Entertainment Properties Trust, owner of approximately 28 facilities used by Imagine Schools, recently presented at a National Association of Real Estate Investment Trusts investor forum. Here is a link to an audio recording of the presentation.

I was interested in EPT’s presentation given the recent closures of Imagine-run schools in St. Louis, Missouri.

CEO David Brain briefly discussed the growth of the charter school sector at the beginning of the presentation, but the more substantive comments begin at the 4:50 mark. I’ve transcribed these comments below¹:

David Brain (4:50-7:15): Going back to education, for a minute. Notably in education, first thing I want to bring your attention to is we’ve moved from two different operators in education last year to now fourteen different operators we’re dealing with in the charter public school space. So we’re expanding our base of contacts and operators there. The other things is our anchor operator, we started in this category and is our largest operator, Imagine Schools, there’s been a lot of discussion and questions about them. Imagine did run into a rather severe conflict with the Department of Education in the state of Missouri and is going to lose a number of charters as a result of that. Those really largely stem not only from not only some personnel issues, but also from kind of the hyper-growth that Imagine went through, as a company and particularly in the Missouri market. The really good news about this is with what Imagine is incurring, we still don’t have a change in our expectation of cash flow because of a strength of their balance sheet, because of the cash flow coverage that is exhibited at the corporate level where we have guarantees, and the fact that we have a letter of credit to our benefit posted that’s two and a half times the rent at issue with these schools. We don’t see any interruption in the payment stream, we’ve never missed a month of rent on a charter public school, we do not expect to miss a month of rent on a charter public school. For all of the schools that are of issue right now it’s about a $70 million investment value. All of those locations are well underway with three major alternatives of recovery both in sublease to other charter operators, swapping those schools for performing Imagine schools otherwise in their portfolio that are unencumbered, and, subject to our underwriting – this is not something they can put to us, it’s something we can accept if we like – and or selling those properties. So we expect 2/3 or 3/4 of the monetary value involved in this issue to be resolved by the beginning of the school year, so very shortly. And even if it is not, I want to remind you of that letter of credit and cash flow support that, even if we carried it unoccupied and not utilized through the school year, we do not expect it to be any problem. So, that’s with regard to Imagine. By the way, I want to say that we are still very committed to the charter public school space. As I indicated at the top, the metrics are still very strong on a national basis, our base of contacts and client base is expanding in this industry. We had a particular concentration that we do not expect to repeat with five schools in one jurisdiction with one operator. But we’re all learning a little bit as we come through this and there are some growing pains in this industry, but it is still a very attractive industry and we’re dedicated to it as part of the fundamental platform of the company.

A few comments:

• Most of this was covered during the May 1, 2012 investor call.
• Interestingly, Brain never mentioned the personnel issues in St. Louis during the company’s May 1, 2012 investor call. He did, however, mentioned “a variety of factors” during that call.

The issue of Imagine came up again during the question and answer session. Two audience members asked questions that were directly related to Imagine. Below is a transcription of the first question and answer:

Question (19:45-22:25): “Would you describe what went wrong in Missouri with Imagine? You said something about a conflict of interest. What did they do wrong there?”

David Brain: Well they entered the market in very large scale, opening in a space of, Jerry, two years [Audience member, possibly Jerry Earnest: “one year”], one year, eight, nine schools embracing attendance of about 6,000, particularly in some very tough demographics of low-performance students. You don’t turn that ship – most guys who go into these urban areas with lower performing students do it in very small measure, grades K through 2 or 3. They tend to build their populations over time, their own culture, and so forth rather than trying to take on 5,000 students at one time, and turn that ship and that whole culture and bias towards education. They also had a person in the market that was fairly hard to deal with with a lot of the supervisors and authorizers and he didn’t have a great relationship and he’d tend to ignore all supervisory bodies and take a very tough attitude towards them. So a combination of politics and the manner which they entered brought them into kind of a cross-position and the authorities were intolerant of their performance. Their performance was harder to achieve year over year because of they way they were biting off so much at one time. So those combination of factors, and then we had a concentration, those are things we do not expect to repeat. We do not expect to repeat with any operator in any way and particularly with Imagine. These are all things we’re learning. Interestingly, going into this year when six of their schools went on probation and now charters are going to be revoked, enrollment went up 8%. One of the reasons is they have some of the nicest facilities, which are our buildings, in the market. This is one of the reasons the market is still positive. And the Mayor of St. Louis, who has been the harshest critic of Imagine’s performance, is pro-charter school. So with a pro-charter environment with good facilities and with the credit support we have, we’re very confident that this comes out in a good answer. We know that this is an optics problem of a great degree. We know it is a real performance problem also to some degree and we’re recognizing that. We’re not trying to be cavalier and shirk this off – we know it’s an issue. What we’re trying to communicate is we think we have enough underpinning here that financially we’re going to be fine in the short run, and fundamentally with the market and the facilities, we’re going to be good in the long run as well.

I can’t help but wonder if the “person in the market that was fairly hard to deal with” was Sam Howard. Howard, a former Executive VP and (I believe) the point man for Missouri operations, was placed on administrative leave in late 2011 after questions were raised about some some financial transactions relating to the construction of St. Louis facilities. He was replaced with Alan Olkes in November of 2011. According to Lori Waters, Imagine’s Director of External Relations, “Sam Howard is no longer with Imagine Schools. The separation occurred in December [of 2011].”²

Another audience member asked:

Question (22:25-23:30): “Do you know if Missouri is the only problem area for Imagine? [Inaudible]

David Brain: We have been through a basically now thorough review and underwriting of the entire portfolio. All these schools score, as you may or may not know, with a federal and state grading. Every school since Bush No Child Left Behind takes tests, gets an aggregate test score, and as your kinda federal grade under NCLB, what’s called AYP, or acceptable yearly progress grade. And then further, each state scores schools as well. We believe Missouri is very particular. It’s not to say Imagine has some issues of performance maybe in Ohio or in Florida, some of which are in our portfolio. Remember, we’re only – of Imagine’s total portfolio, we’re about one third of their landlord position, two thirds are outside of us. So we know there are some issues, but we don’t think there’s any systematic issue of the nature that St. Louis has demonstrated in the Imagine portfolio.

Below are two tables showing AYP results and state accountability results for the Imagine Schools in EPT’s portfolio. It’s worth noting that these accountability measures are not all that great and may in fact stack the deck against Imagine (and many other schools). I’m re-posting these tables mostly because David Brain mentions these measures in his presentation and these measures can be used, for better or worse, in important decisions (like revoking a charter).

More importantly, Brain only mentions academic indicators for the schools in EPT’s portfolio. While academics played a role in Imagine’s closure in St. Louis, financial management issues were also cited as a reason for closing the schools. Are other Imagine-run schools in debt and depositing funds in excess of FDIC insured amounts³? Brain doesn’t address those concerns.

Today, the Wall Street Journal covered the situation in St. Louis:

The turn of events has revived concerns among investors that Entertainment Properties is veering too far from what it does best: build and acquire movie theaters.

“I think the street is going to be a little hard on the stock” until the company resolves the issues with Imagine, said Rich Moore, an analyst at RBC Capital Markets.

Will Imagine and EPT swap the Missouri facilities for facilities in other states? Will EPT sell the facilities? If EPT keeps the facilities, can they find another tenant willing to dedicate such a large share of their expenses to facilities? Much remains to be resolved in Missouri and elsewhere.