Sotherly Hotels: Buyout, Preferred Share Conversion Arbitrage

Sotherly Hotels (SOHO) (~$108MM fully converted market cap) is a lodging REIT with 10 hotel properties located primarily in the southeastern part of the United States.  The REIT is technically internally managed but each of the hotels is under a management agreement (remember, lodging REITs can't actually manage their hotels' operations) with a related party owned by the management team creating a conflict of interest.  For that reason and others, SOHO has typically traded at a discount to peers.  Their hotels:

On 10/27, Sotherly Hotels announced they are being acquired for $2.25 by a JV between Kemmons Wilsons Hospitality Partners and Ascendant Capital with Apollo Global (APO) and Ascendant providing financing for the deal.  Like other REITs with conflicts that trade at a discount, SOHO funded itself with preferred stock classes publicly traded under the tickers SOHOB, SOHOO and SOHON (for purposes of the merger, it doesn't really matter which one you own).  These classes of preferred stock all have provisions that allow holders to convert their shares to common in the case of a change of control, however, there's a catch in the form of a share cap (BHR's prefs have these too):

Upon a change of control (as defined in our charter), holders of our Preferred Stock will have the right (unless, as provided in our charter, we have provided or provide notice of our election to exercise our special optional redemption right before the relevant date) to convert some or all of their shares of preferred stock into shares of our common stock (or equivalent value of alternative consideration). Upon such a conversion, holders will be limited to a maximum number of shares equal to the share cap, subject to adjustments. Each holder of Series B Preferred Stock is entitled to receive a maximum of 8.29187 shares of our common stock per share of Series B Preferred Stock, which may result in the holder receiving value that is less than the liquidation preference of the Series B Preferred Stock. Each holders of Series C Preferred Stock is entitled to receive a maximum of 8.50340 shares of our common stock per share of Series C Preferred Stock, which may result in the holder receiving value that is less than the liquidation preference of the Series C Preferred Stock. Each holder of Series D Preferred Stock is entitled to receive a maximum of 7.39645 shares of our common stock per share of Series D Preferred Stock, which may result in the holder receiving value that is less than the liquidation preference of the Series D Preferred Stock. In addition, those features of our Preferred Stock may have the effect of inhibiting or discouraging a third party from making an acquisition proposal for our Company or of delaying, deferring or preventing a change in control of our Company under circumstances that otherwise could provide the holders of shares of our common stock and shares of our Preferred Stock with the opportunity to realize a premium over the then current market price or that stockholders may otherwise believe is in their best interests.

There is a little more work involved here, you'll have to call your brokerage firm and elect to convert your preferred shares to common after the merger (if you don't, you'll get orphaned).  

Notice to Holders of Preferred Stock

 

With respect to each series of the Company Preferred Stock, pursuant to the Charter, the Company will, within 15 days after the closing of the Merger, provide notice to the holders thereof that the closing of the Merger has occurred (the “Preferred Notice”). The Preferred Notice will include certain details with respect to the Merger and specify a date (to be no less than 20 days nor more than 35 days after the date of the Preferred Notice) by which the holders of the Company Preferred Stock may elect to exercise a right to convert some or all of the Company Preferred Stock held by such holder into the right to convert, subject to the terms and conditions contained in the Charter, including the share cap as defined therein, into Company Common Stock and receive the Per Company Share Merger Consideration.

The common stock trades at only a 12% IRR spread (assuming the deal closes 3/31, in the press release they guided to a Q1 close) indicating the risk of this not closing is pretty low (solid financing, pretty cheap price being paid too) given the illiquidity premium a micro cap arb situation deserves.  The spread on the preferred shares is much wider (I'm still using a 3/31 close date, if you want to get more exact, include a delay for the conversion to close):

Why might this be?  The preferreds are likely held by retail holders, they're relatively illiquid, there's an extra step involved and preferreds notoriously get screwed in deals like this one.  Related, the company has deferred the previously announced Q4 preferred dividend and is suspending future preferred dividends, already creating friction.  This is one you'll need to monitor and not forget, the buyers are incentivized to make converting your shares difficult.  But at a 30+% IRR, seems like a pretty attractive risk/return to me. 

Disclosure: I own shares of SOHOB and SOHOO (just which ones my buy order filled, again, doesn't really matter which class you pick)