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)

Catching Knives w/ FI, FWRD & JEF

Quick update, I've been quiet for a bit, maybe due to some writer's block, maybe because I continue to underperform the market by an embarrassing amount.  Clearly, I've missed the recent big market trends, but even in my niche I've underperformed, just feels like playing a game of Battleship where you're just missing the targets.  Anyway, here are a few new tracker positions I've taken where I admittedly have few original thoughts to add to the greater market zeitgeist.

Three new tracker positions:

Fiserv (FI) ($35.4B market cap, $65.7B enterprise value) is a large legacy merchant acceptance business (the old First Data) paired with a decent but no-growth core account software provider to small and medium sized community banks.  These types of legacy fintech businesses usually have poor reputations with their clients, the view is they've levered up and no longer invest in their product or innovate, rather they rest on their laurels knowing their products are sticky and generally not worth the risk of transitioning away to a new provider.  Fiserv apparently pushed that narrative to the extreme and clients are fighting back on extra fees attached to their Clover product (point of sale device, plus a software platform for small businesses) bringing their previously issued guidance into question.  New CEO, Mike Lyons (joined from PNC, former CEO Fran Bisignano left to join the Trump Administration running SSA and the IRS) pressed the reset button on the company's strategy, management team (hiring new co-presidents for each business segment and a new CFO) and guidance.  Shares dropped roughly in half last week, quite shocking for an real business and S&P 500 component.  

Investor trust has been broken for now, but the reset seems to be the right strategy for the long term (?), this is still a non-discretionary product that should trade for more than ~7.5x adjusted earnings (much of the adjustment is non-cash amortization expense from the First Data merger).  Fiserv has historically been a levered equity buyback story, hopefully they continue to buyback shares down here (they bought back $6.7B in the last twelves months at significantly higher prices) and avoid the trap of management teams hoarding cash just when the stock becomes cheap.

Forward Air (FWRD) ($730MM market cap, $2.4B enterprise value) is primarily an asset-lite (relies on independent contract drivers) less-than-truckload transportation services provider that historically had a nice niche in airport-to-airport routes.  They diversified through acquisitions over the years to include truckload, intermodal drayage (between ports/railyards and other points in the supply chain) services and most recently with their ill-fated acquisition of Omni Logistics, a 3PL service provider.  The Omni Logistics acquisition, announced in 2023 but closed in early 2024, was done at peak post-covid earnings and a peak multiple of 18x EBITDA (which was higher than FWRD's multiple at the time).  The market hated the acquisition from the start, crashing the stock, Forward Air management tried to backout of the transaction but eventually closed it with a small price cut.

In January, Forward Air announced it was conducting a strategic review, there have been reports of multiple (5-6 financial buyers) bidders being interested including Clearlake Capital Group which owns a 12.6% stake in the business.  The strategic process is long in the tooth at this point, Axios recently reported the process is at an impasse due to a wide bid-ask spread.  Shares have traded down as the market seems skeptical of a deal happening, but a turnaround effort is probably best conducted in private hands and activist shareholders will continue to pressure management to sell.  I'm hoping a deal can still be reached as the company has yet to call off the sale process, despite the Axios report being a couple weeks old now.

There's quite a bit of debt on FWRD, it's on the riskier side, but at $18.25/share, its trading at 7.7x consensus NTM EBITDA of $315MM.  Tariffs and supply chain disruptions, plus a general shipping recession is a concern, but on more normalized earnings, this business is even cheaper and could be a home run for a PE buyer.

Jefferies Financial Group (JEF) ($10.8B market cap) is the largest non-bank holdco investment bank in the U.S. which was recently ensnarled in the First Brands bankruptcy.  For those outside of the leveraged finance space, First Brands is a privately held (and non-PE sponsor) rollup of auto parts products that recently went bankrupt after a refinancing of their term loan was paused due to a non-receipt of a quality of earnings report and subsequently the company stopped making payments on their factoring debt.  There's some whiffs of fraud here, First Brands potentially pledged the same receivables multiple times and used a lot of off balance sheet financing that was only weakly disclosed to their term loan lenders (although if credit analysts looked at the cashflow statement, could see that something was off).  Jefferies was First Brands' banker on the failed term loan refinancing and a fund managed by Jefferies was overly exposed to the factoring debt, causing into question the level of due diligence they performed prior to the engagement.  

In the wake of the news, people started comparing Jefferies to B. Riley (RILY) and other runs on financial institutions, but this situation seems pretty contained, Jefferies has limited actual exposure to First Brands and the market will likely forget about it in a quarter or two.  Unlike the other two above, Jefferies isn't as absolutely cheap at 13.5x forward consensus earnings for a cyclical business, but with the continued tailwinds of increased M&A and open credit markets, hard to see this situation (unless you disagree that its a one-off) having a lasting impact.

Disclosure: I own shares of FI, FWRD, JEF

Braemar Hotels & Resort: Gross Asset Management Contract, Initiated Sales Process

It's probably a sign of the times, have to dip in quality to find some ideas and this pitch makes me throw up a little in my mouth. 

Braemar Hotels & Resorts (BHR) (~$200MM market cap, ~$2.1B enterprise value) is a luxury hotel REIT that was formerly known as Ashford Prime, a spin of Ashford Hospitality Trust (AHT) in 2013.  BHR is externally managed by Ashford Inc (formerly AINC, went private via a reverse/forward split last year), the creation of the infamous Monty Bennett.  Hotel REITs are a challenging business because they need to outsource the hotel management function to a third party to maintain REIT status, then also pay for the franchise flag, throw on top of that an egregious external asset management contract and BHR never had a chance.  The only reason these external Ashford hotel REITs exist is because they were all originally under one roof before AINC was spun from AHT.  I don't think this structure would have gotten public otherwise.

Again, skipping a lot of history here, there has been numerous activists at BHR trying various ways to remove Ashford from an otherwise healthy portfolio of luxury hotels.  Finally, on August 26th, the REIT officially waived the white flag and announced the initiation of a sale process.

In a typical external REIT management agreement, there might be a 3x termination fee, not so with BHR, Ashford has negotiated a "discount" to their termination fee with the board to facilitate a sale:

Their termination fee is 12x PLUS another 20% on top of that, again truly gross and no way AINC would have come public without being a spinout of its blood sucking host AHT.  Bennett would later steal AINC by issuing himself preferred stock and draining all value from minority AINC shareholders.  While I just wrote up not being sure about the incentives in the TURN/MCLI deal, here they're squarely in our face that Ashford only cares about themselves and views this as an opportune time to get 14-15 years worth of management fees upfront.

However, I still think there might be a trade here, albeit a very risky one.  This sale process rhymes a bit with Bluerock Residential Growth REIT (fka BRG, now BHM) where you had an externally managed REIT with a messy balance sheet that effectively made the equity a stub.  Any positive surprise in the sales process produced exceptional returns for the stub.  Below is my quick back of the envelope math on the potential outcomes of a BHR sale based on various cap rates:

Most of the value in the portfolio is in a handful of luxury hotels, 4 under the Ritz-Carlton flag (Lake Tahoe, Puerto Rico, Sarasota and St. Thomas), 1 under the Four Seasons (Scottsdale).  Luxury hotels have continued to perform well through the covid bullwhip with some luxury hotels trading hands well within the range above.  I've also included the $25MM termination fee to rid the buyer of Remington, Ashford's hotel management arm, plus the potential for the preferred stock to convert to common above $4.39/share.  Again, it feels a little gross to own this one, Ashford is really incentivized to only get a price above their termination fee so we're counting on the independent board members (one new board member already came out publicly they were unaware of the termination fee negotiation) to keep the process honest.  But I think it's an interesting bet in small size.

Disclosure: I own shares of BHR plus a few call options

180 Degree Capital: Merger w/ Mount Logan Capital, Tender Offer, Questions Remain

180 Degree Capital (TURN) is a microcap (~$46MM market cap) closed end fund (CEF) pursuing an activist strategy in microcap stocks.  Before 2017, some of you might remember the name, it was a venture capital fund known as Harris & Harris Inc (TINY).  There are a few similar ones today, these almost never work.  CEO Kevin Rendino took over, changed the strategy, but was hampered by their legacy venture portfolio weighting down overall returns.  The last few years have been a difficult time for microcap investing, large caps seem to outperform year in and year out, but it's especially difficult to outperform if you're running a subscale internally managed CEF.  Expenses create too high of a hurdle to justify a small fund's existence.

I'm going to skip some background but TURN trades at a discount to NAV (not uncommon for CEFs) and has for some time.  Naturally activists showed up (Marlton Partners and others) and pushed the company to close the discount by repurchasing shares, liquidating and/or distributing the underlying public equities in TURN's portfolio in-kind to shareholders.  To management's credit, TURN did implement a "Discount Management Program", but to limited success.

In January of this year, TURN entered into a reverse merger with private credit manager, Mount Logan Capital Inc (trades as MLC on Cboe Canada) valuing TURN at NAV (later revised to 110%) and Mount Logan at $67.4MM.  This transaction potentially fits the "balance sheet to income statement transformation" theme where the market is currently valuing TURN at a multiple of book value and in the future will judge Mount Logan Capital on an earnings basis.  Marlton Partners pushed back on the transaction, there was even a counter proposal from another CEF, Source Capital (SOR), at NAV, but TURN rebuffed that deal.  Shareholders on both sides of the transaction have now approved the reverse merger with Mount Logan Capital, which should close sometime this month.

Who is Mount Logan Capital?  It is an affiliate of BC Partners, where BC Partners credit team's executive management team also doubles as Mount Logan Capital's management team subject to an expense sharing agreement (so not quite an externally managed company).  Mount Logan has a random assortment of low-quality asset management contracts plus an owned insurance company where they're managing the float for a total of $2.8B (the graphic is from last November), but that number is puffed up a bit by the insurance AUM and a couple run off management mandates.

Source: November 2024 Investor Presentation

It is unclear to me why Mount Logan exists separate from BC Partners which has its own credit platform and the delineation between the two on future asset management contracts.  Management owns some shares here but not really enough to prioritize Mount Logan or become exceptionally rich if it is successful.  The incentives are hard to tease out, which likely means they're not well aligned with outside minority shareholders.  The relationship with BC Partners is strange, the two BDCs (PTMN and LRFC) recently merged, LRFC was being managed by Mount Logan Capital and PTMN by Sierra Crest Investment Management (a JV where BC Partners is the majority owner, Mount Logan Capital held a minority stake), the combined BDC was rebranded as BCP Investment Corp (BCIC) and will be managed by Sierra Crest.  What's the point of Mount Logan?

In the merger proxy, Mount Logan management did put forth some pretty ambitious fee-related earnings projections that seems difficult to achieve:

If the 2026 numbers are to be believed, the $67.4MM valuation put on Mount Logan in the merger (actually less now that its been revised) is only 3.5x FRE (heavily adjusted) and doesn't count the spread earnings they receive from the owned insurance subsidiary.  So either BC Partners is so desperate to get Mount Logan off of a backwater Canadian exchange and onto the NASDAQ, or something isn't right here.  In July, they put out a SPAC-like deck comparing their FRE multiple to much larger more established peers and includes some wild upside targets.

Luckily, as part of the revised merger agreement, new Mount Logan Capital (will trade under the ticker MCLI) has agreed to a $15MM tender offer (presumably funded by liquidating TURN's portfolio) after closing at NAV (~$5/share) for any shareholders that don't want to go along for the ride.  It's a bit of a free look to see if MCLI trades better on a U.S. exchange.  Additionally, they've committed to a $10MM share repurchase program post-tender offer to support the stock and provide liquidity.

Small-cap BDC/credit managers haven't done particularly well in public markets despite the permanent capital angle, two that come immediately to mind are Fifth Street Asset Management (FSAM) and Medley Management (MDLY).  Interested in hearing others thoughts, especially if you have a strong view on the future of Mount Logan.  I own a bit, mostly hoping it trades well out of the gate, if not, there's some support from the tender offer (management has committed to not participating).

Disclosure: I own shares in TURN

Mural Oncology: Update

Mural Oncology (MURA) ($~30MM market cap) has turned into a bit of a battleground busted biotech in the comments section of my original post.  I always appreciate feedback on ideas, in this case it helped me avoid the fall in MURA's stock price after their recently published business update.  The cash burn has been significantly higher than expected as they wind down their R&D and clinical efforts, but included in the press release were a few nuggets worth pointing out making the stock interesting at current price levels.

First, MURA gives a cash estimate for year-end, this is a positive change as they didn't in the original April strategic alternatives announcement:

As of June 30, 2025, the company had approximately $77.1 million in cash and cash equivalents. The company estimates that, if it has not consummated a transaction or other strategic alternative by December 31, 2025, its cash and cash equivalents as of such date will total approximately $43 to $48 million.

At the mid-point, that equates to approximately $2.50/share.  In addition, most companies will warn that any forward estimates could come in lower than anticipated or sale processes take longer than expected, etc., but MURA sort of did the opposite:

This cash guidance is subject to a number of assumptions and actual cash balances may differ materially, particularly if the Company consummates a transaction or other strategic alternative prior to December 31, 2025.

"Actual cash balances may differ materially" then cite a positive type surprise, just found that interesting to note.  Maybe something is already in the works?  Lastly, MURA snuck in language around a liquidation or wind down being a possibility which they hadn't mentioned previously:

any strategic alternative it may pursue, including, but not limited to, an offer for or other acquisition of the company, merger, business combination or other transaction, including a possible wind- down and liquidation of the company

The simple back of envelope math is below, my guess is someone like XOMA or Tang (although one negative here is neither Tang nor BML are known shareholders) come in and make an offer that amounts to a liquidation dressed up as an acquisition (helps with the Irish takeover rules, gives management change of control bonuses, etc.) for 90% of the projected year-end cash:

There is some acknowledged hair on this situation, it is a former spin that hasn't reached the two year safe harbor (would do that in November) and it has also let go of over 90% of their employees bringing into question whether the IRS would still consider this an active trade or business.  My uneducated take is MURA is still in the drug development business, they haven't sold their assets/business (other biotechs, SYBX comes to mind, seem very aware to avoid being classified as a cash shell and continue to mention their IP in filings despite similarly stopping all development efforts), usually there is some grace period but I admit it's a risk.  

It has been several months now since the strategic alternatives announcement, if such a tax issue were a concern, MURA's advisers or legal would have popped it up by now?  Management hasn't hinted at any issues, would be an epic mistake to blatantly shoot yourself in the foot regarding taxes, but I'm sure its happened before and I could have egg on my face with this one.

Disclosure: I own shares of MURA, bought back in recently.

Franklin Street Properties: Office Basket, Strategic Alternatives

The second in the office REIT basket is Franklin Street Properties (FSP) (~$180MM market cap), this one might be a more direct comparable to City Office REIT (CIO) in that it owns 14 central business district (some less CBD than others) multi-tenant office buildings in the sunbelt (like CIO) but also in places like Denver and Minneapolis which have been slower to recover.  FSP has been on my radar for a long time as they've included the below language for years in their quarterly results, it's been an unofficial liquidation of sorts since the pandemic.  They've sold over $1B in property and used the proceeds to deleverage their balance sheet.

We continue to believe that the current price of our common stock does not accurately reflect the intrinsic value of our underlying real estate assets.  We will continue to seek to increase shareholder value by pursuing the sale of select properties when we believe that short-to-intermediate term valuation potential has been reached.

In May, FSP officially announced a strategic alternatives process:

“The Board of Directors is committed to maximizing value for all our shareholders,” stated George J. Carter, Chairman and CEO. "We believe that FSP's share price does not adequately reflect the underlying value of our real estate, and, accordingly, we have undertaken this strategic review process to explore opportunities to eliminate this disconnect."

We haven't seen the CIO proxy yet, but I anticipate in the background to the merger we'll see many counterparties participated in the auction (CIO mentioned conducting a comprehensive process).  FSP could be a consolation prize if you're a private equity manager with cash to burn.

FSP typically hosts a quarterly conference call to review their financial results, earnings were released today and FSP decided to skip having a call.  The market has been frustrated with the speed of this slow motion liquidation, but it appears they're finally serious about selling the remaining assets/entire company.  FSP's portfolio is only 69% leased, the office landlord business has a lot of operating leverage to it, if you (or an interested private buyer) have a strong view that leasing activity will recover then this one might be cheaper than it screens on an current NOI run-rate basis.

Franklin Street Properties is a bit of a family business, management pays themselves well, but do own 10% of the shares and to their credit have shrunk the business over the last 5 years.  The risk here is that they run a process and don't feel like they're getting fair value, continue to pay themselves handsomely and let the slow-motion liquidation continue for a few more years.

Disclosure: I own shares of FSP

Net Lease Office Properties: Office Basket, REIT Spin/Liquidation

I'm starting up an office REIT basket, last week City Office REIT (CIO) announced it was being acquired by MCME Carrell (an affiliate of Elliott Management and Morning Calm Management) for $7/share in cash, which is approximately a 10% cap rate on CIO's net operating income (85% occupancy).

It's been 5 years since the worst of the pandemic, return to office trends keep moving in the right direction.  Anecdotally, my commuter train is generally as crowded as it was pre-pandemic (excluding Fridays) and the Chicago loop seems mostly normal again.  New supply is virtually non-existent, likely will be for the foreseeable future, these things take time, but private equity seems willing to take a risk on office at these valuations.

First up, and likely the least risky of the three, is Net Lease Office Properties (NLOP) (~$500MM market cap), a well-known favorite that many other value bloggers have written up since it was spun off from W.P. Carey (WPC) (NLOP's external manager) in November 2023.  It is a vehicle designed to be a liquidation with a limited life, similar to other REIT spins of the past like Retail Value or Spirit MTA -- popular among value investors, REIT liquidation, gives me nightmares of the New York REIT (NYRT) pitch.  

But this situation has mostly de-risked, at the time of the spin, NLOP was saddled with a 14% interest rate mezzanine loan, after several initial rounds of asset sales, the mezzanine loan has now been completed paid off as of April.  That news is important because the remaining debt is all non-recourse mortgages attached to specific properties, any further asset sales on the unencumbered properties can be used to make special liquidating distributions to shareholders.  Much of the mortgage debt might end up getting extinguished via foreclosure, can almost think of those properties as call options on the office recovery.

As the name suggests, NLOP owns primarily single tenant office properties where the tenant is responsible for most of the operating expenses of the property (net lease or triple net lease).  Keeping things simple, below is a quick back of the envelope illustration of what NLOP would be approximately worth at a 10% cap rate, similar to the CIO transaction.

There's a lot more fun you can have modeling out the liquidation value here, including the cash flow from here until the final distribution, what handing back the keys means on the encumbered properties, etc.  The portfolio is 85% leased, there's one chunky property, KBS's headquarters in Houston that makes up 23% of the rent roll, but I'm generally more optimistic on Houston than others, it wasn't as impacted by covid and has a more in-person office culture than some other cities.  I think it's a manageable.

Disclosure: I finally joined the party and now own shares of NLOP