A long position in MPG Preferred Series A presents an interesting 25:1 reward-to-risk ratio in a potentially short time frame.

 

This preferred has not paid a cumulative dividend since 2008. Liquidation value is just over $34 today.

 

MPG Office Trust is set to be purchased by Brookfield Office Properties (BPO) for about $180 million in common stock value, pending common shareholder approval. As part of the deal, Brookfield has offered to buy all preferred shares for $25 without paying any of the dividends in arrears. Preferred shareholders who do not tender will have their shares converted into preferred shares of the new company, which will be a subsidiary of Brookfield. This is a key point, as this subsidiary will probably not show an operating profit any time soon and will thus not be required to pay dividends on the preferred. If Brookfield was the direct buyer and it absorbed the preferred stock, it would be required by REIT rules to pay the dividends on the MPG preferred. Brookfield made a calculated move to avoid making preferred shareholders whole in an attempt to buy them back at a discount or else shareholders will be stuck with many more years without dividends.

 

The problem for Brookfield is that the preferred prospectus does not allow for the shares to be converted: "Our series A preferred stock will not be convertible into or exchangeable for any other property or securities of our company." Brookfield is attempting to do so anyway and with some precedent. Other preferreds have the same language, yet have been converted in a merger nonetheless (DCAQP being one example known to VIC members). The difference in other cases is that usually the preferreds were current on dividends and trading near par value, so there was little incentive for investors to resist when you could sell your shares and move on. But in this case Brookfield is trying to buy the preferreds out at a 26% discount to liquidation value.

 

Today, a class action lawsuit was announced seeking an injuction on both the tender offer and the merger. A crucial point regarding the trade setup is that BPO has agreed not to close the tender offer set to expire on July 17 until after the injuction hearing on July 24. So we have a binary option here. If the injuction is denied, you can still tender at $25 and only lose $0.35 per share if buying at $25.35. If the injuction is granted, at a minimum we should see an improved tender offer price of at least a few dollars per share and potentially even be made whole at $34+. Thus, there is a compelling tradeoff between the upside potential and downside risk and it should play out in a short period of time.

 

Risks? Yeah, there are risks. If the injuction is denied, BPO could decide to drop the tender altogether. This seems unlikely as they would love to retire as many of these shares as possible at $25. On the other side, if the injuction is granted, BPO might decide to walk away from the whole acquisition instead of giving more cash to preferred holders. This transaction includes more than $2 billion in assets and only $88 million in deferred dividends, so it seems logical that BPO would at least improve the tender price before walking away (if you're adventurous, you can short the common as a play on an injuction causing the deal to fall apart as it does not appear anyone is going to outbid $3.15 per share, a price which was dependent on screwing preferred holders to get it that high). And here's the good news, BPO walking away could be terrible for the common stock, but is almost certainly a better deal for the preferred stock over getting $25. MPG is either going to be sold or liquidated, so any other buyer would know they can't stiff the preferred stock. A liquidation should result in the preferred being made whole and property prices would have to drop quickly before there was a risk of getting less than $25.

 

So it is certainly possible that the preferreds could end up receiving less than $25, but I see this as a low probability. Legal cases are almost never as simple as they appear, but this one seems almost too easy to a non-lawyer like me: the preferred stock cannot be converted, but BPO says it's going to convert it anyway.

 

Comments desired if you disagree with anything presented.

Injuction hearing on July 24 either results in an improved tender/full liquidation of the preferred stock or investors take a small loss and tender at $25.