Lately, I’ve been thinking about middlemen businesses. The Private Investment Brief wrote this thought provoking article on middlemen and why they exist. I've made several investments in middlemen companies - $LNG (toll operator for liquified natural gas), $EVI (distributor of laundry equipment with rollup strategy, $YTRA (#2 OTA in India). LNG and EVI thesis have played out well, while YTRA has been plagued by baffling capital raising decisions by management (25% dilution at $5.5/share. My cost basis ~$7.5/share). This post focuses on investment initiated last week - AINC - middleman / asset manager for AHT and BHR.
I think middle men definitely provide value, and they charge fees for that. But sometimes middlemen can also extract value from the ecosystem, which can be a good or bad thing depending on where you stand. An example: Warren Buffett recently commented that real estate agents (middlemen) provide valuable services especially for first time home buyers. I have the opposite opinion : realtors are extremely pricey middlemen that don't provide value for the high $ commissions in high cost regions, especially now that Zillow and Redfin provide so much search data. Buffett gains from the realtor fees from Berkshire Hathaway HomeServices, while I lose on the fees if I buy a house. How we think of middlemen depends on where we stand.
Now on to Ashford Inc Ashford Inc (AINC) – the asset manager for Ashford Trust (AHT) and Braemar (BHR). I first found about Ashford Inc from Greenhaven Road Capital's Q118 letter to investors. The basic thesis is that AINC is the vehicle for the CEO (actually the Bennett family) to extract value from AHT and BHR. Again, how we think of middlemen depends on where we stand. So if we stand as investor in AINC we can benefit, while shareholders of AHT and BHR might lose (gain and loss are relative terms here).
Stable base fees and onerous termination clause
AINC is setup to extract fees from AHT and BHR. Its the vehicle for Bennett family to extract more value for themselves. AINC provides management services for Ashford Trust and Braemar based on contract that has onerous termination requirements (atleast 12 times net earnings from each of the REIT, among other conditions). Such onerous termination clauses make the base fees a stable revenue source.
Base fees 0.7% of Market capitalization (where Market capitalization includes both equity and debt)
Incentive fees 5% * TSR outperformance * Total equity
2017 Base fees: $34.7M (Ashton Trust) and $8.8M (Braemar)
2017 Incentive fees: $1.8M (Ashton trust) and $1.3M (Braemar)
Ashford Inc shown as New Holdco in this diagram
Where is Bennett family money tied up?
The upside comes from the fact that Bennetts can increase assets under management for AHT and BHR and increase the fees they get from AINC. This seems easy to do since they manage all three entities – AINC, AHT, BHR.
Another useful check if AINC earnings are Bennett’s top priority is to check which entity has most of their capital tied up. Among the public companies that they manage, Ashford Inc is their biggest asset, i.e. their main vehicle to grow their riches. Post Remington Project management transaction, the Bennetts will have $225M tied in AINC ($22M stock + $223M in convertibles) vs $70M in AHT and $16M in BHR.
The Bennett family privately owns Remington Holdings LP – property and project management company – that Ashford Inc tried to buy in September 2015 for $321M (combination of stock and convertible). But Ashford terminated the merger agreement in Mar 2017 because it was not able to get favorable tax ruling (private letter ruling). In April 2018, Ashford Inc announced plans to acquired only project management portion of Remington for $203M in form of convertibles with convert price of $140. This acquisition is not contingent on favorable tax ruling.
Shares outstanding = 2.1M
Current Bennett ownership = 0.3M
Shares from converts = 1.45M
Bennetts will own ~50% of the company after Remington Project Management acquisition. They benefit a lot from this transaction – rich valuation on project management business.
Adjusted EBITDA = $17.4M (from AHT and BMR base fees_ + $4.5M (From J&S full year) + $16M (from Remington project management) = $38M
EV = $130M (market cap) + $203M (convertible for Remington project management transaction) - $34M (cash) = $229M
EV / EBITDA = 7.8
While this seems okayish, there are plenty of levers on growing the earnings here. Further, there will be positive impact on earnings from lower tax rates.
Earnings Growth levers:
- Ashford Trust and Braemar acquire more hotel assets via debt or equity issuance
- Ashford Inc expands J&S audio across its entire portfolio
- Pure Rooms and OpenKey growth adds to bottom lin
- Ashford Inc acquires more hotel middleman services
- AHT or BHR acquire another hotel REIT since that area seems ripe for further consolidation
The risk is further dilution by Bennetts who might enrich themselves at expense of minority shareholders. This could happen if AINC decides to acquire Remington asset management portion, which is likely to be $100M+ transaction based on previously abandoned deal.