Description

Temple Hotels (TPH-T)

Temple Hotels was initially structured as a distribution paying Canadian REIT and made a big bet acquiring hotels in Fort McMurray, Alberta, a town that was booming due to its proximity to various Canadian Oil Sands projects. As a non distribution paying and leveraged “busted” REIT, TPH now trades at C$1.57 from a peak of ~C$46 (split adjusted). While it was always tempting to take a flyer on TPH, the recent back to back rights offerings and insiders oversubscribing makes this a very timely idea.

Summary of my investment thesis:

1. I think downside is in the $1.20 range based on ~$40 mln operating income the hotel portfolio should be able to generate

2. Upside is in the $4 range using Temple’s own 2014 appraisal figures, net of cumulative impairment charges.

3. From Temple and Morguard’s actions, it is reasonable to speculate Morguard seems to be in a rush to accumulate shares that may be interpreted that Morguard sees value in Temple either through a go-private transaction or a sale from Temple’s ongoing strategic review.

4. The involvement of George Armoyan (from Clarke Inc.) gives comfort that minority shareholders’ rights and interests won’t be abused.

5. The opportunity exists because TPH screens poorly and there probably is general apathy in the shareholder base.

Background

TPH was originally founded by Arni Thorsteinson in 2006 and had acquired its first hotel, the Temple Gardens Mineral Spa Resort in Saskatchewan Canada. With the market giving TPH a generous valuation and TPH’s external management contract (with Arni) giving them an incentive to grow, TPH went on an acquisition spree in Fort McMurrary, a town in Alberta, Canada in close proximity to various oil sands projects that was booming at the time. Coming out of the financial crisis, TPH once again resumed being acquisitive, doubling-down in Fort McMurray again and also buying in Regina, Saskatchewan, New Westminster, British Columbia and Calgary, Alberta.

With a leveraged balance sheet and distribution cuts, TPH was targeted by activist investors and also got the interest of Morguard Corporation in 2015.

https://business.financialpost.com/news/fp-street/another-externally-managed-real-estate-company-under-attack-first-huntingdon-reit-now-temple-hotels

Investors were ultimately successful in ousting Arni and replacing the management team with Morguard executives – although still putting in a Morguard external asset management structure at 1.5% of revenues. Morguard’s “victory” was short-lived as the oil downturn hit Fort McMurray particularly hard as oil sands producers have little incentive to pursue large projects in a US$50 WTI (vs. US$100) environment. To make things worse, pipeline access issues (depressing producers’ realized prices vs WTI) and 2016-2017 Fort McMurray wildfires further depressed the operating results of TPH’s hotels in the region. Interestingly, throughout this turmoil, Morguard consistently increased its ownership in TPH from ~ 10% to now > 70%.

Fundamentals and Valuation

Currently, TPH has 31 hotel properties and an effective interest in 3,867 rooms. As a percentage of total rooms, TPH room breakdown by geography is:

• 3% in BC

• 23% in Fort McMurray

• 18% Alberta (outside of Fort McMurray)

• 5% Northwest Territories

• 14% Saskatchewan

• 4% Manitoba

• 18% Ontario

• 14% Nova Scotia

Capital structure proforma the 2 rights offering YTD:

• TPH shares outstanding ~75.6 mln, $119 mln market cap

• Estimated net debt ~ $332 mln

• Enterprise value ~ $450 mln

• Bonus: $217 mln in unused tax losses (no value given, free option)

In terms of valuation, I don’t have any fancy or proprietary method other than to assume TPH NOI $42 mln, less $22 mln interest expense, $4 mln G&A, $7 mln capex = $9 mln in FCF to equity ($0.12 per share). So using a pretty conservative 10x FCF multiple (which almost no real estate company is valued this way, except for Keck Seng Investments), I get a downside valuation of $1.20. If you assume Morguard takes control of TPH and does not have to pay the 1.5% management fee, FCF per share is more like $0.15, so my $1.20 downside is more like 8x FCF.

For upside (which is probably why Morguard and Mr. Simoyan is rushing to buy shares), I use the 2014 published appraisal values, less the cumulative impairment charges TPH has taken and made some minor adjustments to get equity value of ~$325 mln of $4.30 per share.

Basically, I took the $877 mln, less $158 mln in cumulative impairments taken, less $62 mln from hotels sold (i.e. Holiday Inn Express, Hotel Saskatchewan, 30% of Acclaim Hotel) to get $657 mln. After subtracting net debt, I get ~$325 mln.

Understanding Why This Opportunity Exists and the “Setup”

It is important to understand what is our edge in this situation, and, to be honest, it is not in having proprietary appraisals and site visits to each hotel and determine why TPH is mispriced. Rather, it is from understanding why the opportunity exists and the implied information from insider actions.

Why this opportunity exists:

1. An income vehicle not paying a distribution. Combined with a tiny market cap, there are very limited holders

2. TPH screens horribly and even real estate investors don’t like it as a quick $/room calculation does not show TPH to be cheap

• TPH has negative equity book value

• TPH is in breach of debt covenants (but that’s not as scary as it looks as banks are unlikely to play hardball with Morguard)

• It looks like TPH trades at $117,000/room. The overall Canadian average estimated by Colliers is $130,000/room. (the answer is 30% of TPH revenues from “other revenues” like conference facilities, spa, gaming, etc.  TPH has 5 larger hotels of this type, hence the $/room makes TPH look expensive)

3. Investors refusing to put anymore capital in TPH – this is evident by Morguard’s ability to oversubscribe in the first rights offering this year, taking their ownership up to > 70%.

4. Fatigue from a “strategic review” that has been put in place since 2016

Understanding the setup:

Normally, having done the work and understanding the situation based on what I wrote above is enough to make the case to buy TPH here. The clincher is the involvement of George and Sime Armoyan through their vehicle G2S2 Capital Inc.

https://www.bloomberg.com/press-releases/2019-04-09/g2s2-capital-inc-announces-investment-in-temple-hotels-inc

For those unfamiliar with George, he is a Canadian activist investor that runs Clarke Inc. To make things more interesting, Clarke Inc. owns just over 50% of Holloway Lodging Corp (HCL CN Equity). Not only that, George went activist on Royal Host REIT, another hotel REIT that was mismanaged and went from $12 to below $1.40 before being acquired by HCL (read about George below).

https://www.theglobeandmail.com/report-on-business/you-want-a-piece-of-him/article970605/

It is very reasonable to assume Morguard seems very interested in accumulating shares quickly (TPH had a *buyback* in place at higher prices in 2017 and 2018), then flipped to back to back rights offerings in 2019. Not only that, I can’t seem to come up with an alternative reason for these “awkward” capital allocation decisions at TPH other than to facilitate Morguard building up its stake as quickly as possible. The risk, of course, is that TPH does a go-private at the least opportune time, resulting in a “take-under” (i.e. Brookfield with Teekay Offshore).

With George’s involvement, I believe at a minimum he could help protect the rights of minority shareholders. Further, it is not inconceivable that, when faced with a low-ball bid, George/G2S2/Clarke could credibly offer a higher bid for the company given the natural synergies with HLC, and also the asset management fee savings from not having to pay 1.5% of revenues to Morguard.

Disclaimer: The write-up is only intended for VIC members and not for dissemination (especially to the issuer).

Not investment advice, no warranties expressed or implied, subject to material and potentially egregious errors. Write-up includes opinions, guesses and speculations that should not be taken as statement of fact. Basically, do your own homework. Under no obligation to update VIC. Could take opposite position at anytime.

Catalyst

Strategic Review Update

Transaction with Morguard or Clarke