Description

A misperception of NAV guidance has created a buying opportunity in the stub equity of liquidating SMTA,  which is currently trading below a conservative 9/30/19 liquidation basis NAV. Although the lessees of three of the remaining eleven properties (Children’s Learning Adventure locations) are currently in Chapter 11, our review of the bankruptcy proceeding leads us to believe that the 9/30/19 NAV is conservative.  The tenants remain current on their lease obligations and adjusting to a reasonable (non-bankruptcy, non-vacant) valuation for the three rent-paying properties, the upside is attractive even considering the illiquidity from SMTA’s transition to a liquidating trust in early 2020.  

Current situation

SMTA was covered well by value_31 and the associated comment board, so we won’t recount the history here.  Suffice it to say that having sold the Master Trust, the final chapter of the SMTA story has started.  The stock remains tradeable for a few more months and will then convert to a non-tradeable liquidating trust, subject to the discretion of the Board of Trustees, in the first quarter of 2020.

To date, the SMTA spin from SRC has proceeded largely consistent with management’s guidance.  Certainly the Shopko bankruptcy impacted the potential upside, but management did well to address this event via the non-recourse financing and eventual default.

Today, SMTA is a collection of cash and 11 properties, five of which are currently vacant.  According the to the 9/30/19 10Q, the NAV is $0.74 and management intends to sell the remaining properties and complete the liquidation by 12/31/20.  

Investment Thesis

• Stock currently trades at a discount to conservative NAV (11/19/19 stock price: $0.70) 
• On 10/4/19, Company guided to total liquidation distributions of approximately $0.92, 25% upside from 9/30/19 NAV of $0.74
• Estimated liquidation completion timeline: one year (12/31/20)
• In the most recent filing (9/30/19 10Q), management values three Children’s Learning Adventure locations as if vacant, though they are operating, albeit with the tenant entities in bankruptcy.  
• However, the entities are current on obligations to SMTA and bankruptcy court filings appear to indicate that bankruptcy emergence is possible and SMTA management’s 9/30/19 value estimate of certain assets could therefore be understated

Why is it cheap:

• Liquidation and liquidating trust is coming
• Headline 9/30/19 NAV down from 30-day-old management guidance
• Who wants to look into bankruptcy filings?

In its 10/4/19 press release, SMTA management guided the following related to total liquidation distributions to shareholders:

Assume the midpoint: $8.925, or $0.925 net of $8.00 per share distribution paid to shareholders on 10/23/19.  Yet, the 9/30/19 liquidation basis NAV indicates: $0.7365 - a 20% discount.  What makes up the difference?

In our estimation, a significant portion of the delta can be explained by a conservative 9/30/19 valuation of the three remaining assets leased to Children’s Learning Adventure (“CLA”).

The company notes the following in the filing related to these assets:  

“CLA is currently in bankruptcy and is paying its rental income in accordance with the lease agreement. In the event that CLA successfully emerges from bankruptcy, there is potential for a significant increase in value for these properties.”

We recently explored the court filings to see what we could learn about the assets and the prospect for emerging from bankruptcy to add to SMTA’s disclosure.  

At today’s price, you pay nothing for CLA bankruptcy emergence upside.  In fact, you are paying less than the value management ascribes to the bankruptcy assets assuming they do not emerge.

CLA Assets and Court Proceedings

Children’s Learning Adventure operates approximately twenty-nine brick and mortar early childhood education centers serving children aged 6 weeks to twelve years.  Three CLA learning centers, The Woodlands, TX, Fall Creek/Humble, TX and Henderson, NV (the “CLA Centers” and each a separate legal entity) lease property from Spirit SPE Portfolio 2012-5 LLC (“Spirit”), an entity that was spun out by SRC to SMTA in the initial spin off transaction and is included in the “workout assets” bucket.

The CLA Centers originally entered into a Master Lease with Spirit in December 2014.  In December 2017, the CLA Centers defaulted on the Master Lease due to non-payment of the December 2017 monthly rent payment and the property taxes due.  In January 2018, the CLA Centers, individually, filed for bankruptcy protection along with numerous other CLA entities not related to Spirit. On February 1, 2018, Spirit sued Children’s Learning Adventure USA LLC (“CLA USA”), the parent of the CLA Centers and guarantor of the lease, for payment under the lease agreement.  CLA USA and Spirit settled this lawsuit in October 2018, but the CLA Center entities each remain under bankruptcy protection. It does not appear that CLA USA is (or has been) under bankruptcy protection.

While the settlement between CLA USA and Spirit does not appear to be public, the data provided in the 9/30/19 10Q by SMTA seems to indicate that a rent reduction was negotiated as part of the settlement:

Importantly, all three centers remain in operation and are current on all lease obligations per SMTA disclosures.  The entities that own the centers, however, remain in bankruptcy protection.

Court filings indicate that the three CLA Center entities reported the following unsecured creditors as of 9/30/19:

The significance of the above list is that there appears to be only one unaffiliated entity remaining as an unsecured creditor to all of these bankrupt entities, namely Anything Aquatic that is owed $4,750.00.  Otherwise, the only remaining (assuming CLA of Texas LLC is affiliated) unsecured creditor of note is Spirit, the landlord. This is significant.

On November 12, 2019 U.S. Trustee Ilene J. Lashinsky who is overseeing case No. 2:17-bk-14851-BMW, which is jointly administered with the CLA entity cases, moved to convert the jointly administered cases (including the Spirit cases) to Chapter 7 proceedings while the debtors are seeking to have the cases dismissed.  In the filing, the Trustee distinguishes between the CLA entities’ cases and all of the other jointly administered cases because the CLA entities are the only cases with leases that “have not either lapsed or been rejected.”   In a key passage, the Trustee states the following:

“Spirit...would prefer that the Court dismiss [the CLA] cases rather than convert them [to Chapter 7].  However, the same arguments to protect smaller and more vulnerable unsecured creditors made...with regard to [certain other CLA cases with different landlords] also exist in the Spirit Cases.” [my emphasis]

Based on this passage, it appears the Trustee favors Chapter 7 (rather than dismissal) to benefit “smaller more vulnerable unsecured creditors.”  However, according to the tables recently produced by the three bankrupt entities above, there are no unsecured creditors other than Spirit, save one that is owed $4,750.  Given the absence of “vulnerable” unsecured creditors and noting the Trustee’s statement that Spirit prefers dismissal (and we know that CLA USA also favors dismissal because they opposed the Trustee’s motion) it would seem likely (to us) that dismissal occurs.  The timing, however, is uncertain.

The Trustee closes by stating:

“The US Trustee fully appreciates that the conversion [to Chapter 7] of the Spirit cases will require further hearing by the court, including allowing Spirit to engage in any such matter.”

There is nothing currently on the docket from Spirit, but based on this information, we would expect Spirit to join the debtor entities and CLA USA in seeking dismissal of the cases and therefore allowing the CLA property owners’ emergence from bankruptcy. 

Valuation

The value driver in this thesis is the CLA assets.  Assuming the other assets are fairly valued as of 9/30/19, here is a look at the impact of changes to the 9/30/19 valuation of CLA properties based on income capitalization (based on annualized cash rent for triple net leases) rather than vacant comps.

We reached out to the company for additional information about the CLA bankruptcy and were directed to the existing SMTA disclosure.

In summary, given SMTA management’s 10/4/19 guidance towards liquidating distributions “closer to the middle” of the estimated range and the apparent lack of unsecured creditors to the three debtor entities, we believe emergence from bankruptcy for the CLA entities is a reasonable likelihood leading to a commensurate increase in NAV due to CLA property re-valuation.

Risks

• The CLA entities don’t emerge from bankruptcy and are sold at a valuation comparable to vacant space
• The CLA business struggles, though it is current on the lease payments and the lease payments are clearly critical to its business operation
• Timing extends beyond 12/31/20 (I’m looking at you, GYRO)
• 9/30/19 estimated values of non-CLA real estate assets are not realized
• Opportunity cost due to illiquidity of Liquidating Trust

Catalyst

• Emergence from bankruptcy for CLA entities
• Interim distributions from sale of assets