Power REIT: Why David Should Defeat Goliath

by Al Speisman, Esq.

Al Speisman, Esq.

Power REIT¹ (NYSE MKT:PW) is a micro-cap Real Estate Investment Trust with assets generating consistent, secure cash flow.  Power REIT’s assets consist of long-term railroad infrastructure as well as 600 acres of land leased to solar farms. Power REIT’S current underlying value of $11.07 per share is delineated in a shareholder presentation on Power REIT’S Web-Site. This valuation does not factor in potential success in Power REIT’s pending Federal Appeal.

A recent article appearing in Value Investors Club lists Power REIT’s Net Asset Value at $10.62 per share plus a “lawsuit optionality value” of $1.09 or a total current valuation of $11.71 per share.  The Value Investors Club analysis assumes a 15% probability of success in the appellate litigation.  I believe this greatly under-estimates Power REIT’s chance of success, and the company has a strong chance of prevailing on its appeal.  The potential damage recoveries should it succeed are huge.

The Case

Power REIT has a CEO with vision, persistence and patience: David Lesser.  Mr. Lesser has been involved for several years in pursuing Norfolk Southern on potential lease violations and defaults. The Power REIT/Pittsburgh & West Virginia Railroad (PWV) litigation with Norfolk/Wheeling has been going on for five years. The Appellant Brief (PW), the Appellee Brief (Norfolk/Wheeling), and Appellant Reply Brief (PW) have been filed with the Third Circuit Court of Appeals (Federal Court).

Power REIT’s appeal with Norfolk Southern and Wheeling & Lake Erie Railway (Case No 16-1195) is ripe for a decision. The case “will be submitted on the briefs” to an Appellate panel of three justices on Thursday, January 19, 2017.  As is the norm in the vast majority of 3^rd Circuit cases, “there will be no oral argument.”  It is reasonable to believe that the appellate decision should be forthcoming during the First Quarter of 2017.

My summary of Power REIT’s position on the appeal follows.  My primary source is Attorney  Steven A. Hirsch

’s Amended Appellant Brief and Reply Brief.  It is enlightening to review both of these in conjunction with the original lease document.  Mr. Hirsch’s background and the outstanding job he has done preparing the appeal both lead me to believe it has an excellent chance of success.

The Lease

My overall assessment is that the lease itself is the key to this case, and the lease is the “blueprint of the deal.” 

Power REIT’s subsidiary, Pittsburgh and West Virginia Railway (PWV), owns 111.21 miles of rail line going between Pennsylvania and Ohio.  It also owns 5 short branch lines comprising an additional 20.38 miles.

In 1962, PWV entered into a 99-year renewable lease with Norfolk Southern (hereinafter “Norfolk”) with a fixed base rental of $915,000 per year plus “Additional Rent.”  Additional Rent includes, among other things, “deduction-based additional rental.” (Federal tax deductions for depreciation, amortization, etc.)  Norfolk is also obligated to pay all expenses Pittsburgh & West Virginia Railroad incurs when they come due and assumes “all obligations” Pittsburgh & West Virginia Railroad incurs relating to Pittsburgh & West Virginia Railroad performing its legal duties and protecting its rights under the terms of the lease.

Key lease provisions include:

• Leasing of Pittsburgh and West Virginia Railway’s property including the 111 mile stretch of Railroad and the 5 short branch lines (limited exceptions excluded). (See Section 1.)
•   Pittsburgh and West Virginia Railway property that Norfolk Southern determines to be not “necessary or useful” may be sold, leased or otherwise disposed of” by Norfolk Southern and shall be an indebtedness to Pittsburgh and West Virginia Railway. (See Section 9.)
• When lease terminates, whether by failure to renew or by default, leased property “shall be returned to Lessor in the same condition as it (was) in at the commencement of the term of this lease, reasonable wear and tear excepted….” (See Section 11.)
•  Norfolk Southern shall return enough property at the termination of the lease to run the railroad for one year with such property being in unchanged condition. (See Section 11.)
• A default under the Lease requires Pittsburgh and West Virginia Railway to provide 60-day written notice to cure. Upon determination of default, Pittsburgh and West Virginia Railway is entitled to the return of its property. (See Section 12b.)
•  Damages from a default of the lease include Interest at 6% from date of default, reasonable attorneys’ fees and expenses. Also, all remaining indebtedness becomes due when the lease is terminated. (See Section 11.)
•  Indebtedness between Norfolk Southern and Pittsburgh and West Virginia Railway is capped at 5% of the value of Pittsburgh and West Virginia Railway’s total assets “as long as any of the obligations of lessor (Pittsburgh and West Virginia Railway) which have been assumed by lessee (Norfolk Southern) remain outstanding and unpaid.” (See Section 16a.)

During 2011, David Lesser became CEO of Pittsburgh and West Virginia Railway.  He pinpointed the injustices involved in the Norfolk Southern transactions.

Norfolk Southern attempted to sell certain property and Power REIT challenged Norfolk Southern, alleging among other things, that it was entitled to attorney fees for reviewing and acting upon the proposed sale.  Norfolk Southern, trying to avoid a “default” under the lease terms, filed a Declaratory Judgment action in Federal District Court.  The District Court determined by summary judgment that Norfolk Southern had not defaulted.

A key aspect of the case, which goes to the extent of the damages recoverable by Power REIT, is whether Norfolk Southern and/or its sub-lessee, Wheeling & Lake Erie Railway Company, defaulted on the lease.

Four (4) potential defaults under the lease are being appealed by Power REIT:

1. Norfolk Southern violated Section 9 of the lease by failing to pay or record as an indebtedness almost $14 Million from “dispositions” of Pittsburgh and West Virginia Railway’s Property.

2. Norfolk Southern violated Section 11 by allowing resource extraction from these unrecorded dispositions, thus permanently altering Pittsburgh and West Virginia Railway property.  Each time resource extraction occurs it should be construed as a “permanent transfer”.

3. Norfolk Southern violated Section 4(b)6 by failing to pay Pittsburgh and West Virginia Railway’s attorney fees and litigation costs.

4. Norfolk Southern violated Section 16(a) which imposes a 5% cap based upon the assets of Pittsburgh and West Virginia Railway.  The section requires Norfolk Southern to pay any excess indebtedness in the Transactions/Settlement Account beyond the 5% c
ap to Pittsburgh and West Virginia Railway.  Confirmation of the indebtedness is evidenced by Norfolk Southern’s course of performance with the IRS.  Norfolk Southern prepared Pittsburgh and West Virginia Railway’s tax returns through 2012. Norfolk Southern’s tax returns, as well as the tax returns prepared by Norfolk Southern on behalf of Pittsburgh and West Virginia Railway, acknowledge and affirm the outstanding indebtedness in the Transaction/Settlement Account. (For greater detail and analysis of the tax treatment involved, see the Alpern Rosenthal expert report dated 3/29/13 concluding the Settlement Account on Norfolk Southern’s financials is an indebtedness/liability to PWV.)  Based upon that report, the Settlement Account balance exceeded five percent (5%) of the value of the assets on a market capitalization basis, of each year ending December 31, 1983 through December 31, 2012.  By December 31, 2012, the balance of the Settlement Account, per Norfolk Southern, was $16.66 Million and exceeded five percent (5%) of the value of Pittsburgh and West Virginia Railway’s assets by $15.91 Million.

Potential Damages include:

1. Recovery of Power REIT/ Pittsburgh and West Virginia Railway Attorney Fees: approaching $4 Million.

2. Recovery of Interest:  Section 11, (Termination of Lease) provides for interest at 6% per annum from date of default.

3. The Transactions Account reflects an admitted indebtedness of approximately $17 Million as of 2012. Of that amount, approximately $16 Million exceeds the 5% cap.  No updates of the current Transactions Account balance have been provided by Norfolk Southern to Pittsburgh and West Virginia Railway.

4. An additional $14 Million in dispositions have been identified by Pittsburgh and West Virginia Railway but have not been recorded by Norfolk Southern in the Transactions Account.

5. If the Court determines a Norfolk Southern default has occurred, under Section 11, Pittsburgh and West Virginia Railway is also entitled terminate the Lease and to “such machinery, equipment, supplies, motive power, rolling stock and cash as will be sufficient to enable Lessor to operate the demised property for a period of one year after the return thereof….”. A key variable in determining the amount owed to Pittsburgh and West Virginia Railway would require analysis of Wheeling & Lake Erie Railway Company’s detailed financial statements.

6. If the Court rules Norfolk Southern has defaulted, the entire property reverts back to Pittsburgh and West Virginia Railway.  The rental established of $915,000 per year was established in 1962 and does not escalate and is likely significantly below the current market value.

7. What Pittsburgh and West Virginia Railway could actually lease the property for in today’s market is speculative. Norfolk Southern and Wheeling & Lake Erie Railway have refused to provide operational and income data to Pittsburgh and West Virginia Railway (also a potential default based on a failure to comply with a contractual right contained in the lease that allows Pittsburgh and West Virginia Railway to inspect the  books and records of Norfolk Southern).  However, based upon discussions with railroad consultants, a generic valuation range may be in the range of $1 Million per track mile. Pittsburgh and West Virginia Railway has a total of 131.59 track miles. Note that in recent years, Wheeling & Lake Erie Railway has experienced significant traffic growth as a result of Marcellus Shale activity.

8. One could speculatively project that with either a new or renewed lease, annual revenues to Pittsburgh and West Virginia Railway would be between $5 Million to $10 Million per annum.  That projected valuation does not include potential mineral rights on Pittsburgh and West Virginia Railway land.

Summary

Litigation, especially Appellate Litigation, can have a life of its own. Recent articles written on Power REIT have predicted a probability of success in the area of 10 to 15 percent. However, after extensive review of the ongoing litigation, including in depth review and analysis of the facts and pending appellate briefs before the 3rd Circuit Court of appeals, I sincerely belief that David (Pittsburgh and West Virginia Railway) should defeat Goliath (Norfolk Southern) based on the merits of the case. Ultimately there is no way to know if the appeal will be successful….

Endnote

1) Price (1/13/17):  $6.88.  Shares Outstanding (in M) 1.78 Million.  Market Cap:  12.28 Million. Core Funds from Operations Annualized (FFO) .50 to .60.  Net Asset Value (NAV):  $10.62 to $11.07 (assumes Power REIT loses appeal)

ABOUT THE AUTHOR: Al Speisman is the principal of Speisman Law, LLC. As an investor, he focuses on undervalued, micro-cap companies. He received his M.B.A. from Northwestern University’s Kellogg Graduate School of Management with concentrations in finance and accounting. Mr. Speisman earned his Juris Doctorate degree from The John Marshall Law School.

DISCLOSURE: Al Speisman is a significant shareholder in Power REIT.  On January 3, 2017, he filed an Amended 13G.

DISCLAIMER:  Al Speisman is not employed with Power REIT.  Nor is he a Board Member. The above article should not be construed as legal or financial advice.  It’s strictly the opinion of the author.  For specifics regarding Pittsburgh and West Virginia Railway’s legal position on the appeal, Power REIT’s appellant briefs should be reviewed in detail in conjunction with the lease. The appellee brief filed on behalf of Norfolk Southern/Wheeling should also be reviewed. These, as well as other documents, are readily available on Power REIT’s website: www.pwreit.com. Go to PWV Litigation Update under the “Investor Relations” tab.

Other sources of articles online to consider reviewing when evaluating Power REIT as an investment include, but should not be limited to, the most recent Power REIT Investor Presentation on Power REIT’s website: www.pwreit.com, Tom Konrad’s numerous articles on Power REIT, several articles published with Seeking Alpha, Forbes On Line, AltEnergyStocks.com, and most recently Value Investors Club (VIC).
Investors are also encouraged to participate in dialogue on this article via http://investorshub.advfn.com/Pittsburgh-&-West-Virginia-Railroad-PW-20486/ as well as via the Seeking Alpha post of this article.