Safe & Green: Two Ways To Play Real Estate Development (NASDAQ:SGBX)

Safe & Green Holdings (NASDAQ:SGBX) delivers exactly what its name suggests – high quality, environmentally sound buildings and components. The Company exploits repurposed and recycled materials and completes manufacturing in a controlled and efficient central location. Minimal assembly work on location reduces site disruption and saves as much as 50% of construction time. The arrangement makes it possible to offer more durable and lower cost buildings compared to conventional construction methods.

The Company’s ‘Safe and Green’ modular buildings and components have been certified by The ICC Evaluation Services as meeting the International Building Code and Residential Code as well as stringent building standards in California and Florida. The Company could be the first modular building producer to receive such certification, a status which could give Safe & Green a clear competitive advantage in the construction market. Additionally, structures that incorporate the Company’s modular design with recycled materials can potentially earn points for LEED certification (Leadership in Energy and Environmental Design).

Its Own Best Customer

Safe & Green sells its products directly to third parties such as construction companies, architects, and builders, among others developing real estate for commercial or residential use. Most recently, the Company sold an additional thirty-eight modular structures to an unnamed customer, which has deployed units from an earlier order across multiple states in the U.S. The follow-on order is valued at $2.5 million, representing approximately $65,000 per unit.

The Company has been developing its own residential properties, using its proprietary modular construction units to build brand distinction and add value. The company has used metal shipping containers, converting the rectangles to meet the needs of customers for housing or office space. However, the company’s manufacturing arm, SG Echo, has gone far beyond container conversions. A mix of wood and steel is used to fabricate the Company’s exclusive designs at a central manufacturing site. The units are then assembled onsite and given final finishing touches.

Favorable Demand Trends in Target Markets

The Company may be approaching the market at exactly the right time. Higher costs for construction materials and labor as well as interest rate hikes motivate real estate developers to find lower-cost alternatives. (1, 2)

Supply side cost pressures are intensifying just as the U.S. is experiencing a crunch in housing stock. There is a shortage in residential homes, particularly for the middle market. According to the National Association of Realtors, the U.S. housing market is short more than 300,000 affordable single-family homes of middle-income buyers. (3) Down market there appears to be an even more acute supply deficit. According to the National Low Income Housing Coalition, there is a shortage of 7.3 million rental homes that are affordable and available to rental householders after the U.S. lost approximately 8% of the total affordable housing units following the Covid 2019 pandemic. (4)

Capital for Growth

The Safe & Green team is ready to fill in the housing market gap, an ambition that requires capital. Safe & Green had $1.6 million in its bank account at the end of June 2023, could be used to fuel its growth plans, that is after providing support for operations. The Company has not yet achieved profitability with operations tapping cash resources by $3.0 million in the first six months of 2023. That implies a cash burn rate near a half million dollars per month.

The cash kitty could be boosted in the near-term by the sale of its Lago Vista property in Texas. At least one offer near $12.5 million has been received based on the Company’s announcement in June 2023 of a letter of intent to buy Lago Vista. (5) The offer could be a compelling win for Safe & Green that compares favorably with the present value of future development projects. The company originally paid $3.6 million for the property in 2021, and invested another $824,231 to smart it up. With a book value of $4.4 million, the math suggests an astute move by Safe & Green management to monetize a real asset.

Some investors might be disappointed the Company may not go so far as to develop the project with its modular building units. This author’s recent conversation with Safe & Green management via video conference call suggested the Company is seeking the right deal, even one that could involve a development pact and the Company’s modular structures.

Strategic Restructure Plan

If investors are scratching their heads over selling good property before it is developed, they must be really perplexed with plans to spin off the development subsidiary from the Safe & Green parent. (6) Safe & Green Development Corporation is to become a stand-alone public company with shares listed on Nasdaq. The company plans to retain ownership of 70% of the shares and distribute 30% of the shares to SGBX holders.

A fairness opinion commissioned by the Company pegs the standalone value of its development subsidiary at $74 million, suggesting the stock distribution to shareholders could be valued at approximately $22.2 million. This presents an interesting setup given that the parent’s entire value represented by the market cap of SGBX shares that has ranged from $12 million to $26 million over the last six months.

Complex Business Model Frustrates Fair Valuation

The problem is, Safe & Green leadership believes the Company has not been getting fair treatment in the U.S. equity market. Complexity could be the wrench in the works and the SG DevCo spinout could help simplify the Company profile. Indeed, the company has a mix of business models under one roof. Property development and manufacturing are just two of them. Safe & Green also deploys specialized modular units for medical testing. A fourth business is service oriented, collecting and treating medical waste for disposal. Investors may simply not want to do the extra work to fully understand or value each business component.

Granted the healthcare sector is robust and represents steady demand. Capturing the low-hanging fruit from a particular vertical, in this case the medical field, could elevate the Safe & Green brand for uses of its modular building units in other sectors. However, successful penetration of the health care market requires an entirely different business development effort than real estate development or building module manufacturing. It is noteworthy that Safe & Green leadership is well experienced and knowledgeable in the healthcare sector. However, their unique qualifications may not be clearly evident to investors.

A View on the Spin Out Proposal

Spinning out the development subsidiary to a separate company with its own stock may have multiple benefits. As a standalone operation, analysis is simplified. The drivers of value will hinge on property acquisition, partnership formation, cost controls, construction management, and marketing – all for real estate development.

Perhaps more importantly, out of the shadow of the parent, the SG DevCo management team might find new inspiration and energy, building reputation, creating brand awareness and accelerating growth. SG DevCo has reported a robust project development pipeline valued at over $800 million over the next seven years. A newly energized team could glean even more than the $200 million in potential returns that have been predicted for the portfolio.

The parent operations could also get a valuation boost. As noted above the Safe & Green parent is retaining a 70% stake in SG DevCo. The majority equity stake will still be represented on the Safe & Green financial reports. Like all other shareholders, the parent will benefit from improved financial performance at SG Dev Co as well as any shift to a fairer valuation for the development business.

Furthermore, the spinout could strengthen the Safe & Green parent’s capital position. In the future, the parent may be able to monetize its equity stake in SG Dev Co, securing new capital for its own strategic growth plans.

Call to Action

It would appear the Is are all dotted and Ts crossed for the SG DevCo spinout. The Securities and Exchange Commission has given its approval. A record date of September 8, 2023, has been set to determine eligible shareholders for the stock distribution. Setting the record date calls shareholders and prospective investors to action.

First choice is to take a long position in SGBX before the September 8th record date and receive the stock distribution of SG DevCo. The move gives shareholders stakes in two companies and optionality in future profit taking. Shareholders of the parent would receive 0.93 shares of SG Dev Co for every 5 shares of SGBX. Shares of the two separate companies could appreciate at different rates, leading shareholders to hold one and take profits in the other.

Those ignoring the spin out record date will not be left behind as a second alternative is to grab shares of SGBX and participate in the fortunes of SG DevCo through the parent’s retained ownership. If an opportunity arises later to accumulate shares of SG DevCo at a compelling price, investors can increase exposure to the development business with direct ownership of its shares. On a cautionary note, at least initially, trading volume in shares of SG DevCo could be somewhat shallow given that only 30% of issued shares will be in the public flotation.

Risks

The Safe & Green opportunity is not for investors without tolerance for risk. The shares of SG DevCo will be entirely unseasoned and will not have the benefit of a ‘roadshow’ period to introduce the shares to investors. Even the parent company shares carry elements of hazard. The bid-ask spread represents 2.2% of the current share price. The immediately trim-off of capital value is even more concerning given low trading volume near 55,000 shares per day.

The Company is not yet profitable and needs cash resources to support operations in the near-term. As noted above the Company has enough cash in the bank at the end of June to support operations for at least three months based on the recent cash burn rate. A dwindling bank balance has put Safe & Green’s management in the hot seat.

There are plans in the works to monetize one of the Company’s plum real estate assets, which could provide adequate cash to support operations through to profitability. However, in the current economic environment with rising interest rates could present obstacles to a timely closing of any deal.

It is notable that the Company recently filed a registration statement for the sale of up to $50.0 million in equity or debt securities. It could mean fast cash for the Company, but the sale of common stock or warrants could be dilutive for shareholders. Debt issuance would preserve the equity position for existing shareholders, but the interest burden could weigh common stock value.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

Underwriters of the Prime series may have a beneficial interest in, serve as agents of, or act as advisors to the companies mentioned herein.

Company Financial Data Sources:

Safe & Green Holdings Corp. S-3 Registration Statement and 10-Q Financial Statement filed with the Securities Exchange Commission on July 21, 2023 and August 14, 2023, respectively.

Economic Data Sources:

1 Construction Materials Costs Rise 10.1 Percent Between November 2021 And November 2022 With Double-Digit Increases In Numerous Building Products

2 Here Are Mortgage Rates for May 1, 2023: Rates Trend Down

3 US Housing Market Needs More Than 300,000 Affordable Homes for Middle-Income Buyers

4 Multifamily Developers Predict Further Decline in Affordable Housing Supply

5 Safe & Green Holdings Corp. Announces Letter of Intent to Sell Lago Vista Site for $12.5 Million

6 Safe & Green Holding Corp. Announces Intended Spin-off of Safe and Green Development Corporation

Editor’s Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.