Mid Year 2021 Portfolio Review

It has been a surprisingly great start to the year, a continuation of an almost straight line up from November -- my personal account returned 38.27% during the first six months, for a reference point the S&P 500 had a total return of 15.25%.  The biggest positive performance contributors in the first half of 2021 were DigitalBridge Group (fka Colony Capital), MMA Capital, NexPoint Strategic Opportunities and PhenixFIN, the only significant detractor to performance in the first half was CIM Commercial Trust. 

Despite the headline overvaluation in markets, the current environment seems ripe for special situation investing.  There is a post-recovery mess to be cleaned up, companies will look around in the changed operating environment and likely need to be consolidated or otherwise restructured, split up, taken private, etc.

Thoughts on Current Positions

• After my update post on MMA Capital (MMAC), I kept thinking as long as MMAC's capital partner was willing to continue contribute to the Solar Ventures after the February ERCOT storms, their problems were likely only temporary.  I bought more thinking those with the most information regarding the problem assets were continuing to increase their exposure and might be a possible exit for MMAC.  On 5/24/21, MMAC announced that Fundamental Advisors (their capital partner) would be buying the company for $27.77/share in cash.  The company didn't run a full sale process, the merger agreement includes a 40 day go-shop period that expires next week, the deal premium to the prior day's trading price was certainly a nice surprise but the deal is being done at a fairly cheap multiple to book value.  Given the structure of the joint ventures however, it seems unlikely that someone else would make sense as a buyer, but I'm holding through the go-shop period at the off chance there is an overbid.
• BBX Capital (BBXIA) has a current tender offer outstanding for $8/share, the 3/31 book value is a little over $16/share and likely reasonably higher than that when they report 6/30 after selling some real estate at a gain, bringing IT'SUGAR out of bankruptcy and just general covid beneficiary tailwinds of their businesses (mostly Florida real estate development).  For me this situation seems similar to others over the years, management's reputation to abuse minority shareholders causes the stock to trade at a considerable discount which then incentivizes management to continue to transfer wealth to insiders.  I won't be tendering shares this time around as I could see the stock trading higher after the tender is complete, it will be accretive to book value, and I doubt it will be the last time they attempt it.  For me, this situation is a combination of DVMT (reflexivity in how the market views management and it encouraging management to close the valuation gap for themselves), TPCA (tender offer on an illiquid OTC stock, afterwards shot up) and ASFI (family controlled, disliked management that eventually took a company private that had no business being public, essentially using cash on the balance sheet to do it).
• For the next two I'm going to outsource to a couple other posts:
• My thesis on ECA Marcellus Trust (ECTM) in the last portfolio review generated a little bit of chatter, my liquidation thesis turned out to be wrong and I got lucky with a natural gas rally which has turned the tiny trust right side up again.  Here's a great explanation of the current thesis here, I might exit after it flips to long term gains for me as the thesis changed and I'm not a great commodity investor, but that post is worth a read if you're interested in ways to invest in natural gas.
• After the MMAC deal closes, Franchise Group (FRG) will be my second largest holding, it is not exactly an event-driven name anymore, it graduated to a jockey bet on Brian Kahn, who recently bought a million shares in the open market.  Modeling the company is a bit difficult as there's constantly moving pieces, but Michigan Value Investor over on Seeking Alpha did a nice job of presenting the current situation today.

Previously Unmentioned Positions

• Capitala Finance Corp (CPTA) was another "ADL" suggestion, it rhymes with other ideas I've done well with over the years, a BDC (can be any externally managed YieldCo) that went astray with its previous manager, cut the dividend, the mostly retail investor base fled and it trades at distressed prices, new manager comes in to right the ship and eventually reinstates a market dividend.  With Capitala, the new manager is Mount Logan, an affiliate of BC Partners which manages Portman Ridge (PTMN), a BDC that was once KCAP Financial, BC Partners has gone on to consolidate three BDCs into PTMN over the last two years.  They have a playbook and have executed it reasonably well, this situation is slightly different as they're just taking over the management contract, possibly because this parallel tracked another PTMN acquisition in Harvest Capital (HCAP, I did own it for the arb).  But I think the results should mirror an acquisition (and might become a formal one at some point), albeit over time as they'll reinvest the portfolio much the same way PTMN is managed today.  CPTA trades at 55% of NAV, PTMN is around 80%, that discount probably narrows.

Closed Positions

• My biggest performance detractor this period was CIM Commercial Trust Corp (CMCT), the original thesis of a proxy battle being either conceded by management or won by activists has been thwarted as the company went ahead with a rights offering at ~40% of their own stated NAV (same NAV that serves as the fee basis amount for their management fee).  It shows incredible distain for minority shareholders, I can't imagine the board won't get sued.  The rights offering, along with getting booted out of the Russell may create some technical selling right now, so while I sold a few days after the rights offering was announced and still have a few days to go to avoid cancelling my tax loss, CMCT could be an attractive post-rights recovery swing trade if that's your thing and you can stomach the management team here.  Still surprised CIM damaged their reputation for this small sleeve of their overall business.
• I did the buy-write (June expiration) strategy on Pershing Square Tontine Holdings (PSTH) that was suggested by Andrew Walker last December, it worked out largely as planned.  As everyone is well aware, Bill Ackman announced a complicated transaction with Universal Music Group that will also create two other securities.  I don't have a strongly held opinion on UMG, there is a lot of great analysis going on around it on Twitter and elsewhere, but for me how the trade was structured, I have short term gains from selling calls and now a loss on the PSTH shares.  It makes sense for my tax situation to sell PSTH to offset some of the income generated, then re-evaluate as we get closer to the transaction closing and the three pieces being distributed later this fall.
• The Medley LLC (MDLQ/X) bankruptcy is getting dicey, it appears the proceedings have pivoted to a liquidation and wind down of the company versus trying to pursue a going concern restructuring with Medley Management (MDLY).  In an asset management business, there aren't a lot of assets with value other than the management contract revenue streams, with Medley's separately managed accounts fleeing and Sierra Income Corporation pursuing strategic alternatives (there is no termination fee on the Sierra contract), it appears there is a little value left at Medley LLC or Medley Management.  MDLY has some meme like day trading happening in it, I sold my baby bonds for a negligible gain on a day when MDLY spiked.  I'll still follow the situation, but mostly just for curiosity.
• I have a few themes that I tend to like, one is when a clinical stage biotech misses on its primary candidate, sometimes the stock will drop below net cash and the company puts itself up for sale.  Often they'll do a reverse merger with another pre-revenue biotech, so by buying the cash shell you can get in before the "IPO pop" of the new exciting company.  That's essentially what happened with Catabasis Pharmaceuticals (CATB), Catabasis also got wrapped up in some of the speculative retail trading in the first quarter, but on 1/29/21 Catabasis announced the acquisition of Quellis Biosciences, the stock popped and I sold that morning (a bit too early, hard to put on my day-trader hat and time these perfectly right).  Unfortunately, the market has seemed to catch on to this trade and other failed biotechs haven't traded down quite as cheaply recently.
• I exited Five Star Senior Living (FVE) over concerns about the RMR relationship, FVE has a lot of cash on its balance sheet for an asset-lite management company, wouldn't be surprised if RMR makes an acquisition within FVE to increase their revenue share agreement instead of doing a buyback or some other capital return that would benefit minority shareholders.  Management at FVE clearly had their hands full during covid, but a year on since the recapitalization and they still haven't really laid out a clear capital allocation plan.
• Perspecta (PRSP) was a 2018 spinoff of DXC, basically a replay of CSRA, both of which got sold shortly after the two year spinoff window lapsed.  Last year, I sold PRSP common stock near the bottom in covid as it went down less than others due to the government link, but jumped back in with naked calls on the rumors it was being shopped, got lucky, Perspecta was taken private by Veritas Capital, a PE firm that already owned a significant stake.
• I closed both sides of the Madison Square Garden (MSGS/MSGE) split in the last month.  MSGS is kind of cheap on an NAV basis, depending on how large of a "Dolan Discount" you think it should receive, but I'm just finding better more actionable opportunities.  Premier market sports teams are a scarce asset that should hold their value over time, public markets are volatile, might make sense to sell puts occasionally when the discount gets particularly wide.  MSGE is a grab bag of development assets that I typically like but I just can't get comfortable with the Sphere project.  It's a bet the company style project, it could work, but reminds me a bit of the mess with the Seaport for Howard Hughes, delays, might have to get repurposed and shift strategies part of the way through, etc., add in the strange deal with MSGN, I decide to exit. 
• Macquarie Infrastructure Corp (MIC) worked out pretty quickly and about as expected, rather than wait around for the big distributions and potential headaches, I sold and moved on, might return if there is forced selling after the Atlantic Aviation deals closes and the company converts to a partnership.  If you run the IRR based on the expected distributions of $37.35 for AA and $3.83 for MIC Hawaii, you get a healthy upper teens IRR, so it could still be a good liquidation play depending on your tax situation.
• Acres Commercial Realty Corp (ACR) also worked out pretty quickly, this was a strange mispricing potentially because of a name change, but similar to CPTA and others, it was a broken mREIT that got rescued with a new manager.
• Ladder Capital (LADR) was another commercial mREIT recovery trade that has mostly played out.  The company was hyper conservative over the last year raising a lot of cash, letting their short duration loans roll off, while at times a bit frustrating as a shareholder, it validated the original thesis during the covid-crisis that their investment/loan book was high quality.  I'll continue to listen to their conference calls as Brian Harris runs a fun fireside chat format where he provides his views on all corners of the real estate market.
• As mentioned in my year end 2020 post, I was selling calls against my Wyndham Hotels & Resorts (WH) position until it got called away, it did shortly after in February as the reopening trade has hotel franchise/management companies trading above where they were pre-pandemic.

Current Holdings

No cash was added or withdrawn during the period.  

Potential Changes

Going forward, the format and transparency of these portfolio updates could change, when I started writing no one read the blog and now that my personal and professional circumstances have evolved, it might not make sense anymore.  I also may finally move away from Blogger, similar to other Google properties, it has been neglected for years now and Google is discontinuing the email feature in July which I'm guessing is how most people receive my posts.  TBD on the next direction there, if any.

But as always, thank you to anyone who has reached out, offered an idea to look at, pushed back or commented on a post, I genuinely appreciate it, it is the primary reason I keep active.  Always looking for more ideas, currently kicking around HFRO, RMRM, FWP, AAMC, WHLRD, SOHO prefs, CVEO and a few others .  Enjoy the holiday weekend.

Disclosure:  Table above is my taxable personal account.

Condor Hospitality Trust: Covid Deal Break, Renewed Strategic Alternatives

Condor Hospitality Trust (CDOR) is a small (~$80MM market cap), illiquid (50+% owned by two funds), lodging REIT that owns 15 hotels primarily across the upscale and upper-midscale segments, with an emphasis on extended stay layouts, both of which have held up better than the upper-upscale or gateway/convention market type peers.  Back in 2019, Condor had an agreement to be purchased by NexPoint's lodging REIT (NHT in Canada) for a $318MM enterprise value or $11.10/share (it trades for $5.00/share today with a $260MM EV), that deal was delayed during the outset of the pandemic last year, later broke, and now that hotels are in recovery mode, Condor is once again putting itself back up for sale.  Given private equity's interest in hotels and particularly the extended stay segment, I could see Condor receiving plenty of buyer attention and selling for a price above where it trades today.

Condor used to be similarly positioned to CorePoint (CPLG), focusing on the midscale and economy select-service segment with a couple hundred hotels, but over a decade or so, they sold off most of that portfolio and repositioned themselves into the 15 hotels (1,908 rooms) they have today:

Most of these hotels were acquired since 2015 for a total purchase price of $288MM.  The portfolio is in reasonably good shape, and in healthy markets where covid restrictions have been relatively minimal (TX, FL, etc); just two of their hotels closed briefly in April 2020, only to reopen a couple months later by the start of July.  Hotel level operating metrics have improved dramatically, the company as of March was no longer burning cash, April occupancy was over 70% largely on the back of leisure travel, with management also optimistic on business travel "We anticipate that business travel led initially by local business demand, and then regional demand, will begin late in the second quarter and improve over the remainder of 2021."  Take these types of metrics with a grain of salt, but the company also likes to tout how they're outperforming their peer set on a relative basis:

Either way, best I can tell, this portfolio is of reasonable quality and likely not at risk for obsolescence in a post-covid recovery.  Hotels are generally are in recovery mode, STR has a good report here with some interesting charts, longer term I think there could be some tailwinds, people might extend vacations knowing they can work remotely and hotels themselves have shed operating expenses (daily cleaning, guest services via mobile app versus the front desk, etc.) some of which could become permanent.  And if you're in the market for real estate recovery plays, hotels just seem better positioned longer term than the other bombed out sectors like office or retail. 

So you have a relatively bite sized portfolio that held up well comparatively through covid, some emerging tailwinds as people begin traveling again, plenty of PE money sloshing around the industry (thinking about CLNY selling their big select-service/extended stay portfolio, BX/Starwood buying STAY, etc.), and a company that's already sold itself once before and clearly motivated to do it again.

A quick review of the capital structure, this is fairly leveraged entity, like many of the lodging REITs they had to raise capital to make it through the crisis.  But here's where things get a little harry, the company issued a "bridge loan" in the form of convertible debt to one of the two funds that own a significant portion of the common stock and the preferred stock.  The convertible debt has a 10% coupon (bumps up under certain scenarios) and is convertible at $2.50/share, it was in the money from the beginning compared to where the stock was trading at the time in November.  The proceeds were used to pay down the KeyBank credit facility and the convertible will likely convert to equity here in the coming days as a requirement for the one of the many amendments to the credit agreement.

With that dilution, we have about 16 million shares at a ~$5/stock price, for a $260MM enterprise value.  Now obviously valuation is a little tricky these days, 2020 was an extraordinary year for the hotel industry, most transactions I've seen quote a "2019 cap rate" as a normalized value, we can argue if that's realistic, it'll likely take a couple years to get back to 2019 run rates, but that's how others are quoting transactions that are happening today.  In 2019, Condor generated $26.2MM in "hotel EBITDA" which is a reasonable proxy for net operating income, on the $260MM enterprise value, that's an approximate "2019 cap rate" of 10%.

Recent Lodging REIT transactions, each of these are better located/quality properties than CDOR, but still good relative data points as they're all similar brand/format sales/purchases:

• Park Hotels & Resorts (PK) sells two hotels in May (better located, but two brands CDOR has in its portfolio) for a 7-7.4% 2019 cap rate
• Somewhat close peer, Apple Hospitality (APLE) in their recent earnings release "The company has acquired five hotels for a total purchase price of approximately $161 million since the beginning of the COVID-19 pandemic."
• Chatham Lodging Trust, another somewhat close peer, in December, sold a Residence Inn in San Diego for $67MM, a 6.5% 2019 cap rate

Again, probably none of these are a perfect comparable, but they've all moved at much lower cap rates than what the CDOR equity implies, seems like an interesting setup.  Per the background section of NexPoint deal proxy, the company began to explore a sale in 2018, they actually received 7 initial all cash offers for the REIT, before settling in with NexPoint.  Times have clearly changed, but given the concentrated ownership here, I think the company will almost certainly be sold again, an 8.5% "2019 cap rate" (the quotes mean I know its a bit of a silly valuation metric) would be $7.40/share.

Other thoughts:

• Probably only 1% of the thesis, but I like that Matt McGraner from NexPoint led the acquisition negotiations in 2019, he's the brains behind NexPoint's real estate strategy and from what I gather quite talented.  Obviously things have changed, he's an asset gatherer so maybe wasn't the most price sensitive, but another point in the "these assets are decent enough" bucket.
• The OSK X mortgage loan listed above is financing one property, the Aloft in Leawood, KS (suburb of Kansas City), that was purchased from a local bank by O'Brien Staley Partners.  Condor had previously gotten covenant waivers from the local bank, but O'Brien Staley Partners has put them into default on the loan.  Condor believes they can refinance the loan with another lender, but there's a possibility that property goes back to the lender in foreclosure.
• My guess is they've received inbound inquiries already and that the sale process won't take more than a few months, again, lots of interest in the sector, we're at a tipping point, I think those that have a bullish thesis on hotels want an opportunity to express it before the recovery becomes fully obvious.

Disclosure: I own shares of CDOR

Regional Health Properties: Inadequate Pref Exchange Offer

Reader "ADL" mentioned this one in my ill-fated Medley post the other week and I took a small position but the write-up hung out in my draft folder, this afternoon the company announced an exchange offer that appears inadequate to me.  Regional Health Properties is offering 0.5 shares of common stock for each preferred share, on a headline basis its a healthy 20+% premium on today's closing prices (RHE closed at $12.04, RHE-A closed at $4.90), if fully exchanged the preferred stock would only receive 45% of the proforma shares when it should be 90+% (similar situation would be the AHT preferred exchange last year). The exchange offer requires an amendment to revise the terms of the preferred stock (liquidation value to $5/share, eliminate the accumulated dividends) that would require 2/3rds preferred shareholders voting for the amendment (non-votes are the same as no votes).   Below is the original write-up, but now that things are in motion, seems like an even better opportunity as the company attempts to recapitalize.

Original Write-up

Regional Health Properties (RHE) (fka AdCare Health Systems)  is a real estate investment company (but technically not a REIT) focused on senior housing in the southeast United States.  It's another small and illiquid idea, the common stock is probably uninvestable and the preferred stock has a market value of $12.4MM. The company has a rough history, some previous fraud accusations, multiple CEOs in a short time frame, etc., but if you look past the mess to the underlying assets and the recent announcement of a possible recapitalization of the balance sheet, there might be an interesting personal account type opportunity here.

High level summary, the company's primary business is owning or leasing 24 senior housing properties and then leasing or subleasing those properties on a triple-net lease basis to operators.  A few of these properties the company now either manages or operates on a temporary basis due to operators failing.  Of the 24, 12 are owned and leased out under traditional triple-net leases, meaning the tenants pays for all expenses, the rent is virtually the same as net operating income to calculate a cap rate.  I don't quite understand the leased model where they then turn around and sublease the properties, seems like a dangerous spread trade to me where you have to reach for risky tenants to make it work.  It appears that's how its played out with most of the distress in their tenant base happening in the subleased book, so we'll ignore that for the purposes of the pref thesis.  Below is the rent-roll for the owned properties:

This portfolio is financed with an assortment of government guaranteed debt (generally a negative, means the borrower couldn't get reasonably commercial terms without the government guarantee), total debt is approximately $55MM.  

Add in the $12MM as the market value of the preferred and through the preferred stock you're buying the owned triple-net portfolio for $67MM or an ~11.5% cap rate, as usual with me, pretty back of the envelope math.  The preferred stock trades for $4.50, has a standard liquidation preference of $25, but hasn't paid a dividend in several years. The total liquidation preference is over $35, but it almost doesn't matter, the preferred stock is unlikely to be made whole so any incremental value above the senior debt accrues to the preferred stock, it is the fulcrum security despite the common having a current market cap above $20MM.

In their recent earnings release, RHE added this line:

In early 2020, the Company began on-going efforts to investigate alternatives to retire or refinance our outstanding debt of Series A Preferred Stock through privately negotiated transactions, open market repurchases, redemptions, exchange offers, tender offers, or otherwise. Costs associated with these efforts have been expensed as incurred in Other expense, net and were approximately $394,000 and approximately $144,000 for the three months ended March 31, 2021 and March 31, 2020, respectively.

Apparently they initially started down this path just before covid, now that things are opening up and rent collections are largely back to normal, the time is right to address the capital structure as it clearly doesn't work anymore.  My guess is RHE will attempt to exchange the preferred shares for common stock, maybe something similar to what happened over at Ashford Hospitality Trust (AHT).  Just for a quick example, if you valued the triple-net lease portfolio at a 9.5% cap rate (a higher quality but smallish triple-net like CareTrust REIT (CTRE) trades at 6-7% cap and has been buying properties this year in the 8-10% range) then the preferred might be worth $25MM, or a double.  But that's just a guess, the upside seems highly variably in mind but the downside is fairly well protected.

Other thoughts:

• Senior housing obviously suffered during covid, but with vaccinations now widely completed for the elderly and front line workers, new residents can begin to move into facilities.  There might be a temporary ramp up as move-ins were delayed the last year, but there's certainly an open question at least in my mind if covid permanently impaired senior housing and whether alternatives might become more popular than housing the most at-risk all together in close quarters.
• Whatever the common stock is doing is a mystery to me, it might be caught up in meme stock trading or other pump and dumps, ignore it, its almost certainly going to get completely diluted.  The unpaid preferred is $30.1MM, so the total due to prefs is ~$100MM, you have to be pretty optimistic on their leased/operated properties to see any value to the equity, and if you are optimistic, the preferred is still the better risk/reward.
• I don't know who owns the preferred stock, it's hard to parse out with publicly available data sources, and surprisingly/concerning that despite having the right to nominate board members to represent the preferred stock, no one has to-date.
• RHE should probably just sell themselves, but in their press release and 10-Q they hint their strategy is in the opposite direction, they want to go in growth mode, difficult to fully understand how they could do that but certainly couldn't without first resolving the preferred share overhang somehow.

Disclosure: I own shares of PHE-A