LEGACY HOTELS REIT
Legacy Hotels REIT owns 24 hotels with over
10,000 guest rooms in both Canada and the United States. The REIT
owns several of Canada’s landmark hotels, including the Fairmont
Chateau Frontenac and Toronto’s Fairmont Royal York. In addition to
its luxury properties, Legacy’s portfolio includes 11 Delta hotels
and the Sheraton Eau Claire in Calgary, Alberta.
Legacy is now starting to achieve traction as
the Canadian hotel industry recovers from 9/11 and SARS. Legacy’s Q1
2006 revenue was the highest in its history, and more importantly,
gross margins reached levels not seen since 2001. Despite this good
news, the REIT still faces challenges such as a high Canadian dollar
and rising labour and energy costs. Legacy’s units are still down
over 15% from its $10/unit 1997 initial public offering.
Despite the Trust’s near-term challenges, we
believe the units are fundamentally undervalued at current prices.
Indeed, Legacy is an example of the market failing to see the forest
for the trees. Recent market data suggests that asset values in many
of Legacy’s markets have appreciated significantly since its 1997
offering. We see an opportunity to unlock even greater value through
strategic alternatives such as condo conversions, selling excess
land, and joint venture development projects that will surface the
hidden value of these historic properties. We believe that Legacy’s
net asset value is approximately $9.50 unit.
Kingdom’s purchase of Fairmont early in the
year garnered much media attention and led to speculation about its
24% stake in Legacy. At that time, we argued that both Legacy and
Fairmont stakeholders would benefit from either a sale of this
interest or the acquisition of Legacy in its entirety. Now, only
four months later, with the announcement that Fairmont will convert
its 9.8 million exchangeable shares into trust units, it appears the
sale of its 24% stake is imminent. In a related announcement,
Kingdom revealed that it is close to selling 15 hotels for $3
billion, including Canadian landmarks such as the Fairmont Jasper
Park Lodge and Fairmont Chateau Lake Louise.
As Kingdom starts to sell its Canadian
properties, we believe it will highlight the disconnect between
Legacy’s current market value and net asset value. Fairmont was
purchased for more than $370,000 per hotel door. In comparison,
Legacy’s current unit price implies a valuation of around $175,000
per door (below its book value of $190,000 per door). In addition,
we believe that a competitive bidding process will also demonstrate
that hotel assets with third party management contracts are not only
desirable, but in strong demand.
KEYNOTE SYSTEMS
Keynote Systems is a California-based leading
provider of measurement and monitoring systems for e-commerce
websites with a market share of approximately 80%. Its customers
range from small web-based companies to large Fortune 500 companies
such as Amazon, American Express, Cisco, Dell, EBay and Microsoft.
The company is headed by Umang Gupta, one of Keynote’s largest
shareholders owning approximately 1.8 million shares or 10% of the
company.
Keynote went public in September 1999 at $14 a
share and didn’t look back. Five months later it did a secondary
offering at $105. The shares rose to an incredible $163.75 in March
2000 before succumbing to the bursting technology bubble. By
December 2000, Keynote shares had given back all it had gained and
eventually fell below its original IPO price. For the last five
years, Keynote’s stock has been virtually flat in comparison to its
amazing rise and fall in 1999-2000. During this time, however, the
Company has quietly improved its product and service offerings and
managed to remain the dominant monitoring company in the industry.
It is also interesting to note that since 2000, Keynote’s share base
has declined from 23 million to just under 19 million today.
We do not usually purchase shares in
technology companies because they are often too expensive on a book
or net asset value basis. However, when we discovered Keynote
trading below its tangible book value of $10.43, we felt it
warranted further investigation. After doing our homework, we found
that Keynote was in fact an ABC-type stock. With a market
capitalization of close to $200 million, Keynote was debt free with
cash in the bank of $137 million. It also owned its headquarters in
San Mateo, California. The building, which was purchased for $85
million in 2000, had been subsequently written down in 2002 to just
$35 million. When we added the cash and real estate together, we
found that it accounted for nearly the entire market capitalization
of the Company. In effect, we were getting the remaining technology
business for next to nothing.
Today, CEO Umang Gupta is focused on expanding
Keynote’s service offerings and increasing its customer base. With
the company’s large war-chest of cash, he is also on the prowl for
opportunistic acquisitions. But with its share price continuing to
trade at such low valuations, the hunter could become the hunted.
Given its large cash position, hidden real estate, and dominant
market position, we think Keynote might just end up being sold to a
larger industry player. If it was to be purchased, we think an
acquirer would have to pay a premium price to where the stock is
currently trading.
Irwin A. Michael, CFA
