also interesting that they're issuing it at NAV because presumably, somebody believes that NAV enough that they're actually buying at that price but I don't know. The short answer is I don't know. I don't think it's NXDT, I think they're kind of trying to conserve cash but that's a good data point.

Andrew: Just I suspect. I have not done crazy amount of work. I'm just glancing at the 8k and when you were talking about it, I'd noticed before. I suspect because they say, we issued shares for 60.4 million in aggregate, and we also pay 2.9 million of selling commissions and fees and connections. I suspect it's to retail shareholders through brokers because that's about a 5% fee that's generally what you see, but no guarantees and there.

Anyway, you're about to talk about the the other assets behind Vinebrook Homes before I so rudely interrupted you, please continue.

Rich: No. That's a great point and it's a really, really interesting data point. I guess before I kind of go on, basically, the majority right now, they reposition the portfolio so that they owned really a bunch of different assets. The majority is real estate but they've been trying to sell the co-post-reorg, bankruptcy companies, and other kinds of random stubs that they owned and redeploy the proceeds into more real estate assets.

So I think as of the Q3 NAV report, they had something like 70% of their assets. In real estate, this is obviously what you want to do if you are transitioning to REIT but the one underlying message that I want to come across is we already talked about the single-family rental asset, but they also have, basically, a bunch of assets that are focused on, I think, just good places to be. So they have good exposure to single and multi-family residential and then they also have exposure to basically self-storage assets, which has been a really good place to be, historically, but also throughout the pandemic.

So their next biggest asset is called NexPoint Storage Partners. They have about 12% of NAV is tied up in this. This is basically a billion-dollar storage platform originating company. It was acquired partly through an acquisition, and currently right now as of the mid-year report they have about 52 self-storage investments across the U.S. And 41% of those are wholly owned.

Historically, Self Storage has been a good place, especially in the pandemic in terms of different sub-sectors of real estate. But I don't have tremendous granularity or insight into whether or not these assets are marked appropriately. Any other questions, Andrew, before I go on to the next big asset?

Andrew: No, I think that was great. I think that was great.

Rich: Okay. So the other big asset which is kind of interesting is City Place Tower. So those of you who are watching or listening who are in Texas, maybe you can check out this asset in person. But essentially, this is a tower in Dallas, Texas. It has a 42-story office on tower that was acquired in 2018. Me being kind of a generic real estate investor, Dallas seems to be a good place to be, business friendly, good climate, low taxes. It seems like people are [crosstalk].

Andrew: Oil and gas coming back. Dallas is ready to rake in the cash there, yeah.

Rich: Exactly. And also, I was amazed that taxes are really low in Dallas wherein Texas, I didn't appreciate that. You have a good climate, so people, perhaps even entrepreneurs coming from California that want to go to a more business friendly state. Then you also have the tail winds from the boom, and the oil and gas market. So it seems like it would be a good place to own real estate. The other interesting on an angle here that I picked up just from reading the history and the reports is that this asset is in the process of basically opening an intercontinental hotel.

It's going to open in early 2023, and it is going to basically occupy about eight floors of the 42 floors in the building. There's a little throwaway line in, I think it's the 2020 inreport that says that NexPoint expects NOI to double once the building is stabilized. And so again, I don't know how much of that was baked into the acquisition price in 2018. But presumably, if NOI is going to double, you could see a nice pickup in terms of kind of asset value if once that asset is stabilized in 2023. So that's the other pretty big asset that I think is is is worth talking about.

I think one of the things you've heard me talk about is I don't have tremendous insight, unfortunately, into whether the marks are accurate on this portfolio. It seems to be selling at a big discount. The stock seems to be selling at a big discount too to NAV, but there are a couple of things that give me comfort, and we've already hit on one of them. But the first is that this is a fund that historically has traded closer to about a 20% discount to NAVs most closed-end funds traded a discount to their net asset value whether that's 10% or 20%, 40% is pretty extreme.

I guess my point is the assets were valued the same way last year in the year before as they are today. Even if you're not completely comfortable with how the assets are valued, I guess I get a little bit more comfort that the stock, the securities trading at a 40% discount today versus 20% pre-pandemic. So that's the first data point that gives me a little comfort.

The other data point again, is that we've talked about is that James Dondero is just buying kind of relentlessly in the open market, he's increased his stake from about 10% of the company to about 14%. And he's buying, really, any chance he get. I presume, he's a fairly sophisticated investor. I don't think he would be buying if he didn't have confidence in the marks.

So those are the two points that really give me comfort, even though there isn't much granularity or at least, I don't have much granularity and to the underlying marks on those assets.

Andrew: Let me ask you real quick. You've mentioned twice the company uses to create at a 20% discount NAV, and I think that's pre-pandemic is when it mainly traded for 20% and now, today, 40% discount to NAV. Is there anything that's changed particularly between, obviously, there was a pandemic. I'm living here cooped up in my studio apartment and everything but is there anything material that has changed between now and then?

Because you could say, I'm just throwing out example, I haven't looked at the boundary pre-pandemic but you could say, "Pre-pandemic, everything they did was they own all publicly listed stocks and traded a 20% discount to NAV and then the pandemic, they sold all those and they bought a bunch of E-liquid private investments and now trades at a 40% discount so you could say 20 to 40 and then I'd say, "Oh, yeah, but now you're getting the liquidity in this kind of everything." So does anything materially changed between the 20% a couple years ago to 40% today?

Rich: Yeah. A couple of things have changed. So the first thing is NexPoint Real Estate Financial, which is their biggest asset. So that actually became public. So that went from being a level three asset to basically a level one asset. So you would say that that's a positive. The other change and this is something that I think is really important, especially in the context of who would buy a closed-end fund is the yield. So the yield, the dividend has been cut twice, and we probably should have talked about this earlier, but that I think that's really important. And I think that actually is a potential bull case that the dividend could eventually be reinstated a lot higher.

Andrew: Let's talk about the dividend because I think that actually play more when we start talking REIT. So we'll talk about that in a second but I do want to talk that asset that went level 3 to level 1. Again, like I do work for this podcast, but I didn't go through four years with fishing stuff and that district means interesting in one particular respect. When it went from a level asset to a level one asset, do you know how closely it kind of followed the pre level one asset valuation?

Rich: Yeah, it's so funny. I don't know that but that's a phenomenal question. As I was kind of finalizing my notes for this podcast, that was on my list of something to do because it would give you insight. The key point is to give you insight into or the other level three assets actually marked correctly. So that's on my list of things to do but it's a great point.

Andrew: Well, you and I will follow up on that offline because I'm always interested. But look, people ask me all the time like, "Hey, why do you write? Why do you pocast?" And the answer is a lot of times it's stuff like that. Right? When we do the interview, that question, it kind of sounds obvious when someone poses it but when you're doing work on a company, like there's so many things you're thinking about, there are so many things you're doing, it's very easy to not kind of think about that. That's a real clear mark but it's very easy to test it over and that's one of the great things about writing, doing these interviews, and stuff. So just for everyone who's thinking about writing or coming on the podcast, that's one of the reasons to do it.

Okay. So I think we went through a lot of the assets and we're going to talk some other things in a second. But a lot of these assets I do think one of the things people worry about is not just the level 3 nature of these but a lot of the assets are- NexPoint controls this REIT, and NexPoint controls a lot of the assets that they're investing in. So there's two ways, people are worried about there. We'll talk these in a second, but fees on fees, fee layering is one way they worry and we'll talk that in a second. Put that aside for now.

The other thing people worry is not only you have level three assets that are marked to market, but you this controlled entity investing into other controlled entity. Whenever you say controlled entity investments and other controlled entity, anyone who's investing for a while immediately the hairs on the back of their neck stand up because they're like, "Oh, this all have been burned a hundred times before." So can you just talk about that kind of risk right there?


Rich: Yeah, I mean, I think there's no way to get around it. So it definitely is a risk. I think there have been maybe some corporate governance concerns in the past with the NexPoint and the fact that they are essentially mentioning vehicle that's investing in another REIT. So by definition you're essentially stacking fees. I guess, again, it goes back to this is a concern I think that the markets have for a long time. Historically, that return that concern was priced kind of at a 20% discount to the NAV. Right now, it's priced at a 40% discount.

So my thought processes that that it is perhaps reflected in the current share price, but it is a concern. I don't think there's any way that you can get around that. I will say it is going to be an externally managed REIT which is going to be a negative. It's going to be a next one thing that is going to be kind of managing the REIT, but they are capping expenses in the year following conversion at I think 150 basis points which I'm not a REITexpert by any means but I think is kind of in the realm of reasonability, in terms of what external managers typically charge.

Andrew: I'm looking on the right side of my screen because I'm trying to remember. NXRT, which again, this is so many people and I said, we're going to talk NXDT. I have so many events fund people reach out and they were like, "That's been on my list." Including myself personally, it's been on my list because I remember an NXRT, NXDT rhymes with an NXRT. I've been meaning to look at it. NXRT is obviously they were externally managed so that's one thing like you can have a screaming home run when you're an NXDT REIT. And I think when they spawn, they had a lot of the same and NXDT like, oh, we invest on a lot of related party issues and they cleaned that up over time, but I can't remember correctly. I was trying to get cleared in that. Do you remember?

Rich: Yeah, so it was and remains in externally managed REIT. The strategy there was essentially, that fund was incubated within NXDT but the strategy was really to basically kind of streamlined the process, redeploy assets into multifamily, B Class real estate. Lever the assets up kind of appropriately. I don't think they were kind of optimally leverage within the closed-end fund structure. I think that's part of the reason when you're in a closed-end fund, your leverage is a little bit restricted.

And so, yeah, it was externally managed and continues to be and there was some repositioning of the portfolio, which ended up essentially creating net asset value, and growing earnings over time.

Andrew: This is just NXDT. It's one of the funny ones because I could paint two stories so easily for you. Have you heard of doing a post mortem, right? Where you're investing in something you say a post-mortem is, 'Hey, if I die, if I lose on this investment, you write how you probably lost before it even happens so you can think through the wrist." And here, the post-mortems really simple. You invest it into a controlled company that invests another controlled companies like, boom. Post-mortem writes itself. But the bull thesis writes itself too. NXRT was a 6X, it followed the exact same path as this. There were the exact same concerns. I would like a 6X please. Right? So that's pretty simple.

I want to ask a couple other things, but I just want to hammer one other point home. NXRT, was a big winner, single-family homes, B class, very simple, storage cell. NXDT if and when they get their REIT going and that's a question and we'll address that in a second but if and when they get the REITs going like they've just got a mismatch passes, right? You mentioned the Self Storage. You mentioned that they're invested in the private single-family homes and everything. They say that their NX development, I think they kind of think of themselves as a spin factory for all these other things. NXRTs got roots here, but you can't have a REIT that's a spin-off factor. So what is their strategy going to be? What's the core focus three years from now, if they become a REIT, what are we going to be talking about?

Rich: Yeah, so it's really in terms of that they haven't shared a whole lot, they did file a proxy when they basically wanted shareholders to vote in favor of the REIT conversion. When they made that presentation, they made all the points that you would expect that they would make. A REITs typically don't trade it up at a discount, closed-end funds do. You get more analyst coverages more liquidity, you get inclusion in and all the indexes. But they didn't really dive too deeply into kind of what the strategy would be other than saying that they're going to be a Diversified REIT.

I did have a chance to catch up with Aira recently and she couldn't give me a lot of guidance. And I think a lot of that will come with time but they basically want to kind of continue. They view themselves as a little bit of an incubator and that they're going to be potentially, she referenced the NXRT spin-off, and also the NREF IPO/spin-off. The guidance that I got was that essentially it's going to be kind of like a spin-off factory going forward. It's going to be an incubator where they incubate new strategies and essentially spin them off to investors.

And then one other point that I wanted to make before we move on is you're right. In terms of the postmortem, it's a controlled entity investing into another controlled entity. As you said, the post-mortem could write itself. What I like about this situation is that I think the downside is pretty limited. So, it is trading at a big discount to NAV. It does pay a pretty decent dividend yield of about four and a half percent. And it seems like in following spin-offs, a lot of times, the spin-off will be announced and everybody gets excited. The stock pops, and then everybody just kind of forgets about it.

And I think it just seems like there's a lot of fatigue with the stock. People were writing about it in 2020 when the initial proposal came out where they were going to transition into a REIT. So I think there's a lot of people who are like, "I don't really care. This is never going to happen anyway." That leads me to believe that perhaps even if this is indefinitely delayed or perhaps it doesn't even take place, the downsides are pretty limited. And so maybe you don't get the upside, but you don't lose a lot either.

Andrew: Let's dive into that point. So I agree with you. NXDT was looking for approval to convert from closed-end fund to REIT in August 2020, not 2021, 2020. So we're approaching 18 months that they've been going through it. I think they got approve around August or September 2020. So 18 months from then to now, that is the definition of at this point, people are like, "Yeah, it's never going to happen. The markets just gotten fatigue on this thing." So the question to you is, why is this taking so long? When they got approval, they thought they'd be done first half 2021. We've missed that by a year. I haven't seen a ton of new stuff. I think the last press release they put out on the conversion was in October. So why is this taking so long? Do you think this is actually going to happen? And I think you already addressed this but we can address it one more time. If it doesn't happen, what happens?

Rich: Yeah, so I think, is it going to happen? I think it's going to happen. They continue to come out every quarter and say, we're making progress, we're making progress, it's a little bit more delayed but at the end of the day, I don't know. The company has talked to the SEC. They have provided the SEC. There's a process where they go back and forth with the SEC, answer all the SEC's questions. And the company per IR has basically answered all the SEC's questions and there have been no more questions. So you would think that the spin-off or the conversion, you know what happened at some point...

Andrew: What did the SEC's questions focused on?

Rich: Investor relations didn't really articulate about what she did. What she did say was, "How long is it going to take you to base the reposition the portfolio to be kind of 80% plus focused on real estate?" I think there were some questions about that timeline. The other thing that they focused on was basically operating as a REIT. So right now, they're kind of operating under the basis that they're going to distribute 90% of taxable income, which I don't think is very hard for them to comply with. But that's kind of the process as it's gone so far.

The one other point that I will mention, is the proxy statement that was filed two years ago somewhere of 2020, they stated that it could take up to, I think Q2 of 2022 or somewhere of 2022. So it's not completely unprecedented. The SEC is a bureaucratic institution, to some extent you're just waiting on them. So it has been delayed. It is a little bit disappointing. I think ultimately, it does happen but I think we already touched on it a little bit. If it doesn't happen, I tend to think maybe the stocks sells off because people are pissed, but I think if it didn't happen, it would probably be within conjuncture with, "Hey, we're doing big tender offer to buy back a bunch of stock or we're doing XYZ to create shareholder value." And again, it gets back to kind of the insider ownership in the alignment there.

Andrew: That actually brings me nicely to one of my final questions. Share BuyBacks, I think this company has a decent history of buying back shares. They actually did some Share Buybacks in 2020 in conjunction with going through the reprocess. They did a really big Buyback, which was also kind of interesting because it was not a buyback, it was a tender offer with an exchange where they gave out some crafts, 20% cash, 80% crafts. Don't have to dive into these mechanics but they used it to retire like 15% of shares outstanding at a nice discount to book. Very nice trade, especially if you believe book, if you think this going to trade it at NAV when it goes three. Right now, they are not buying shares.

So my two questions and you kind of address through one angle a bit was, why are they not buying back shares? Does that have something to do with being stalled out by the reprocess and if they get can convert to REIT or if they can't convert to REIT and they continued straight a discount, do you expect to Buyback shares going forward?

Rich: I do. I think they will. I do not know exactly why they're not buying back shares in the market. On the one hand, you could think maybe for some reason due to the transition to REIT, they're prohibited from buying back their own shares. If that were the case, I don't know. Maybe you would think that insiders would be prohibited from buying for buying as well. I don't know, but I don't know. It's interesting.

In 2020, they were buying back shares hand over fist. Right now, they're not. I don't know exactly why they're not able to do that. But I assume it does have something to do with the conversion process because they've been very consistent in their messaging that, "Hey, we're trading at a big discount to NAV. We don't think that necessarily reflects or value [inaudible]." We're going to do everything in our power to [inaudible] question or did I cover it?

Andrew: No, that was great. You were cutting out for a second there. But I think all that came through and you definitely address those questions. Last question. I want to rewind just a little bit and make sure we address this.

Traditionally, the issue with closed-end funds and this is closed-end funds as a general, not NXDT of specific is a closed-end fund because it's not a mutual fund where you can redeem if the managers bad. Closed-end funds are basically locked in these streams unless an activist comes and tells them to liquidate. Everyone knows if you're paying a manager one or one and a half percent just to manage what looks like a mutual fund or something like, just go do a Vanguard ETFs or closed-end funds generated for a discount because of that management fee stream.

The NXDT is a little different because you can't exactly go buy an index of all the different little non-operative, these are publicly traded investments. So they charge about 1% annually, 20 basis point, one percent management fee. I think, like 20 basis points to cover other custodial things. They pay their board trustees pretty well, but the fees are not crazy here by any stretch of the imagination.

So I'll give you that part of the answer but I do think a lot of people say, "Yeah, they're not crazy, but they're also investing in related party entities which then charge fees. So when you look at the whole thing and the whole domino's the fee stream gets pretty high. I know some people were asking, "What's the look-through fee stream if you include all those assets?" I don't know if you know that answer, but I just want to talk about the fees and kind of that fee layering concern.

Rich: Yeah, I mean, it definitely is a concern. You articulated very well, essentially, they're managing, call it nine hundred million assets, a billion dollars of assets. Many of those assets are invested in other REITs that they're also charging fees on. In terms of the total, I guess from my perspective, where I come out on this is I would prefer that they didn't do that. I guess a couple points here.

The first point is that, yes, they are charging double fees. If you're charging double fee as a closed-end fund, why not just not bother converting to a REIT? why not just continue to charge double fees? Why even bother going ahead and converting to a REIT and trying to increase your older value if all you really care about is these streams? So I think that's point number one.

Point number two is they have historically spun off either through IPO or pure spin-off some of this kind of related parties. It seems to me based on my conversations with the management team or with investor relations that that is going to be part of the strategy going forward. So you're going to be getting rid of. If they do that, you will be getting rid of the double layer of fees. If you as an investor are getting a part of the portfolio at NAV, obviously, the rest of the company's gap to NAV is going to have to shrink because of that.

The way that I think about it is, it is a concern. I think, hopefully through spin-offs and other other types of situations, other types of transactions, the double layer of fees goes away. But I think that's also why the opportunity exists. I think that's why it trades at a 40% discount. Partially, it's kind of reflected in the show price.

Andrew: Last thing I want to ask you about and then we'll kind of do closing thoughts, and everything. The dividend, right? Dividends generally, I'm very dividend and agnostic. Honestly, I'd much rather see Share BuyBacks because I think the things I don't undervalue and I love to see retiring shares. But dividends for closed-end funds can be nice because if they traded a discount and they're paying out cash to you, as you said if they're spinning stuffed off and all of a sudden you're realizing an NAV, the discount, the gap kind of widens and widens as you're getting that cash back.

So the main thing I want to ask about the dividend instead of ranting about dividends, once they convert to a REIT, they've discussed what the go-forward dividend strategy will be. I know right now the dividend yields about four and a half percent and that's one of the things you like about it. But once they convert the REIT, the dividend will probably look different. So let's talk about assuming they can convert to the REIT, what happens to the dividend and we can kind of go from there?

Rich: Yeah, so first of all, they they've caught their dividend pretty drastically. As recently, as October of 2020, so really not that long ago. It's a monthly dividend and it was cut from 20 cents down to 10 cents. That step was really taken partially because real estate assets, at that point, we had no vaccines. People were still very concerned about covid-19. We were thinking that we're going to be seeing the end of it. And so I think it makes sense to kind of retain liquidity a little bit.

Andrew: Can I push back on that?

Rich: Yeah.

Andrew: I hear you on that and that would be one suggestion, but I believe if I remember correctly, around the same time they cut the dividend, they actually ramped up the Share BuyBacks. So your way of saying it could be one, and my way of saying it could be, "Hey, this year's were so undervalue, they wanted more cash to Buyback shares," and the truth could be somewhere in the middle. Like companies can be a lot more flexible with Share BuyBacks than dividends, but that's just another interpretation. You can correct me if I was wrong there.

Rich: No, I agree completely that I would prefer to see Share BuyBacks instead of dividends, in terms of actually increasing value, especially, if you have an asset that that is trying to get a discount to fair value. So I think that's definitely a prudent use of cash. In the press release that they put out where they talked about why they're cutting the dividend, they did say kind of industry market conditions. They also said that they're transitioning portfolio to a more higher quality portfolio, which isn't necessarily going to yield as high, generate as much cash flow, but it's higher-value assets. But maybe the real reason was they were just like, "Hey, we think the stock is cheap and all the stuff that they put out wasn't true and they just wanted to buy back the stock," which I think would make would make a ton of sense.

So that was the first one and then they also basically cut the dividend again. So went from a 20 cent dividend per month to a 10 cent dividend in October of 2020 and then a little bit later. So I'm looking for the date of this. I believe the second dividend was cut, so it went from 20 cents to 10 cents and then from 10 cents down to five cents. The second cut was in October of 2020, and that was also kind of in conjuncture with basically that Share Buyback.

But essentially I think part of the reason why they cut the dividend was to buyback shares, but it was also because they were in the process of transitioning the portfolio. There're going to be some kind of one-time expenses in terms of transition from being a closed-end fund to REIT. So I think they were doing in part to retain cash flow. I don't have tremendous insight into kind of what the free cash flow generation of the business is going to be post-conversion but my sense is that they'll be able to pay out more than five cents per month which could attract another whole stream of potential retail investors that are attracted to REIT with a relatively high dividend.

Andrew: The hope is you flip it from a closed-end fund to REIT that in tracks a lot of buyers, it opens you up to retaill. It opens you up to REIT indexes, may be retail buyers who want a consistent REIT dividend come in, and then maybe you start increasing the REIT so you get in the growth REIT indexes. We've heard it before and it can work out great. I've also seen it work out poorly, but it generally works out poorly when you rely only on financial engineering and you don't have any real asset value there.

Last thing I want to ask about NXDT. We've covered a lot. I'm actually surprised by how much we've covered. I think we did a nice job. Is there anything we didn't hit on NXDT that you wish we had hit, or anything that maybe we glossed over a bit that you think we should hit a little harder?

Rich: No, I think I think we've hit on everything that really deserves attention. I'm not a REIT investor so anybody on Twitter who wants to reach out and kind of share data points and kind of give me bull cases, bear cases, I'd love to hear it. I would love feedback. I think the only other point that I wanted to hit on is just to provide some data in terms of what we can expect if the REIT conversion takes place.

So I looked at all the REITs that are classified as Diversified REITs from the North American Real Estate Investment Ttrusts Association, NAIREIT. I tried to, this is a little bit in a formal but I basically just tried to dig up all the Diversified US traded REITs and figure out how much packs of ownership there is. And if you have a market cap, that is below five hundred million, even if you're a diversified REIT ,there's very little passive ownership. But once you get up above 500 million to a billion, the passive ownership increases very significantly.

So I think there was one REIT, I'm blanking on the name. I can look it up, that had a market cap of about 700 million, or 800 million, which is where I think NXDT would be. And there was about 17% passive ownership based on Vanguard or State Street and Blackrocks. I think once if this catalyst does happen, I think we are going to get front of some indiscriminate buying pressure.

Andrew: And just to hit your point home for you. Right now, there's basically no passive...

Rich: Yes.

Andrew: So you'd be looking at, who knows, but if it gets into the indexes added, you probably get 15 to 20% of the shares need to be bought by the indexes and then there's always some index huggers, and followers who follow. And that's a real catalyst. People put pot. People put pot but getting past the fund flows can certainly drive a stock.

Okay. That's great. Hey, I've got two more for you. I'm going to put you on the spot. We haven't talked about these but we might as well.

You are the stockspinoff guy. I get your weekly Friday letter. So I'm leaving the horse a little bit. But outside of NXDT, what is your favorite recent spin-off that you're kind of following?

Rich: Yeah. So the name that I like to my biggest position is Jackson Financial. I don't know if you've looked at that one at all.

Andrew: I've looked at it a little bit. I've also looked at Bright House BHF which is a Compton Jackson Financial. Look, I love the thesis. I'll let you go to these but I would just say, pull up the 10K and read through the accounting. My God. To me, it's more a basket position where you want to play the event, the angle and the quant fund but it's just hard to take a huge swing at it because of the underlying assumptions is just tough, but I'm sorry to rant. Please go ahead.

Rich: No. 100%, 100%. And I am not by any means an accounting, annuity expert, or life insurance expert but the setup initially was really interesting because it was basically spun off from Prudential PLC, a UK-listed company selling off a US subsidiary. So the setup was beautiful. The ratio was perfect. I think for every 40 shares you owned at Prudential, you're going to get one share of Jackson Financial.

Andrew: Would you want to just explain why that ratio is perfect for people looking for Alpha. I know but to just drive that home.

Rich: Exactly. Yeah. Essentially if you own, let's see, if you own [crosstalk].

Andrew: Use 400 shares of Prudential for this.

Rich: 400 shares of Prudentials, essentially, you're going to get one share of this tiny little crappy spin-off that is just a rounding error in your portfolio. Not only is it a rounding error but it's a bad business, right? It's an annuity business. It's also traded in the US, Europe, UK. You're a UK investor, owning a UK company, you never made a decision to invest in this pure play, American annuity company. Essentially, it's just a complete pure greenblatt set up for kind of indiscriminate selling pressure.

So, that's the reason why there was a lot of selling pressure. Typically with spin-offs, you want to wait till at least 50% of the share count has traded before establishing a position, even if you think the stock's unattractive stock at trading an attractive valuations. This one was kind of a perfect case study for that. After 50% of shares, I'm started trading. The stock started to recover a little bit.

The thing that was really interesting about Jackson was that they had initially telegraphed that they were going to be returning edit slows about 16% of the market cap for dividends and through Share BuyBacks. I was hoping that a good portion of that would be returned through a dividend. I know BuyBacks are a lot better in terms of creating value than dividends. But in terms of a hard catalyst to force a stock to re-rate dividends are amazing like with Contour Brands. We saw the same thing with Jackson Financial. And the other reason why I was so excited is because Bright House has been buying back stock forever and it hasn't done anything. It hasn't done anything for the stock price. My interpretation of that it's incredibly simplistic but it's basically nobody believes the earnings are real to your point about what are all these accounting adjustments.

If their earnings were real, you would have comfort paying out a dividend. You don't have comfort paying out a dividend. So you're going to use that cash to buy back stock. You don't think it's rear car. So my thesis was that signaling that they're going to pay a dividend would basically signal to investors that management had a lot of confidence in the cash flows. So the stock is still trading, two times earnings. It's trading at about a five and a half percent dividend yield. Bright House does not pay a dividend yield, it's been using its extra cash to buy back shares. Equitable Holdings has a dividend yield close to two and a half percent. So I think there's a lot of room for that yield to compress and then they're also buying back a bunch of stock. So they've been buying back stock on a very accelerated basis. So that's one that I think even though it's kind of hard to wrap your head around, it's still pretty interesting.

Andrew: Look, I'm kicking myself because it's worked absolutely pitch perfectly, exactly how you said it was going to work as you said like if I just look at spun off and I think the day it's been off the share price was on 30 and by November it was around 25, 27 and as you and I are talking today, it's at 38. So from November to, we're talking on February 1st or 2nd, it's gone from 25 or 27 28 to 38. And by the way, markets have been in many meltdown mode over that time. So it's like, literally pitch perfect for y spin-offs, y selling and all this type of stuff can really work.

Last question for you and then I'll let you go. We talked about NXDT, great idea currently. You said Jackson still remains your favorite past spin-off. It's probably about eight spin-offs in the works right now, maybe a little bit more. Of all the spin-offs you're working, I know you start tracking and following them before, what's kind of the one not tradable today, it hasn't spin-off yet but what's the one you're most excited for that you're kind of getting ready to track?

Rich: Yeah. So the cool thing about spin-offs is you don't have to buy them all. You can wait for indiscriminate selling pressure. You can buy in before the spin-off takes place. You can buy them after. You can buy the parent or the spin-off. You don't have to buy the spin-off but I think one that looks actually really interesting is Bausch and Lomb.

Andrew: It's the most popular event that desperate name right now. It's somebody who traffics in events. I can tell you that everyone is talking Bausch and Lomb right now.

Rich: That makes me a little scared. Maybe it's not as good of an idea as I think. But the reason why I think it's so interesting is the thesis in a nutshell is that Bausch & Lomb is basically going to be spinning... I forget where the [inaudible] is. BHC is going to be spinning off Bausch and Lomb. Bausch and Lomb is a contact pure-play comp for Alcon that makes eye care products, contact solutions, contacts consumables, other eye care products. And the great thing about that business is it's very durable. It's pretty defensive. Alcon trades that have really, really nice high multiple. And so the thesis in a nutshell is that EBITDA, the revenue that's going to be generated by Bausch and Lomb, the spin-off is going to be traded a higher enterprise value. Then the remaining company is going to be kind of like a specialty pharma company with very high margins, lower growth but a lot of free cash flow.

And the reason why I was, if you run the math and you just try to figure out how much enterprise value creation this transaction is going to take place, it's not that much. It's not like the enterprise value is going to double or anything like that. Maybe it's going to increase by 10% or 15% or 20%. But the most interesting aspect of the way that they're setting up this transaction is they are basically leaving the vast majority of the debt with the parent company. So they're going to leave 6.8 terms of debt with the parent company. And the Bausch & Lomb, the spin-off is only going to have, I think, two and a half turns of debt. And so Alcon, I think trades about 20, 21 times EBITDA. So the vast majority of Bausch and Lomb of its enterprise value is going to be equity.

And one concern that I had for the parent company was that if you look at Via traceur, Organon, these are all recent spin-offs that are slow growth pharma companies that are trading ridiculously low valuations 5-6 times EBITDA. But by leaving so much debt, six and a half turns of debt on this parent company, the market is forced to value it at least six and a half times EBITDA. So maybe you get a half a turn for equity. So the market is going to be forced to value it that seven times on EBITDA basis.

And if you just run the math and you assume that Bausch and Lomb trades it called 20 times EBITDA, I think I get to like a 16 billion dollar enterprise value or something close to, then you subtract about two billion dollars of debt, get you to 14 billion of equity value. And equity value for Bausch and Lomb right now, I think it's like eight. So presumably there's a ton of upside if this action takes place, it's a big if. One thing that I'm digging into is, are the creditors going to basically sign off and on on it. That's kind of the big if from my perspective.

Andrew: Just to add to this because I have not done crazy amounts of work, but I've had a hitch and you just laid out a super compelling super interesting thesis, just add to it. For those who don't know, Bausch health, BHC is the ticker we're talking about. This is the former Valiant and one of the angles that a lot of event people have gotten into is exactly what you're saying, "Hey are the creditors going to let them spin this off or not?" And a lot of people say, "Well, almost all of the debt comes from back in the Valiant hey days, where Valiant was a high-flying stock backed by Bill Ackman." $200 per share was going to take over the world and revolutionize the pharma business. So a lot of debt was issued back in the high-flying days and guess what? High-flyers get really good covenants on their debt. So a lot of the event guys have been like, "Hey go dig through the debt and you could drive a truck through all the loopholes in the debt."

So they're kind of saying like, "Look, they're going to be able to spend this out." Exactly what you're saying. "You spin this out, all the current share price and more is going to be in the Bausch & Lomb business," which they've spun out. Yeah, the Stub Co, I mean, there's just probably option value there, but it doesn't matter because the stock is 25. I think you get $30 on the Bausch and Lomb side. All of that gets stuck at the current side and maybe there's a dollar or two for share or more if things work out especially pharma co, but that's a really attractive trade if they can get the spun out, which is why the event people love it and they let you work on and everything but this was great.

Rich, this has been great. I think we've run over time which sometimes asset plays can kind of go so quick. So this has been great. I've had so much fun. Looking forward to following up on NXDT, stockspinoffinvesting.com. I'm going to include a link in the show notes. I'll include a link to Rich's Twitter account, so you can go give them a follow. Shoot him DMs if you want to follow up on any of the questions we talked about here. And again, we've got eight or ten spin-offs in the work. So I'm looking forward to having you on later this year to talk about the next one. Rich Howe, thank you so much.

Rich: Yeah. Thanks so much, Andrew. This is great.

Andrew: Perfect.

[END]