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!

Overall market thoughts – volatility – fossil fuels

This is another rambling post with no coherency. The quarterly reports from companies are flowing in and I am reading them – but there are few companies that are below my price range where I start to care about them in detail. As such, my research pipeline at this point is in the exploratory mode rather than doing detailed due diligence.

It is in the middle of summer and I am not expecting much in the way of volatility – it is truly a summer where major portfolio decision-makers have decided to take away from the trigger switches.

Accordingly I have been sitting and watching with respect to my own portfolio while I do my casual research. Probably my biggest error of omission was watching the solar market rise over the past six months – I’d written them off, along with almost everybody else, as languishing when the price of fossil fuel energy dropped. A lost opportunity there – there was one company in particular which I earmarked, financial metrics looked great, but didn’t even pull the trigger, primarily due to insider selling. If I executed correctly on it, I would have been looking at a double now. Oh well.

An equity chart that caught my attention was the high expectations of investors of Canaccord pulling a great quarter, which came nowhere to fruition:

This is very obviously the chart of expectations crushed after a quarterly report – a regression to the recent mean would suggest a $4.50-ish stock price. I also notice their domestic competitor, GMP, being crushed after their quarterly report.

I also notice most liquid fossil fuel companies are getting hit badly and are close to multi-year lows. In the USA, most of the companies receiving boosts are the ones that have had been relieved of their debt burdens through the Chapter 11 process (LNGG is a great example of this). I still don’t think equity holders of fossil fuel extraction companies are going to be too happy over the next 12 months.

I also took notice with Interactive Brokers, and Virtu’s commentaries with respect to Q2-2017 as being one of the lowest volatility environments possible – they are two types of businesses that generate revenues as a function of trading volumes. Volatility correlates negatively with an increase with the broad markets – I am looking for defensive-type companies that will do okay in an environment like present, but will really do well when volatility increases.

Interactive Brokers is a classic example of a great company (they are the best at what they do by a hundred miles over everybody else), but one who’s stock I am not interested in buying at current prices.

Mostly everything in the Canadian REIT sector seems to be over-valued. An interesting trend is that the downfall of retail is somewhat being projected by RioCAN’s chart – trading below book value, it might seem to be an interesting value, but are they able to keep up occupancy and lease rates to businesses that have to compete against Amazon? The residential darling of the market is Canadian Apartment Properties (CAR.UN) but they are most definitely not trading at a price that would suggest a future performance beyond a high single digit percentage point and this is under the assumption that their real estate portfolio asset value remains steady. Trading in the entire REIT sector seems to be entirely yield-focussed which is never a good basis to invest, but it is a good basis to evaluate other investors’ expectations on these entities.

Gold has also been up and down like a yo-yo and might be an interesting bet against dysfunctional monetary policy. Unfortunately my ability to analyze most gold mining firms is generally not that fine tuned.

The liquidity of my overall portfolio is very high (nearly a quarter of the portfolio is collecting dust at a short duration 1.5%), but right now I don’t see much investment opportunity that would suggest avenues for outperformance. I could shove the money into some sub-par debenture (e.g. TPH.DB.F which buys you a 7% coupon until March 31, 2018 maturity) but do I really want to lock my capital into something that is questionable? It is the literal metaphor of picking up pennies in front of a steamroller. My policy is that if I have to force my money to work, chances are the investment decision’s risk/reward is worse than if I just held it in cash and waited for some sort of crisis to hit. I generally define “crisis” as something that will take the VIX above 30%, but it has been awhile since we last saw it:

It is pretty ironic how the election of Donald Trump was foreseen by most pundits to be the end of the world and higher volatility times, but so far the opposite has turned out to fruition. Will it continue? Who knows.

I see a lot of people making the mistake of impatience, and also the mistake of assuming that the index ETFs that they are investing into (Canadian Couch Potato, etc.) will leave them safe through masked diversification – works great as long as there are net capital inflows, but what happens if there is a correlated bust among these products? Will retail continue their conviction when they see a 10% drop in prices, or will they grit their teeth and add to their positions?

I continue to wait. It might be a very boring rest of the year with very limited writing. If you think you’re in a similar predicament, I’d love to hear your comments below.