Description

LSR is UK based REIT that is currently in liquidation mode and trades at 30% discount to NAV. More than half of the properties have already been disposed at a slight premium to BV. Despite reduction in the size of portfolio, operations remain cash flow positive. Timeframe for the liquidation of the remaining assets is 2-3 years. Thus investors have possibility to generate c. 10%-20% IRR with a well-protected downside.

Due to small capitalization and minimal liquidity this idea is applicable to PAs only.

Background

LSR is a collection of small retail RE properties spread across UK. Composition of current portfolio (Sep 2016 year-end):

• 327 properties that are divided into 1014 letting units;

• 50% of properties are valued at less than GBP120k, so tiny local shops;

• Property yields are 9%+ with renewals happening at similar prices (like-for-like rents are -2%);

• Vacancy rate is stable at 10%-11%.

Net Debt to value is at 52% and company is using proceeds from asset disposals and operations to pay down debt. Taking into account most recent asset sales (after year-end), net debt to value is reduced to 48%.

Overheads were cut successfully together with the reduction in AUM. Company is profitable at operational level and has generated 0.8p and 1.3p of per share operating cashflow (vs 29p share price) during 2016 and 2015 respectively. Capex outlays are minimal.

Liquidation timeline

The decision to liquidate the company was taken back in July 2013 so the process is already ongoing for more than 3 years. Initial plan was to complete the asset disposal process and return cash to shareholders by the end of 2017. However, disposals were moving far too slow. Recently (potentially due to unsuccessful proxy by the largest shareholder) a more detailed liquidation timeline has been announced and final wind-up targets have been pushed out by couple of years.

Liquidation is weighted more toward the outer years with the largest part of the portfolio up for sale only during H2 2018. So far management seems to be sticking to this plan with 44 smaller properties sold for net proceeds of GBP5.5m since the new timeline was announced.

Property disposals so far:

• FY2013 – 12 properties for GBP1.4m, 16% premium to book

• FY2014 – 23 properties for GBP4.3m, 17% premium to book

• FY2014 – Single transaction 235 property sale for GBP79.3m, 1% premium to book

• FY2015 – 37 properties for GBP5.3m, 9% premium to book

• FY 2016 – 27 properties for GBP5.0m, 2% discount to book

• 2016 Q4 – 22 properties for GBP2.0m, 1.75% premium to book

• 2017 Feb – 22 properties for GBP3.5m, 8.5% discount to book

Overall assets have been sold around book value and the large discount during the last auction sales is either due to specifics of individual properties (worst properties are being disposed) or reflection of deteriorating RE environment following Brexit vote. I attribute this to the former, however results of further asset disposals will show whether properties are systematically overvalued on the balance sheet.

Even if the remaining properties are disposed at the same 8.5% discount to BV, such liquidation would still result in NAV of 36p/share or 15% upside relative to current share prices. Discount to book needs to widen to 16% for this trade to break-even.

Worth noting that LSR is also revising property valuations downwards every year with negative fair value adjustments of GBP0.5m in FY2014, GBP1.6m in FY2015 and GBP1.1m in FY2016 – this likely reflects minimal capex investment to maintain the properties in liquidation phase. However, due to cash positive operations and asset disposal at slight premium, BV per share has remained stable since 2013.

Risks

• Remaining assets might be liquidated at significant discount to BV. The possibility of this has clearly increased after the latest auction results (8.5% discount) and with the continued negative news flow with regards to Brexit and its impact to economy. Still these properties are likely to be sold based on rental yields - commercial rents in UK have so far proved resilient.
• Liquidation might take longer than expected. Unlike previously (2013), this time management announced quite a detailed path towards full wind-up of the company and have exposed themselves to being measured against these published targets. Further delays will likely cause another proxy fight.
• Cash burn due to unprofitable operations with diminishing portfolio. I think this risk is somewhat mitigated by the successful overhead reduction track record over the last three years as well as largest asset sales planned in a single transactions towards the end of the process.
• External manager not incentivized to increase value for shareholders. Liquidation is carried out by INTERNOS, institutional real estate asset manager that was appointed in 2013. Their incentives were agreed with expectation of fast liquidation. However, due to extended timeline, INTERNOS has no chances of receiving anything on terminal fee as the hurdle rate is currently above NAV (was at 36.1p in 2013 and then increased by 8% annually). Total fees paid to INTERNOS have been gradually decreasing from GBP1.3m in 2014 to GBP0.96m in 2016. These will drop further in Jul 2017 when the minimum AUM fee changes from GBP0.9m to 0.7% of the assets (which would be equivalent to $0.5m for current portfolio). INTERNOS only upside is the increased rate (from 0.5% to 1.5%) on asset sales above GBP150m, but that only amount to incremental GBP0.2m if all portfolio is liquidated at current BV. On a positive note these reducing fees will clearly help with the cash burn. There is also a risk that INTERNOS might want to renegotiate the contract sometime in 2017 to ensure higher profitability.

Catalyst

Further asset sales at or above book value

Final liquidation of the company in 2-3 years