Holloway Lodging Real Estate Investment Trust (TSX: HLR.UN HLR.DB.A) (“Holloway” or the “REIT”) announces that it has today given notice to the holders (the “Debentureholders”) of its 6.5% convertible unsecured subordinated debentures (the “Debentures”) that it will redeem the Debentures in full on January 23, 2012 and that it will satisfy the redemption price of the Debentures on the redemption date by issuing trust units (“Units”) of the REIT in lieu of cash, in accordance with the terms of the trust indenture for the Debentures (the “Indenture”). Any accrued and unpaid interest on the Debentures will be paid in cash on the redemption date.

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The number of Units to be issued to Debentureholders will be determined by dividing the aggregate principal amount of Debentures outstanding by 95% of the weighted average trading price per Unit for the 20 consecutive trading days ending on the fifth trading day preceding the redemption date (the “Current Market Price”). Based on the redemption date of January 23, 2012, the 20-trading day period commenced on and included December 15, 2011 and will end on and include January 16, 2012.

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Holloway also announces that it will not make the interest payment on its Debentures when such payment is due on December 31, 2011. Holloway intends to make such payment by January 13, 2012, as permitted by the terms of the Indenture.

This is a significant development for unitholders in that the roughly $51.8M face value of debentures outstanding (at least as reported by the TSX; this may be slightly lower due to buybacks) will be converted at the rate of approximately 7-8 cents per share, at least given existing trading patterns to date. Unit prices cratered from 20 cents to as low as 4 cents upon the announcement (currently trading at 10 cents), while debenture prices dropped from 58 cents to as low as 40 cents and is currently at 53 cents on the dollar.

Assuming an 8 cent per unit conversion price, this would mean dilution of about 94% for existing unitholders. Somebody holding $1,000 face value of debentures would receive 12,500 units, implying a unit price of about 4.25 cents post-conversion. The remaining entity will have about 670 million units outstanding and at 4.25 cents per unit it would imply a market capitalization of about 28 million.

Using the 2010 cash flow statement as a very blunt proxy for future performance, the entity without the convertible debentures will be able to pull in about $5.9 million in operating cash flow, which would put it on sounder financial footing. It could suggest that the post-conversion trading price of the units will be around 7-8 cents.

Finally, the company has decided to consolidate the remainder of its non-mortgage debt on the chairman’s company Geosam:

Holloway also announces that it has entered into a second amendment to its credit agreement dated as of June 15, 2011 among Holloway, Geosam Capital Inc. (“Geosam”), as administrative agent, and Geosam, together with such other persons from time to time party to the credit agreement, as lenders, (the “Credit Agreement”) to increase the amount of funds available for drawdown by $3.6mn for certain limited purposes. Holloway has increased the amount outstanding under the Credit Agreement by $1.8mn in order to purchase from the holders of its interest-bearing promissory notes approximately $2.8mn of such notes, representing all of Holloway’s interest-bearing promissory notes outstanding.

This is presumably linked to the resignation of the CEO (Squires) that lasted in the company longer than I expected him to after the takeover of the company by George Aryoman and Geosam.

My conclusion here is that the market is valuing the debentures and units as slightly expensive, but it is within an order of magnitude of a fair valuation. Finally, my continuing thesis is that the only entity that will make any money from Holloway will be Aryoman and Geosam by virtue of their control of the company and the secured credit facility which will continue to hive off interest income from Holloway unitholders. This will continue as the assets are stripped and sold from the trust.

In other words, this is a fun one to watch, but not to invest in. I feel fortunate to dump my debentures at the price that I got for them (roughly 60-65 cents) and get out of dodge. If unit prices go down to the 4 cent level again, the trust may be worth putting a few pennies in, but this would be one of those typical “pick up the cigar butt off the street for one last puff” type value plays.

One thing I do know, however, is that unwinding from an extended stay out of the country takes a long time, and recovering from a 16 hour time change is not pleasant!

10-year bond yields are now lower now than they have been since January 2009 (the depths of the financial crisis). The bond markets are highly pessimistic about any form of economic recovery and are trading as such.

Short term rates are no longer pricing in a sure chance of a rate increase – BAX futures are as follows:

The December BAX Futures are at 98.66 (1.34%) compared to 98.46 (1.54%) when the Bank of Canada made its last pronouncement on short term rates.  It no longer appears that short term rates will be rising at all.  Three month corporate paper is still at 1.17%.  If there is any hint of economic recovery, it is not seen in the bond market.

Reflecting all of these factors, the Bank has decided to maintain the target for the overnight rate at 1 per cent. To the extent that the expansion continues and the current material excess supply in the economy is gradually absorbed, some of the considerable monetary policy stimulus currently in place will be withdrawn, consistent with achieving the 2 per cent inflation target. Such reduction would need to be carefully considered.

The Greenspan-esque interpretation of the tea leaves will point out that prior wording stated “eventually will be withdrawn” while this press release states that it is approaching if the rest of the financial world does not implode.

When reading the more detailed Monetary Policy Report, two charts came to mind:

Total CPI is increasing significantly – it is no surprise to hear this as commodity prices continue to shoot up like a rocket and prices are passed along the supply chain.

Finally, BAX futures shot down for the year-end interest rate – at 98.46 (1.54%) compared to 98.61 a week ago. This is projecting a near-certainty of a 0.25% rate increase by years’ end.

If short term interest rates rise and the yield curve continues to flatten (10-year rates are still at 2.89% even after the bank rate announcement), this will start to have interesting effects on “yieldy” equities as the leveraged bet starts to become less profitable. There are also implications for the real estate market that I won’t be getting into at this time.

Finding good microcap companies reminds me of the process of mining for bitcoins – you can spend hours (and days) doing it, but still end up with nothing. That was pretty close to what the last half day of my life feels like.

When doing some intermediate analysis on 9 companies, one managed to clear the necessary thresholds for “interestingness” on my watchlist, although this was not a case that screamed at me as a company that will see 5-fold increases in its equity prices. It would be considered a value play. I set a price target that was roughly 20% under what it was currently trading as this would be a valuation that I would be interested in doing some more extensive due diligence for a potential purchase (although it would be a small allocation if it ever got to that point). I will receive an email if it reaches this price threshold.

However, there were two interesting “discards” that I will share.

The first company is Audiotech Healthcare (TSX: AUD), which operates a few hearing clinics in more remote areas of BC, Alberta and the USA. They are family run and family-controlled and stable and profitable. Their balance sheet is in OK shape, with sufficient cash on hand to cover upcoming debt maturities and otherwise not polluted with massive goodwill (indeed, none). Management is relatively respectful of shareholder value (likely due to its significant economic interest in the company) and related party transactions are at an acceptable level (the worst of it is a dead real estate lease in Calgary which will likely be off the books soon). Valuation is relatively cheap, with recent business performance in the last fiscal year producing $347,000 in free cash flow on a (undiluted) market capitalization of $2.38 million. They are ripe to go private or to be consolidated by a larger player.

Unfortunately, their shares are completely illiquid. With $10,000 in volume traded over the past 30 days, a single trader can probably take the stock price up 50% in a day. Hence, this company is in the “interesting but not practical” list of investment candidates.

The next company that I had to do a double-take on is a little more strange. Spot Coffee (Canada) (TSX: SPP) operates coffee franchises, not too dissimilar from Blenz, Waves, Second Cup and Starbucks, in locations in Western New York state, Toronto and one location in Florida. The only difference is that they appear to be larger scale than the typical Starbucks chains and they also serve slightly more complex food offerings.

What is particularly strange is that when you read the management/director biographies, you ask yourself “What the heck are these people getting into this business for?”. I will post the following from their most recent management information circular and let you come to your own conclusions:

The company itself seems to be financed mostly with equity, with the company raising equity capital through private offerings as the need arises. The last private placement was at 10 cents per share for $500,000 and warrants to purchase shares at 15 cents a piece expiring in 3 years. The current market value is $8.6 million and 13.5 cents per share. Operationally they are losing money, but this is due to the lack of economies of scale associated with having such a geographically dispersed operation and relatively low numbers of operating coffee shops.

Gross profit margins have been improving – the most recent quarter being 73%, which is a good improvement over the previous year. Presumably if they manage to scale up their sales in other locations they can actually start to make money, but I haven’t bothered doing the breakeven calculations. This is investing in an industry that is already well established.

Although I won’t be touching the equity on this company, something makes me suspect that this company might be the recipient of some “hype valuation” if they continue opening more stores, sort of akin to Caribou Coffee (Nasdaq: CBOU).

That concludes my investment research for the day – little to show for it.

December BAX Futures are at 98.61; with the current 3-month banker acceptances at 1.20% (98.80), there is a moderate expectation of a 0.25% rate increase. However, I do not believe this will come to fruition and it is highly likely the Bank of Canada will continue to keep the short term target rate at 1% until such time that 10-year yields rise above 3.5%.

Since the markets are awash in liquidity and credit is very cheap, investors will continue to chase yield. When will this party stop? If I gave you a million dollars for 10 years at 2.95%, do you think you can do better? I’d take all the money I could at that rate and fixed term.

Some of his quotes on his PrefBlog are just golden. When commenting on the recent price plunge (which he has been actively looking at over the past couple weeks) on Yellow Media’s (TSX: YLO) preferred shares:

Mean Joe Green used to crash through offensive lines. Mean Joe Yellow offensively crashes through your portfolio.

This, in addition to many other quips (not to mention his market analysis) is why I enjoy reading him.

Whistler Blackcomb (TSX: WB) – I stated in an earlier article that this is one to avoid and I might think about it at $5.30/share and so far nothing has changed this assessment.

Athabasca Oil Sands (TSX: ATH) I did not have a firm valuation opinion other than that the shares seemed to be overpriced at the offering price ($18/share) and stated the following (previous post):

Once this company does go public it would not surprise me that they would get a valuation bump, and other similar companies that already are trading should receive bumps as a result. I have seen this already occur, probably in anticipation of the IPO.

If you had to invest into Athabasca Oil Sands and not anywhere else, I would find it extremely likely there will be a better opportunity to pick up shares post-IPO between now and 2014.

While the valuation pop from the IPO did not materialize (unlike for LinkedIn investors!) the rest of the analysis was essentially correct – investors had the opportunity to pick up shares well below the IPO price (it bottomed out at nearly $10/share in the second half of 2010), although I don’t know whether the company represents a good value at that price or not. I didn’t particularly care because Athabasca Oil Sands has some other baggage that made it un-investable (in my not-so-humble opinion).

While I am reviewing my track record on this site, one of my other predictions dealt with BP, Transocean and Noble Drilling, that:

Over the course of the next 2 years, $10,000 invested in BP (NYSE: BP) at the closing price of June 16, 2010 will under-perform $10,000 evenly invested in Transocean (NYSE: RIG) and Noble (NYSE: NE). Assume dividends are not reinvested and remains as zero-yield cash.

At present, BP would have returned US$14,392.46 to investors, while RIG and NE would have returned US$14,198.52. If I had the ability to close this bet for a mild loss, I would – the political risk for the three companies in question have completely gravitated toward the “status quo” once again after the Gulf of Mexico drilling accident. Drilling capacity is likely to rise, depressing the value of the contractors and favouring BP in this particular bet.

Anything more and you have to work your way up the risk and term spectrum. In terms of term, you can get GICs that give larger rates, but it is at the cost of yield in case if you want your cash to be liquid (e.g. a 5-year term deposit has a break penalty becomes progressively more expensive as you approach maturity).

When you increase risk, the corporate debt market is the next logical step up – there are some short term maturities out there of companies that are virtually guaranteed to pay off their debt giving out yields that are about 300 basis points better than what you can get with Ally. The cost is the “virtual” part in terms of the guarantee of repayment and also liquidity risk dealing with the term – you generally want to wait until maturity or you will have to pay the bid-ask spread.

Investors generally get trapped aiming for yield, but I am finding it difficult to not tweak the portfolio to shift idle cash balances into something earning a bit more, with nearly equivalent safety. I do not think this will burn me and is a suitable way of earning a little more on cash until I can decide what to invest it in. When I think of how many pizzas this can purchase at the end of the day, it becomes a little more meaningful.

With the surge of the NDP in Canada, there is a distinct possibility that the NDP will be a very significant partner in any coalition government against the Conservatives. Economically, one of the promises all the other parties have had is an increase in the corporate tax rate. In particular, banks and oil companies have been singled out by the NDP. Whether they would take action upon them in government or not is another matter, but the corporate tax rate increase is something they would likely implement.

In terms of making a trade based on the projection of the election, I would suspect that selling/shorting profitable large-cap companies on the TSX would be the best way of betting against a Conservative majority government. You would close the position on May 3rd.

In the event that the Conservatives are quite short of a majority government (e.g. a status quo situation), there is likely going to be a few months of major uncertainty before the House of Commons sits for its throne speech. Although the writs are going to be returned sometime in the later part of May, the Prime Minister has the option of not convening Parliament until after the summer break, in September. This is probable if there is another minority government.

This uncertainty only leads in one direction – equity price decreases in Canada.