Want to make a few pennies? Temple Hotels Debentures

This is a bet on the confidence of your fellow investors to vote against a bad deal.

Temple Hotels (TSX: TPH) is a borderline-profitable hotel operating company. Financially they are in miserable condition. They have mortgages that are in covenant default, loads of debt and other issues (being in the wrong geography at the wrong time).

For whatever reason (still can’t figure it out today), on December 2015 Morguard Corporation (TSX: MRC) decided to take them over (via control of the asset management agreement) and recapitalize the corporation with equity capital through a rights offering. They used the funds ($50 million) primarily to retire about $60 million in convertible debentures in cash. Morguard owns about 56% of Temple’s stock.

Temple still has about $80 million in convertibles outstanding (TPH.DB.E, TPH.DB.F), and $45 million of it is about to mature on September 30, 2017. Yes, that’s in about three weeks.

Looking at their June 30 balance sheet, they have $14 million in cash and the Morguard parent would need to pay up. (I’ll note at this point the busy Canadian summer hotel season will produce about $7 million in operating cash flow, but this is not including mortgage principal payments and maintenance capital expenditures which would bring this figure down a little).

Management, therefore, is floating a proposal to extend the maturity of the debentures 3 years to September 2020. The terms are to keep the interest rate the same (7.25%), decrease the conversion price to something astronomically high ($40.08/share) to something very high ($15/share, or something that’d need to more than triple in order to get at-the-money) and do a 5% redemption at par at the end of the month.

In other words, they are offering nearly zero incentive for debenture holders to extend.

Indeed, management is continuing a practice that the Securities Act should ban, which is the payment to third-party dealers to solicit YES votes in proxies:

Subject to certain terms and conditions described elsewhere in this Circular, the Corporation will pay a solicitation fee equal to $7.00 per $1,000 principal amount of Debentures that are voted FOR the Debenture Amendments, payable to the soliciting dealer who solicits such proxy or voting instruction voted FOR the Debenture Amendments, subject to a minimum fee of $150.00 and a maximum fee of $1,500.00 per beneficial owner of Debentures who votes Debentures with principal value of $10,000 or greater FOR the Debenture Amendments. No solicitation fees will be paid to the soliciting dealers if the Debenture Amendments are not approved by the Debentureholders at the Debentureholder Meeting.

Insiders own 2.49% of the debentures. The vote requires 2/3rds of those voting to pass and a minimum quorum of 25% (which should be attained).

So this becomes a test of whether your fellow debtholders are stupid enough to vote in favour of this agreement or not, and also a function of whether you believe Morguard will back up Temple in the event that this proposal fails. You would think Morguard would provide some debt credit to Temple because otherwise why dump the tens of millions of dollars into the corporation and just have it get thrown away with a CCAA arrangement at this stage? Or have they decided that the salvage operation they are currently conducting is negative value and basically want to throw away this asset?

Since the TPH.DB.E series is trading at 96.5 cents on the dollar, it means that if you bought $1,000 par value you’d be looking at a 3.6% gain in three weeks if the proposal is rejected (it is too late for management to exercise the share conversion option) AND that Morguard gives capital into Temple to pay off the subordinated debt (nobody else would be sane enough to do it without ridiculous concessions).

The risk/reward is isn’t high enough for me to take the risk but I’m floating this one out here for the reader if you are!