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MarketScreener Homepage  >  Equities  >  Nyse  >  Colony Capital, Inc.    CLNY

COLONY CAPITAL, INC.

(CLNY)
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COLONY CAPITAL : Management's Discussion and Analysis of Financial Condition and Results of Operations. (form 10-Q)

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11/08/2019 | 04:58pm EST
The following discussion should be read in conjunction with our unaudited
consolidated financial statements and accompanying notes thereto, which are
included in Item 1 of this Quarterly Report, as well as information contained in
our Annual Report on Form 10-K for the year ended December 31, 2018, which is
accessible on the SEC's website at www.sec.gov.
Overview
We are a leading global investment management firm with $53 billion in assets
under management ("AUM"), which includes approximately $14 billion of AUM from
Digital Bridge Holdings LLC ("DBH"), a leading global investment manager of
digital real estate infrastructure assets including cell towers, small cells,
fiber and data centers. We manage capital on behalf of our stockholders, as well
as institutional and retail investors in private funds, and traded and
non-traded real estate investment trusts ("REITs"). We have significant holdings
in: (a) the healthcare, industrial and hospitality property sectors; (b) Colony
Credit Real Estate, Inc. (NYSE: CLNC), which is externally managed by a
subsidiary of the Company; and (c) various other equity and debt investments. We
are headquartered in Los Angeles, with key offices in Boca Raton, New York,
Paris and London, and have over 450 employees across 21 locations in 13
countries.
We were organized on May 31, 2016 as a Maryland corporation, and was formed
through a tri-party merger (the "Merger") among Colony Capital, Inc. ("Colony"),
NorthStar Asset Management Group Inc. ("NSAM") and NorthStar Realty Finance
Corp. ("NRF") in an all-stock exchange on January 10, 2017. We elected to be
taxed as a REIT for U.S. federal income tax purposes commencing with our initial
taxable year ended December 31, 2017.
We conduct our operations as a REIT, and generally are not subject to U.S.
federal income taxes on our taxable income to the extent that we annually
distribute all of our taxable income to stockholders and maintain qualification
as a REIT, although we are subject to U.S. federal income tax on income earned
through our taxable subsidiaries. We also operate our business in a manner that
will permit us to maintain our exemption from registration as an investment
company under the 1940 Act. We conduct substantially all of our activities and
hold substantially all of our assets and liabilities through our Operating
Company. At September 30, 2019, we owned 90.3% of the Operating Company, as its
sole managing member.
Our Business
Our vision is to establish the Company as a leading owner and investment manager
of assets, businesses, and investment management products in which the digital
and real estate frontiers intersect. We believe our deep understanding of
commercial real estate and digital infrastructure provides us a significant
advantage in identifying relative value throughout economic cycles. Through our
prudent sector or subsector capital allocation and operational capabilities, we
aim to generate outsized total returns on our balance sheet and third-party
capital. Specifically, our preference is to invest our balance sheet capital
alongside third party capital to create alignment and generate returns for our
shareholders in two ways. First, through the return on investment through our
balance sheet capital. Second, through base management fees paid by third party
capital and potential carried interest, which provides us with a greater
participation of profits after a minimum return is achieved. Over time, our goal
is to manage third party capital alongside the majority of our balance sheet
capital at a higher ratio than what is currently in place.
Currently, we conduct our business through the following six segments:
•      Healthcare-Our healthcare segment is composed of a diverse portfolio of

senior housing, skilled nursing facilities, medical office buildings and

hospitals. We earn rental income from our senior housing, skilled nursing

facilities and hospital assets that are under net leases to single

tenants/operators and from medical office buildings which are both single

tenant and multi-tenant. In addition, certain of our senior housing

properties are managed by operators under a RIDEA (REIT Investment

Diversification and Empowerment Act) structure, which effectively allows

us to gain financial exposure to the underlying operations of the facility

       in a tax efficient manner versus receiving contractual rent under a net
       lease arrangement.


•      Industrial-Our industrial segment is composed of primarily light

industrial assets throughout the U.S. The light industrial properties

serve as the "last mile" of the logistics chain, which are vital for

e-commerce and tenants that require increasingly quick delivery times. In

addition, in February 2019, the Company entered into the bulk industrial

market as bulk assets remain integral to highly functional distribution

networks. Driven by significant appreciation in the value of our

industrial portfolio, in June 2019, we engaged advisors to market our

industrial portfolio and the related management platform for sale and in

September 2019, entered into definitive sale agreements. As the planned

       sale represents a strategic shift that will have a major effect on the
       Company's



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operations and financial results, the operating results of the industrial
business are presented as discontinued operations on the consolidated statements
of operations.
•      Hospitality-Our hospitality portfolio is composed of primarily extended

stay and select service hotels located mainly in major metropolitan and

high-demand suburban markets in the U.S., with the majority affiliated

with top hotel brands such as Marriott and Hilton.

• CLNC-This represents our investment in Colony Credit (as described below),

a commercial real estate credit REIT with a diverse portfolio consisting

       primarily of commercial real estate ("CRE") senior mortgage loans,
       mezzanine loans, preferred equity, debt securities and net lease
       properties primarily in the U.S.


•      Other Equity and Debt-Our other equity and debt segment consists of a
       diversified group of strategic and non-strategic real estate and real

estate-related debt and equity investments. Strategic investments include

investments for which the Company acts as a general partner and/or manager

("GP Co-Investments") and receives various forms of investment management

       economics on related third-party capital. Non-strategic investments are
       composed of those investments the Company does not intend to own for the
       long term including other real estate equity, real estate debt, and net
       leased assets, among other holdings.

• Investment Management-Our investment management business raises, invests

and manages funds on behalf of a diverse set of institutional and

individual investors, for which we earn management fees, generally based

on the amount of assets or capital managed, and contractual incentive fees

or carried interest based on the performance of the investment vehicles

managed subject to the achievement of minimum return hurdles. The

potential sale of the industrial segment includes our general partner

interest in the industrial investment vehicles and related management

contracts, reported under the investment management segment.



Colony Credit
We own an approximate 36.4% interest, on a fully diluted basis, in Colony Credit
Real Estate, Inc. ("Colony Credit"). Colony Credit was formed on January 31,
2018 through a contribution of the CLNY Contributed Portfolio (as described
below), represented by our ownership interests ranging from 38% to 100% in
certain investment entities ("CLNY Investment Entities"), and a concurrent
all-stock merger with NorthStar Real Estate Income Trust, Inc. ("NorthStar I")
and NorthStar Real Estate Income II, Inc. ("NorthStar II"), both publicly
registered non-traded REITs sponsored and managed by our subsidiary (the
"Combination"). The CLNY Contributed Portfolio comprised our interests in
certain commercial real estate loans, net lease properties and limited
partnership interests in third party sponsored funds, which represented a select
portfolio of U.S. investments within our other equity and debt segment that were
transferable assets consistent with Colony Credit's strategy. Upon closing of
the Combination, our management contracts with NorthStar I and NorthStar II were
terminated; concurrently, we entered into a new management agreement with Colony
Credit.
Corporate Restructuring
Following a strategic review process, in November 2018, we announced a corporate
restructuring and reorganization plan aimed at reducing our annual compensation
and administrative expenses over approximately 12 months. The restructuring plan
was designed to match resources that further align our increasing focus on our
investment management business by, among other things, reducing our workforce
globally by 10% to 20%, primarily in connection with the exit of non-core assets
and business lines, together with general cost reductions.
We have now achieved approximately 80% of our expected $50 to $55 million ($45
to $50 million on a cash basis) of the previously announced annual compensation
and administrative cost savings on a run rate basis, with remaining cost savings
expected to be achieved by the end of 2019.
Corporate Governance Enhancements
In February 2019, we announced the implementation of a series of changes
designed to enhance our corporate governance, and entered into a cooperation
agreement with Blackwells Capital LLC, a stockholder of the Company. In
connection with the cooperation agreement, our board of directors appointed
three new independent directors to the board. In addition, in accordance with
the cooperation agreement, our board of directors formed a Strategic Asset
Review Committee composed solely of independent directors to review, evaluate
and make recommendations to the board on issues relating to our assets and
business configuration.

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Strategic Asset Review Update
As part of a comprehensive review undertaken by the Company, together with its
Strategic Asset Review Committee and an independent advisor, the Company has
undertaken certain assessments and strategic initiatives intended to build on
core investment management competencies while focusing on high-growth
businesses. A key component of this strategic evolution was our recent
acquisition of DBH, which also addressed our Chief Executive Officer succession
plans. These previously announced and/or completed initiatives also include
termination of our management agreement with NRE in connection with the sale of
NRE, repositioning of Colony Credit's portfolio and its potential
internalization (as discussed below), stabilization of the debt capital
structure of the healthcare portfolio, and a corporate restructuring and
reorganization plan that is on track with its cost savings objectives.
In connection with the acquisition of DBH, we entered into an employment
agreement with Marc C. Ganzi, co-founder and Chief Executive Officer of DBH,
pursuant to which Mr. Ganzi serves as Managing Director of the Company and Chief
Executive Officer of the Company's digital realty platform. Upon the later of
the termination of the investment period of Digital Colony Partners ("Digital
Colony," a fund co-sponsored by us and DBH), and December 31, 2020, Mr. Ganzi
will serve as the Company's Chief Executive Officer, succeeding Thomas J.
Barrack, Jr., who will return to the position of Executive Chairman of the
Company.
Additionally, in June 2019, the Company engaged advisors to market the Company's
industrial portfolio and the related management platform for sale. There has
been significant appreciation in the value of the industrial portfolio driven by
favorable operating fundamentals and strong investor demand for light industrial
assets. In September 2019, the Company entered into definitive sale agreements
for an aggregate gross sales price of approximately $5.9 billion. In November
2019, the definitive sale agreement providing for the sale of the bulk
industrial portfolio for $190 million was terminated. The Company is in the
process of negotiating an agreement with a third party for the sale of the bulk
industrial portfolio on substantially the same economic terms as the prior
agreement. The sale of the light industrial portfolio and the related management
platform is expected to generate a significant gain and is expected to close in
the fourth quarter of 2019, subject to customary closing conditions. However, no
assurances can be made that these sales can be completed within the time frame
contemplated, or on the terms anticipated, or at all. If the sale is completed,
the Company may redeploy a portion of the proceeds into higher total return
strategies (e.g., digital real estate and infrastructure) and may further
consider the reduction of corporate leverage or other uses. The sale of the
industrial segment, including its related management platform, represents a
strategic shift that will have a significant effect on the Company's operations
and financial results, and has met the criteria as held for sale and
discontinued operations. Accordingly, for all current and prior periods
presented, the related assets and liabilities are presented as assets and
liabilities held for sale on the consolidated balance sheets (see Note 7 to the
consolidated financial statements) and the related operating results are
presented as income from discontinued operations on the consolidated statement
of operations (see Note 15 to the consolidated financial statements).
As the Company undertakes its strategic evolution, the Company anticipates
shifting its focus from traditional real estate towards a digital real estate
and infrastructure business. At this time, management, together with the
Strategic Asset Review Committee and its independent advisor, are in the process
of formulating the details around the Company's strategic plan, which is
expected to be recommended to the Company's Board of Directors in the fourth
quarter of 2019 prior to finalization. The strategic plan is expected to provide
a broad outline of topics such as the Company's asset rotation plan, capital
allocation policy, target investment profile and capital structure, and the
vision for establishing the Company as the leading platform for digital real
estate and infrastructure.
A potential strategic shift in the Company's business may represent an indicator
of impairment and the Company performed an assessment as of September 30, 2019
to ascertain if the net carrying value of its investments, including its
healthcare and hospitality real estate, would be recoverable. A final strategic
plan is expected to provide more specificity as to the Company's expected
holding periods for its investments, including its healthcare and hospitality
assets. In the absence of such information, and with considerable uncertainty
still surrounding the strategic plan, the Company applied its best estimate at
this time based upon undiscounted future net cash flows to be generated by these
assets over a long-term hold. The analysis indicated that as of September 30,
2019, the net carrying value of the Company's investments, including its
healthcare and hospitality assets, would be recoverable. A shortened holding
period for these assets may significantly reduce the undiscounted future net
cash flows to be generated by certain assets below their carrying values.
Therefore, if the final strategic plan adopted by the Company contemplates a
shortened holding period for these assets, the Company expects that such a
decision, if and when made, may result in a significant impairment in the
carrying value of its investments, specifically certain of its healthcare and
hospitality assets. At September 30, 2019, the healthcare and hospitality
segments had real estate held for investment with carrying values of $4.6
billion and $3.6 billion, respectively, financed with $3.0 billion and $2.7
billion of debt, respectively. At September 30, 2019, we own 71% of our
healthcare segment and 94% of our hospitality segment.

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Colony Credit
As part of Colony Credit's strategic plan, in the third quarter of 2019, Colony
Credit bifurcated its assets into a core portfolio and a legacy, non-strategic
portfolio, which will allow Colony Credit to focus on the divestment of its
legacy, non-strategic portfolio and to redeploy into and grow its core
portfolio. In conjunction with its focus on its core portfolio, Colony Credit
meaningfully reduced the book value of its legacy, non-strategic assets to
better reflect its market value and reset its annualized dividend from $1.74 per
share to $1.20 per share. As a result of the meaningful reduction to Colony
Credit's book value, in November 2019, the Company amended its management
agreement with Colony Credit to reduce the fee base to reflect Colony Credit's
reduced book value, which will result in a decrease in management fees to the
Company effective in the beginning of the fourth quarter of 2019.
Additionally, in November 2019, the Company delivered a non-binding letter to
the independent directors of Colony Credit, seeking to explore with Colony
Credit the possible internalization of its management and a transfer of the
Company's credit investment management business to Colony Credit to (i) further
the Company's strategic repositioning to simplify and establish the Company as
the leading platform for digital real estate and infrastructure and (ii)
position Colony Credit to become a leading independent real estate credit REIT
with a clearly defined strategy positioned for greater growth. There can be no
assurance that the Company and Colony Credit will reach an agreement with
respect to an internalization of Colony Credit or any of the other matters
described in the letter, that the nature or terms of an internalization of
Colony Credit or any such others matters will not differ from the description in
the letter, or that an internalization of Colony Credit or any such other
matters will be completed. If an agreement is reached between the Company and
Colony Credit on an internalization of Colony Credit and a transfer of the
Company's credit investment management business to Colony Credit, this may
result in a decline in the fair value of the Company's investment management
reporting unit, which may result in further impairment of goodwill in the
future.
Developments in 2019
During the nine months ended September 30, 2019 and through November 6, 2019,
significant developments affecting our business and results of operations
included the following:
Acquisitions, Dispositions and Fundraising
•      In April 2019, acquired the private equity platform of the Abraaj Group in

Latin America, which has been renamed Colony Latam Partners and manages

approximately $574 million of AUM, for $5.5 million. Colony Latam Partners

       will continue to be headed by its existing senior management team.

• In June 2019, classified our industrial segment and related management

platform as held for sale and discontinued operations. In September 2019,

entered into definitive agreements for the sale of our light industrial

       portfolio and the related management platform for an aggregate gross sales
       price of approximately $5.7 billion, which is expected to generate a
       significant gain, and is expected to close in the fourth quarter of 2019,
       subject to customary closing conditions. This agreement now excludes our

bulk industrial portfolio for which we are in the process of negotiating a

       sale separately with another third party.


•      In the first nine months of 2019, the industrial segment acquired 90

buildings and five parcels of land for $1.5 billion, financed through $952

million of new debt, with its existing $400 million revolver replaced with

a $600 million revolver. In terms of fundraising, raised an additional

$142 million of capital in our open-end light industrial fund in the first

quarter of 2019, bringing total third party capital raised to date in our

light industrial platform to $1.66 billion. Additionally, raised $70

million of capital in our bulk industrial joint venture formed in February

2019.

• In July 2019, acquired DBH for $329 million in a combination of cash and

OP units as part of our strategic evolution to become the leading platform

for digital infrastructure and real estate, adding $14 billion of AUM.

This acquisition follows the May 2019 final closing of the Digital Colony

fund.

• In July 2019, formed a strategic joint venture with California Resources

Corporation (NYSE: CRC) through our energy investment management arm,

Alpine Energy, LLC ("Alpine," formerly Colony HB2 Energy, LLC), to which

Alpine has committed to fund $320 million for development of CRC's

flagship Elk Hills field. In August 2019, Equity Group Investments became

a strategic joint venture partner of Alpine.

• In July 2019, closed on our fifth global real estate credit fund (second

as a public company), with total capital commitments of approximately $428

million (inclusive of our capital commitment of $121 million, which may be

reduced to no less than 5% of total commitments from future third party

commitments).

• In September 2019, NRE sold all of its outstanding common stock for $17.01

per share and we received proceeds of approximately $96 million for our

investment in NRE, recording a gain of $12 million, included in equity

       method



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earnings. The sale resulted in the termination of the NRE management agreement,
for which the Company received the remaining $65 million of the $70 million lump
sum incentive and termination fee.
Financing and Capital Transactions
•      Repurchased 652,311 shares of our class A common stock for $3.2 million

under our stock repurchase program.

• In April 2019, amended certain terms of our Credit Agreement, including a

       reduction of aggregate revolving commitments from $1 billion to $750
       million and modification of a financial covenant and borrowing base
       formula.

• Refinanced $2.21 billion of debt principal in our healthcare segment that

was scheduled to mature in 2019 and extended their maturities to 2024

(including extension options). Our completed refinancings included $1.725

billion of mortgage debt, which was paid in full with proceeds from a new

$1.515 billion secured debt, and $250 million of new equity contribution,

       of which $174 million was funded by us and remainder by our equity
       partners in the healthcare portfolio.

• Refinanced an aggregate $116 million of debt principal in our hospitality

portfolio, extending their maturities to 2024 (including extension

options).

Other

• Recorded an impairment charge in June 2019 of $228 million to write down

our 36.4% interest in Colony Credit to the closing price of Colony

       Credit's common stock at June 28, 2019, as part of equity method loss.


•      Remeasured our 50% interest in Digital Colony Manager upon closing of the
       DBH acquisition and recorded a gain of $51 million, representing 50% of
       the fair value of the Digital Colony fund management contract.


•      Entered into a series of transactions effectively terminating the $2
       billion notional interest rate swap assumed through the Merger for $365

million in total, of which $224 million was paid in the third quarter of

       2019, with remaining settlement fixed at $141 million expected to be paid
       in December 2019.


•      Recognized carried interest from our industrial open-end fund of $35
       million, of which 50% is allocated to senior management, investment
       professionals and certain other employees as compensation.

• Recorded impairment of $387 million in September 2019 on the investment

management goodwill, driven primarily by loss of future fee income that is

       expected to result from the pending sale of its industrial business and
       the amendment of Colony Credit's management agreement to reduce the fee
       base to reflect Colony Credit's reduced book value.


Results of Operations
The following table summarizes our results of operations by segment.
Results of operations associated with our industrial business are presented as
discontinued operations for all current and prior periods presented (see Note 15
to the consolidated financial statements). Those results include (i) the entire
industrial segment, and (ii) portions of the investment management segment
associated with the industrial business,

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including fees and carried interest from the industrial open-end fund and related compensation expense.

                                                                                         Net Income (Loss) Attributable to
(in thousands)                 Total Revenues                Net Income (Loss)                 Colony Capital, Inc.
Three Months Ended
September 30,               2019            2018             2019           2018              2019                 2018
Healthcare              $   136,091$   147,907$   (112,554 )$ (15,051 )$      (82,763 )$    (12,197 )
Industrial                        -               -           38,981         6,296             10,263                1,001
Hospitality                 218,378         224,384          (34,365 )     (66,620 )          (28,359 )            (62,900 )
CLNC                              -               -            7,979       (19,480 )            7,277              (18,328 )
Other Equity and Debt       151,137         182,288           (5,160 )      88,053            (16,992 )             57,715

Investment Management 144,203 41,987 (316,302 ) 20,041

           (287,833 )             19,145
Amounts not allocated
to segments                   2,686           2,161         (144,421 )     (30,653 )         (129,409 )            (27,226 )
                        $   652,495$   598,727$   (565,842 )$ (17,414 )$     (527,816 )$    (42,790 )
Nine Months Ended
September 30,
Healthcare              $   427,761$   445,921$   (201,280 )$ (47,665 )$     (148,841 )$    (36,913 )
Industrial                        -               -           60,472        17,285             13,556                3,089
Hospitality                 642,073         649,539          (63,947 )     (71,735 )          (54,670 )            (67,183 )
CLNC                              -               -         (254,420 )     (17,721 )         (239,337 )            (16,670 )
Other Equity and Debt       465,891         578,392           54,399       218,235              1,089              138,157

Investment Management 228,010 131,103 (289,516 ) (115,202 ) (262,934 )

           (108,445 )
Amounts not allocated
to segments                  10,258           5,857         (386,351 )     (70,677 )         (353,407 )            (61,565 )
                        $ 1,773,993$ 1,810,812$ (1,080,643 )$ (87,480 )$   (1,044,544 )$   (149,530 )


Selected Balance Sheet Data
The following table summarizes key balance sheet data by segment and the
industrial business that is held for sale.
All assets and liabilities of the industrial business are classified as held for
sale for all current and periods presented (see Note 7 to the consolidated
financial statements).
                                                                                                              Amounts Not
(In                                                                  Other Equity         Investment          Allocated to                      Industrial Held
thousands)       Healthcare      Hospitality           CLNC            and Debt           Management            Segments           Total           For Sale
September 30,
2019
Real estate,
net             $ 4,497,753$  3,593,772     $            -     $   1,630,895     $               -     $            -     $  9,722,420$   4,240,742
Loans
receivable,
net                  53,677                -                  -         1,400,522                     -                  -        1,454,199                 -
Equity and
debt
investments               -                -            731,306         1,400,684               155,389              3,742        2,291,121            48,478
Debt, net         2,913,811        2,623,383                  -         2,094,893               184,200            849,821        8,666,108         2,131,497
December 31,
2018
Real estate,
net             $ 4,995,298$  3,668,824     $            -     $   2,161,888     $               -     $            -     $ 10,826,010$   2,793,004
Loans
receivable,
net                  48,330                -                  -         1,597,214                13,673                  -        1,659,217                 -
Equity and
debt
investments               -                -          1,037,754         1,307,369               180,882              3,742        2,529,747            13,422
Debt, net         3,213,992        2,603,599                  -         2,309,347                     -            848,434        8,975,372         1,064,585




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