Wednesday, November 18, 2020

NexPoint Strategic Opportunities: Exchange Offer

Back in August, I wrote up a quick post on NexPoint Strategic Opportunities ("NHF"), it is a closed end fund that is transitioning into a REIT over the next 18-24 months (they'll technically be a REIT in 2021, but won't fully transition the assets until later, quite a bit of wood to chop here before its a clean story).  To summarize the thesis, NHF is trading at 57% of NAV and they'll be selling much of those assets presumably somewhere near NAV to invest opportunistically in real estate -- there should be no shortage of attractive opportunities coming out of the pandemic -- add in some leverage and it could have quite the multiplier effect (see what the same team has done with NXRT).  And to get the negatives out of the way, NHF hasn't articulated a clear strategy at this point other than saying it will be a diversified REIT and there's the potential for double dipping on fees, much of what NHF owns today are investments that were at one time or are now managed by NexPoint/Highland, it has sort of acted as a dumping ground for them.

The stock's reaction to the conversion news has been muted and it hasn't rallied much recently in comparison to the market or other real estate assets.  The company came out with an exchange offer structured as a Dutch tender that expires 12/10, shareholders can exchange common shares for a combination of 80% in a newly created preferred stock and 20% in cash, the range is set at $10-12 and the stock currently trades at $9.50.  The $10-12 number is highly dependent on the value the market prescribes to the newly issued preferred shares, the company is trying for a 5.5% dividend rate on the prefs, that feels a bit aggressive, but more on that later.

I love the idea of the exchange, the maximum amount is $150MM on a $433MM market cap company, the exchange will essentially force a portion of the shares to be valued at NAV accruing that closed discount value to the remaining shareholders.  It also further tightens the spring when they do fully transition to a REIT, this is already going to be a levered vehicle.  But again, the 5.5% dividend yield feels a bit aggressive on the preferred shares, so thinking through the possibilities of where the preferred could trade after the exchange, I came up with a little table:

The x-axis is where the Dutch tender prices at and the y-axis is where you think the preferred shares should trade on a yield basis incorporating the 20% cash component.

I've also played around with different scenarios based on how many shares are actually tendered and what it would do to the NAV ($16.70/share as of the latest proxy) of the remaining shares, just based on the share price and my uneducated view, seems like the market is skeptical of the exchange.  The minimum amount is $75MM.

Then my last table is using the NAV in the table above, what the price/NAV ratio would be (using a $9.50 share price, or a 57% starting point):


I've spent a lot of time in the last few months on the commercial mREITs (maybe more posts to come), most of them have preferred shares that have yields well above the targeted 5.5% NHF management is shooting for and that might be skewing my view of where the prefs will trade following the conversion.  NHF is likely to be focused on either self storage or single family homes, maybe both, equity REIT preferreds in those sectors do trade below 6%.  I took a look at the holdings of PFFR, a REIT preferred index fund, and here are the names that trade sub-6.0%, some of these didn't surprise me as they're seasoned and/or loved REITs, but others were a bit surprising.  

For example, Office Properties Income Trust's (OPI) 5.875% pref trades just above par, this is an externally managed REIT of RMR Group (RMR) that has a history of abusing minority shareholders and is in the office sector.  Is 5.5% too aggressive?  Possibly, but not by that much in a zero interest rate world.

I've added to my NHF position.  I'm currently thinking about the exchange like this: I'm planning on tendering a portion of my shares somewhere in the middle of the range (could change as we get closer to the expiration date), but still leaving behind a relatively full position.  If there is enough interest where I don't get filled on the tender and it goes closer to the lower-end of the range, common shareholders should benefit as the NAV increases even more and they've obtained cheap financing.  If I get filled, I still feel comfortable that the trading price of the prefs following the conversion should result in a good short term IRR.  Either way feels like a win to me.  NHF could also bump up the yield on the preferred shares if there isn't enough investor interest (they got a rating agency to put a BBB- rating on the prefs, presumably to head off investor skepticism on the proposed dividend yield), even paying 0.5-1.0% more in yield to entice shareholders to exchange would be very accretive to the remaining common.

Disclosure: I own shares of NHF

18 comments:

  1. This comment has been removed by the author.

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  2. Thanks for this analysis. Appreciate your work.

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  3. Interesting write up. Thanks for sharing. I think they are well positioned to rebound when Covid subsides a bit. SFR and self storage are great markets to be in and the major discount to NAV (most ever for them) provides a really nice cushion here. It’s a small position for me, but I think I’ll add some more tomorrow.

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  4. The price has moved above $10. I think most people will tender high- $11.50 or better.

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    1. I'm bad at handicapping where the tender will price (lost some beer money on the AMCX dutch tender recently), but it looks like the market is warming up to the exchange offer and even if it goes near the top of the range it's good for the common in my mind (again, possibly overly bullish on this situation). I just hope they get enough takers and exchange the full $150MM regardless of price.

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  5. Have you looked at the holdings of the fund -it's an oddball portfolio. I guess that's the opportunity.

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    1. Yes, they haven't really articulated a strategy going forward. I might be reaching for straws here as a bull, but this reminds me of other strategy transitions where management gives the old shareholders an out via a tender offer, then after the tender is completed, shed more light on the new business plan and disclosing more information.

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  6. https://www.sec.gov/Archives/edgar/data/1356115/000119312520315881/d35665dex99a5iii.htm

    NHF extended the offer hoping to get more takers, I'm not tendering, but hoping they get the full ask.

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  7. Will this be an open or closed ended REIT? A closed ended one might not help close the discount.

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    1. It won’t be a fund after it converts, publicly traded REITs at least aren’t open ended, some of the big private REITs can be structured that way. The discount will close because index funds will buy it, other fund managers, etc, those that aren’t natural holders of CEFs or are restricted from buying them like most equity indices.

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    2. If it is REIT (closed end) there isn't really a hard catalyst. According to this article (https://www.cpexecutive.com/post/2020-reit-trading-trends/) REITs trade below NAV. Disclosure: long

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    3. REITs might trade at NAV today, during a pandemic, but they often trade at or above NAV.

      This isn’t a one hard catalyst idea, this will be a series of smaller soft catalysts:
      1) the closing of the tender/exchange offer, often in these business change scenarios where management gives former shareholders a last chance to get out before the business changes, the stock goes up after, remaining shareholders are committed to the new strategy
      2) official REIT conversion sometime in the next several months, becomes eligible for a new pool of shareholders and mandates
      3) management lays out a clear strategy
      4) non-REIT assets are sold and invested opportunistically in value add situations
      5) it looks like a normal REIT, valued off of FFO and dividend
      6) post value add, assets are recycled (see what NXRT has done)

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    4. *Might not trade at NAV

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    5. Thanks for the reply - very insightful.

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  8. James Dondero's other fund HFRO is also attempting to convert to a holding company from a CEF. The vote is soon. Unfortunately the thing tanked after announcement a few days ago and now the NAV discount went from -15% to -25% since then. Pretty much opposite what they though I guess!

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    1. I looked at it briefly tonight, want to think about it a bit more, but it doesn't seem as attractive a situation as NHF. I don't think anyone is clamoring for Dondero's deal making skills, by stating that diversified holding companies trade for above NAV he's comparing himself to Bill Foley (CNNE) and Icahn (IEP), that seems like a big stretch. Part of the appeal of NHF for me, was the relative hands off approach Dondero has shown in the other Nexpoint vehicles, a converted HFRO feels like it would feature more Dondero than the others, but I could be inserting some bias into that.

      The buyback is interesting though, might make it worth a small punt if its trading at a 25% discount, you sort of have a floor there through the conversion, might be worth a look? I'm still a bit undecided, but thanks for flagging.

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    2. That said, looking at their holdings, don't hate the assets. Mostly self storage, timber and CLOs. Could probably make a case for NAV increasing modestly in the near term.

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