Say this about Barry Portnoy and his son, Adam: They were never shy about making enemies.
I like to think of the Portnoys, who run a very big national real estate empire from Newton, as the poster family for bad corporate governance. For years, investors have had good reason to complain about a business bound up in conflicts of interest that favored managers at the expense of owners. But nobody has been able to do anything about it.
Now the Portnoys are facing much more formidable opponents in a fight over Commonwealth REIT, a public real estate investment trust that controls a portfolio of office buildings worth more than $5 billion. A management company owned by the Portnoys oversees Commonwealth and effectively controls it for now. But two New York investment firms, which together own nearly 10 percent of Commonwealth’s shares, are soliciting other investors to fire all of the trust’s directors.
This is no small-potatoes fight. Commonwealth commands a stock market value of $3 billion, and the Portnoy firm has collected fees of about $478 million for managing the business over the past seven years, according to the investors trying to replace the board.
The scale of the Portnoy real estate empire and its conflicts of interest are even larger than that. The family firm manages four other public real estate trusts in a similar fashion, though none are under attack from shareholders at the moment. Those trusts own another $15 billion of property and have a combined stock market value of about $10 billion.
At Commonwealth, the Portnoys are opposed by Corvex Management — a firm led by a former deputy of Carl Icahn — and Related Fund Management, an investment arm of the giant real estate firm Related Cos. Their message to fellow investors is simple: The company has been doing terribly for years, and it is the Portnoys’ fault.
“Their performance has been horrible,” the two firms said in solicitation materials.
Worse, it is almost impossible to get rid of them. Commonwealth’s bylaws provide lots of defenses against raiders. On top of that: Any effort to remove the board requires a two-thirds vote from shareholders, not a simple majority.
Commonwealth, naturally, has a different point of view. It complains that the investment firms are attempting a hostile takeover of the real estate business, acting in their own best interest and without regard to other investors. In this version, the investment firms that are challenging management are the barbarians at the gate.
But there is no getting around the damaging conflict of interest at the heart of Commonwealth’s business. The Portnoys are not employed executives at the trust in any conventional sense and do not own much of its stock. Their firm runs the business under a management contract. In general, the fees go up as the trust gets bigger, and not necessarily when it performs better for shareholders.
This kind of business leadership arrangement is known in the real estate trust world as “external management,” and it has been on the way out for years. Nearly everyone acknowledges its built-in conflicts are toxic.
Green Street Advisors, a well-known firm that covers real estate investment trusts, wrote a report on the Portnoy REITs last March and called them all “uninvestable.” The basic message: External management in the manner used by the Portnoys created conflicts “so severe” that Green Street could not figure out how any of the stocks should be valued.
But the investment firms trying to oust the Portnoys at Commonwealth believe that stock could be worth $35 per share if they are successful. Commonwealth closed Monday at $25.25 per share. I don’t think anyone really has a good idea how the stock would react to a management change.
Corvex and Related have spent a lot of time and money trying to get rid of the Portnoys. They launched a similar solicitation last year and claimed support from 70 percent of shareholders.
That vote was declared invalid under Commonwealth’s bylaws and sent to arbitration. The arbitrator threw out the results, but cleared the way for the new vote underway now and even removed some technical barriers. Legal action has been a big part of the Commonwealth drama, so it would not be a shock to see lawyers return to center stage after the vote, one way or the other.
But the new solicitation period will end in a couple of weeks. And this time, the Portnoys could finally find themselves on the outside looking in.