Stripnomics

Growth by acquisition must always be questioned. Sometimes it makes sense from management’s standpoint because you can take advantage of economies of scale and other forms of comparative advantage. Sometimes management orchestrates a merger to paralyze and confuse the market by forcing participants to figure out two sets of indecipherable fine print instead of just one.

American Campus Communities (ACC) recently merged with the remaining student housing divisions of GMH Communities Trust (GCT). I believe the motives were dubious. Like ACC, GCT was not a healthy company. According to GCT’s last 10K, they were, “…one of the largest private operators of off-campus housing for college and university students in the U.S”. If you wanted to begin to take on the task of understanding this merger, you would first have to tackle GCT’s 150+ page 10K for the fiscal year 2007. I have done so and will fill you in on my findings. 

Let me preface by saying that ACC has a high cost structure for a REIT that will limit profits, growth and eventually drive down the stock price. I’m going to examine GCT’s business to see if the addition will be an asset or a liability to ACC.

Like ACC, GCT offered some impressive amenities to its residents, including some of the following:

• private bedrooms & bathrooms
• cable television
• high speed internet access
• washer & dryer in each unit
• fitness centers
• swimming pools
• computer centers
• study rooms
• game rooms
• employees and managers living on-site
• 24-hour maintenance
• 24-hour emergency services
• athletic competitions
• “battle of the bands” nights
• non-alcoholic (boo!) social events

I mention these amenities because I know they are not free and will affect the bottom line. Take a look at GCT’s Revenue and Operating Costs for its Student Housing Business (from the 2007 10K at pages 78-79) for the last 2 years:

GMH Communities Trust
Owned Student Housing & Student Housing Management Divisions
	2006	2007
Total Revenue	$187,162,000	$212,639,000
Operating Expenses	$149,749,000	$174,969,000
Income (Loss)	$37,413,000	$37,670,000
Expense / Revenue Ratio	80.01%	82.28%

I have excluded depreciation and amortization (which are non-cash expenses) and I have excluded corporate expenses that might not have been transferred to ACC. Otherwise, the expenses would actually be higher. I am trying to give GCT the benefit if the doubt and get a good idea of annual real cash expenses that ACC will inherit. Also, keep in mind that these profits were based on Assets that are supposed to be worth $1.3B+ (How is that for an ROI?).

As you can see, GCT’s student housing divisions have thin margins and expenses went UP by 2%. The expenses are out of control. Think of the expense ratio in terms of renting out a house. For every $1000 of rent you have to pay expenses of around $820 - NOT INCLUDING PAYMENTS TOWARDS PRINCIPAL DEBT. Would you want to be in that situation in this real estate market? I think not. 

We can also take a look at the Ca$h Flow Statement. Balance sheets and Income Statements can be manipulated by crafty legal and accounting tricks. The Ca$h Flow Statement cannot be manipulated so easily, so you really only have to worry about actual fraud (like Madoff, Satyam etc.).

Here are GCT’s operating cash flows including the military housing division that was NOT part of the merger (take my word for it… that was the best business line):

		2005	2006	2007
Net Cash Provided by Operating Activities		$         50,302,000	$         46,609,000	$       31,431,000

 

As you can see, the cash flow is DECREASING and ACCELERATING year after year. After you take into account that the numbers are bolstered by the military housing portion of the business that was actually profitable and not part of the merger - we know the student housing numbers really suck.

Obviously, it will be quite a challenge for ACC to incorporate GCT and make them adequately profitable. We should take a look at ACC’s historic operating cost ratios to gauge the likelihood that management will be able to cut margins. Unfortunately for us, ACC and GCT kepts books differently. ACC breaks out Interest Expense as a separate non-operating expense (as if it’s not really a cost business) so I have to add it back in to get a good comparison. I think this is the most fair way to try and get an apples-to-apples comparison. Again, I will exclude depreciation since it is not a cash expense. 

American Campus Communities (ACC)
	2005	2006	2007
Total Revenue	$82,522,000.00	$118,953,000	$147,135,000
Operating Expenses	$64,974,000.00	$90,361,000	$117,366,000
Income (Loss)	$17,548,000	$28,592,000	$29,769,000
Expense / Revenue Ratio	78.74%	75.96%	79.77%

ACC was actually a healthier company than GCT and the merger saved GCT. However, ACC’s expenses do not look pretty either. They are running expenses around the 80% level also so I don’t expect that they will be able to drastically cut GCT’s expenses much.  Here are ACC’s cash flows for the past 3 years:

		2005	2006	2007
Net Cash Provided by Operating Activities		$         29,047,000	$         35,237,000	$       20,429,000

 

The numbers for ACC are better but still pretty close to GCT’s margins. It’s obvious that expenses in the student housing arena seem to be tough to reign in. Think about it in common sense terms: renting out office space to a corporate tenant takes a lot less time, energy and money than renting to college students. 

Now lets look at the expense ratios for the past 2 quarters since the merger to see how the integration has affected expenses.

American Campus Communities (ACC)
	2008 - Q2	2008 - Q3
Total Revenue	$43,548,000	$72,134,000
Operating Expenses	$33,903,000	$68,336,000
Income (Loss)	$9,645,000	$3,798,000
Expense / Revenue Ratio	77.85%	94.73%

(Please note that the merger was completed on June 11th, less than 1 month before the end of Q2 so Q2 figures don’t fully reflect the impact.)

You can see that the revenue ratio for Q3 (the first full quarter to reflect the merger) jumped all the way to 94%. It is obvious that there are growing pains involved in the merger. In addition, I know that many of the expenses are fixed (like taxes, interest etc.) and cannot simply be eliminated.

I conclude that the merger is unlikely to benefit ACC in the long-run. Historically, ACC has been unable to control its own expenses and I doubt it will be able to reign in GCT’s high costs enough to justify the merger. The merger was essentially the marriage of two crappy companies into one bigger crapppier company.

Investors will figure it all out soon enough.

This entry was posted on Tuesday, January 27th, 2009 at 9:42 pm and is filed under Accounting, American Campus Communities (ACC), Economics, Real Estate, Trading. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.