If you’re looking for a company with serious upside, then you need to check out Equity CommonWealth (EQC 1.10%).
Before 2013, this real estate investment trust, or REIT -- which focuses on owning and leasing office space -- had an uninspiring history. But that changed when the company's management team was accused of aggressively growing assets only to line their pockets with additional management fees. Long story short, there were activist investors, angry letters, and a voting out of the company’s entire board of trustees in March 2014.
Here’s the good news: First, Equity CommonWealth is in full-blown turnaround mode; and that means you will get a nice discount on the stock. Second, the new management team has helped solidify the balance sheet. And third, that new management team is led by billionaire, and chairman of several of the most enviable real estate companies, Sam Zell.
1.The discount
Despite my optimism, during the company’s third quarter call in 2014, Zell said that “we took over a company that was not created with any logic behind it.” He continued, adding that the company is focused on selling assets – and that remains true today.
In short, Equity CommonWealth has a long way to go and there is no guarantee that it will blossom into a good business. That inherent risk warrants a discount.
One way to judge this is with the price-to-book ratio. This metric tells us what the company is worth, per share, if they liquidated their assets and paid off debt. As of Sept. 2015, here is what Equity CommonWealth price-to-book value looks like compared to two of its office property peers.
| Company | Stock price | Book value per share | Price-to-book value |
| Equity CommonWealth | $27.40 | $29.50 | 0.93 |
| Boston Properties | $125.00 | $61.70 | 2.03 |
| Highwoods Properties (HIW 0.39%) | $42.10 | $27.30 | 1.54 |
Source: company filings
Equity CommonWealth is trading at a 7% discount to its book value, and an even greater discount to its peers. This is enough to consider the stock cheap, but let's take it a step further.
As of today, Highwoods Properties is a good direct comparison to Equity CommonWealth. Both companies have $4 billion market caps, and their office properties are located in slightly lower-profile cities like Philadelphia, Atlanta, and Denver.
Therefore, if Equity CommonWealth's book value per share holds steady, and its valuation increased to 1.5x book value (the same as Highwoods Properties), then its stock price would increase 61%.
Moreover, for the company’s to warrant such a valuation investors would likely need to see improvements in earning, book value, and in the quality of the portfolio, and that could push the stock price up even higher. This represents serious upside, but such as dramatic discount could also be a warning sign that the company is in dire straits.
Is the business stable?
One of the best metrics to judge stability is debt to EBITDA. This measure uses a key cash flow measure, EBITDA, and gives insight into how many years it would take the company to pay down its debt, with earnings, if the situation remained constant.
Equity CommonWealth looks like they are in pretty rough shape. In general, a ratio close to nine is miserable and the company’s peers don’t make it looks any better.
However, Equity CommonWealth has been on a fire sale of its less-desirable assets -- this includes a number of smaller or poorly located properties. In fact, since the second quarter of 2014, the company sold off a third of their real estate assets. This has left the company was $1.6 billion in cash compared to just $2 billion in total liabilities. That provides more than enough cushion to feel comfortable about Equity CommonWealth's stability.
The new management team
To this point, you know that Equity CommonWealth is cheap and that the company isn’t going bankrupt -- which is not a compelling reason to buy anything. However, if you change your perspective, what you have is a good price on company that is ready to be rebuilt, and a management team that has proven they can build industry leading companies.
For instance, through his private investment firm, Equity Group Investments, Sam Zell has built three premier REITs: Equity Residential, the U.S.’s largest owner of apartments, Equity Lifestyle Properties, the U.S.’s largest owner of RV and manufactured home resorts, and Equity Office, which was built into the largest owner of office space before being sold to The Blackstone Group in 2007 for $39 billion.
Of the three, Equity Office is particularly important. This is not only because Equity CommonWealth also focuses on office properties, but that company's chief investment officer was David Helfand, who is Equity CommonWealth's current CEO.
Ultimately, Zell and Helfand have put Equity CommonWealth on firm financial footing. Now the company has $1.6 billion in cash -- which is enough to grow assets by 40% -- and two executives that have a proven track record of building companies. There are no sure things in investing, but I think Equity CommonWealth is a good bet to become a successful turnaround story. I will be adding the stock to my Motely Fool CAPS account – you can follow how it does here.
