The purchase of Retirement Residences Real Estate Investment Trust (aka, “Retirement REIT”) 5.50% Convertible Unsecured Subordinated Debentures, due March 31, 2015, represents an interesting investment opportunity (symbol RRR.DB.C on TSX). It could be categorized as a low-risk, modest-return opportunity. Please note that all numbers are in Canadian dollars, unless otherwise noted.
Retirement REIT is a real estate investment trust registered in Canada. The Trust owns and operates a portfolio of retirement and long-term care homes and skilled nursing facilities mainly in Canada (in terms of US exposure, 14% of its 2005 distributable income came from its US operations and 11% of its assets at year-end 2005 were in the US).
Retirement REIT is in the midst of an auction process which started at the beginning of 2006. First-round bids for the company were due in mid-April. The completion of a successful sales process triggers the debenture’s change of control provisions. The change of control provision as outlined in the prospectus is as follows:
“Upon the occurrence of a change of control of Retirement REIT involving the acquisition of voting control or direction over 66 2/3% or more of the Units, Retirement REIT shall make an offer to purchase, within 30 days following the consummation of the change of control, the Debentures then outstanding, in whole or in part, at a price equal to 101% of the principal amount thereof plus accrued and unpaid interest.”
Assuming the sales process takes until the end of July (another 3 months) and the re-purchase of the debentures takes until the end of October (a further 3 months) for a total timeframe of 6 months, an investor should earn $2.75 (5.50% interest x ½ year) for holding the debenture for 6 months plus an additional $5 ($101 - $96 purchase price) on the change of control (per $100 face value of the debenture). Therefore, over a 6-month holding period, an investor would earn 8.1% or 16.2% annualized. To the extent that the process takes longer than 6 months, the return would decrease.
There is some potential upside to this return. Retirement REIT currently trades around $9.60. This debenture is convertible into units at $11.35 per unit, so there is upside if a bidding war breaks out for Retirement REIT.
The risk with this investment is what happens if, for some reason, the auction process concludes with Retirement REIT going it alone. In this case, the debentures could trade down into the low $90’s (they dropped as low as the high $80’s in October of 2005 when there were rumours of distribution cuts to the units and the general market malaise at that time) and the REIT units should trade down due to the fact that Retirement REIT will need to raise money through an issue of additional REIT units to fund capital expenditures on its facilities and as well as for a recent acquisition of nursing facilities for US $100 million. However, by owning the debenture, the downside is mitigated by the 5.5% coupon. If we assume the debentures trade down to $90, with the 5.5% coupon over 6 months (i.e. 2.75%), the downside may be just $93.