Description

I’m recommending the purchase of the 8% CCG cumulative preferred equity.  This trade is really easy – short duration, downside protected, defined and high return.  I don’t want to overcomplicate this, so I’ll keep this write-up brief.  The company, Campus Crest, was recently purchased by Harrison Street and the redemption of the preferred was also announced to happen concurrent with the closing of the purchase of the equity (this announcement was extraneous to this trade as the preferred had a change of control put).  At current prices, you are creating the preferred stock for nearly a 5% gross spread and a 20% annualized spread to what I consider the outside date for the close of the transaction.  Additionally, unlike traditional merger arbitrage trades, this one is credit protected (with cumulative dividends) and even upon a break scenario (which I view as extremely remote) this will still ultimately provide the same outcome just on a slightly extended time frame.  Lastly since the preferred is cumulative, you get paid 8% annualized interest for each day that it’s extended, which makes it incrementally better than other arbs where you aren’t paid to wait.

For a brief history, when Campus Crest announced it would review strategic alternatives in first quarter 2015 it suspended all its dividends (both common and preferred) as it wanted to retain balance flexibility and deleverage to make a sale easier.  After a lengthy process, Campus Crest (a student housing company) agreed to sell itself to Harrison Street for $7.02 per share.  Harrison Street is a private equity firm that specializes in student housing and is intimately familiar with the Campus Crest assets as it was a JV partner in many of them.  The deal is a specific performance deal and the sponsor has committed equity financing from large pensions and debt financing from major investment banks.  The sponsor is highly motivated to close as it will materially increase its fee paying assets under management by purchasing assets it knows intimately well and wants to own.

For those who want valuation/credit metrics, we estimate that the last dollar of risk in the preferred stock stops at around a 10% cap rate on the assets and the dividend on recurring cash flow is almost 3x covered.  The par plus accreted dividends today is 26.80 and by a 2/28/2016 that number will be 27.32 (but grows by an annualized 8% if the deal takes longer).

So why does it trade where it does?  All of merger arb has been hit, so spreads across the board are attractive and I suspect the relative size of this deal and liquidity of the preferred are contributing the attractive return profile.  The instrument is self-liquidating and safer in many aspects than even the “safe” deals that trade as tight as 6%/7% (this is a credit with limited downside versus a “break” in an equity deal).  Even if the deal were to “break”, the next most likely move for the company is to do an equity recapitalization and make the preferred stock current (see preliminary proxy for details on offers they received for equity infusions).

For added safety, you can get comfort that a member of the board recently made a purchase of the equity at 6.60 per share on 11/20/2016 (a slightly wider spread than the preferred).  As insider purchases are rare in merger arb, this is a sign that insiders are confident in the close.  For what it's worth, I also like the equity as an arb trade, but think that the preferred is much easier.

Where should this trade?  At a minimum I think it should trade to a 10% IRR, which would make it 26.65, or if traded on top of its current redemption price 26.80 (an ~8% yield).

Catalyst

1. Final proxy
2. Setting a vote date after the proxy clears
3. Additional insider buying