Description

Long SPPRP ($5) & SPPRO ($13.6) (Supertel Hospitality Preferred)

Note: These are small issues and likely only fit for PAs

As this write-up is based on today’s events, I’ve opted for timeliness over detail.

Today’s Events

Supertel Hospitality announced today that they are suspending dividends on their preferred issues.  The two publically traded issues, SPPRP (8% Series A, $10 Par) and SPPRO (10% Series B, $25 Par) traded down over 40% today on the news and are now roughly at half of par.

Overview

Supertel is a REIT that owns 71 limited service hotels.  There’s a VIC write up from ‘07 that provides some good background.  Since ’08, Supertel has been through rough times as its focus of midscale (think Quality Inn) and economy hotels (Super 8) has been a particularly challenged segment of the market.  In response, the company has been shifting its portfolio towards upper midscale (Comfort Inn) and premium-branded (Hilton Garden) hotels.  The company has been divesting legacy properties and using the sales proceeds and external capital to acquire properties in their new target segment as well as to de-lever.

So what caused the preferred dividend halt?  The proximate cause is a failed stock offering.  At the end of August, Supertel attempted an equity offering for $134m.  $16m of the proceeds would be used to redeem the A & B preferred, $64m for acquisitions, with the balance used to de-lever and for general corporate purposes.  The stock was hit hard following the registration and the offering was withdrawn the following month, with the CEO citing “current market conditions” and “pricing expectations” as reasons for the pull.

The 10-Q following the offering stated: “The costs of this offering and its failure to be completed have had a severe impact on the Company’s liquidity.”  The company incurred $1.1m in expenses from the equity offering, not inconsiderable for a company of this size, when no proceeds were generated.

This led to today’s announcement of a halt of the Preferred dividends, with both securities down 40%+.

The Opportunity

What’s the opportunity with the preferred?  I think there are two key points to address: 1) is the company solvent? and 2) what are the control persons’ attitude towards the preferred?

On the first point, it’s my contention that the company is solvent, but illiquid. The dividend halt is intended to ease a liquidity crunch, and I believe can be reinstated once funds can be raised either via additional property sales, and/or a successful capital market transaction.

My main argument for solvency is Supertel’s book value of $41m as of last Q.  The key question, of course, is how this book value relates to the real value of the company’s properties.  I went through all the sales transactions from this year and compared it to their net book value.  Please see the table below:

As you can see, the sales price equals or exceeds book value in almost all cases.  Keep in mind that these are the company’s underperforming assets as well.   I think there’s enough value here for the Preferred to be covered well above their current market price.

The second question about key stakeholder attitude to the preferred is an important one.  I know many VICers can attest to situations where the ability to pay the preferred was not enough – you need a willingness to pay.

There is a third, Series C, issue of Preferred that I haven’t mentioned yet.  This series is solely owned by Real Estate Strategies, LP (“RES”), and was issued in a private placement at the beginning of 2012 to provide capital to pursue the above-mentioned shift in strategy.  RES is controlled by IRSA (Inversiones y Representacions Sociedad Anonima), an Argentine real estate co, which happens to trade on the NYSE under the ticker “IRS.”

The terms of the Series C are as follows:  3m Preferred were issued with a 6.25% coupon and par of 10, convertible into 3.75m shares (split adjusted).  IRSA also received warrants for another 3.75m shares with strike at $9.6 (again split adjusted), and 4 of 9 board seats.

The rights of the C is as follows: “with respect to dividend rights and rights upon the company’s liquidation, dissolution or winding up, the Series C convertible preferred stock ranks… on parity with the Series A preferred stock and Series B preferred stock.”

I don’t think the IRSA board members enjoyed having the dividend suspended any more than the individual holders.  Since the majority of the outstanding value of all Preferred shares is in the C class, most of the dividend goes to IRSA.  My thesis is that the halt was done as a prudent move during a liquidity crunch, and will not be a permanent impairment.  IRSA could also serve as a potential source of liquidity, as it doesn’t seem logical to let liquidity problems impair their $30m investment (Supertel recently received a waiver from GE for breaching covenants).

Today’s announcement of the suspended preferred dividends led to indiscriminate selling in a thinly traded security.  Buying these preferred at half of par gives you an accruing (but unpaid) yield in the high teens.  The company’s book value and the alignment of preferred holders with the major investor / board members gives me a degree of comfort that this will turn out well.

Catalyst