Tag: MRC

Melcor / Melcor REIT / Firm Capital

Looks like another dust-up happening in the Canadian REIT market. First we have the ongoing saga at Artis (TSX: AX.UN), but now Firm Capital (TSX: FC) is launching a salvo against Melcor REIT (TSX: MR.UN).

Considering that 55% of Melcor REIT is owned by Melcor (TSX: MRD), clearly Firm Capital won’t be trying to overthrow the board of trustees. However, they can threaten to make things very expensive:

If an oppression action was brought against MDL, MDL would be required to either purchase minority unitholders equity at fair market value or have the business sold accordingly.

The summary of Firm Capital’s argument is that the REIT has an NAV of about $9, while the market value is at $4. Melcor has it at NAV on their books, and is economically extracting far more than it should be, so therefore, the solution is to buy out the 45% it doesn’t own for a small fraction under NAV. Simple!

Firm Capital, in its letter, points out precisely the reason why I don’t invest in the equity of these majority-owned REITs that are spun off from the parent corporation – related party fees tend to put the minority in an unfavorable position. Another obvious corporation/REIT combo is Morguard (TSX: MRC), Morguard REIT (TSX: MRT.UN) and North American Residential (TSX: MRG.UN), where the terms of engagement are set by the parent corporation.

Within the capital structure of Melcor REIT, the convertible debentures are another story. As long as you get paid out in the end, it doesn’t matter if management has their hands excessively in the cookie jar, unless you paid excessively for the call option value of the equity conversion component. Fortunately, in Melcor REIT’s case, when I purchased my debt, they were so far out of the money that it wasn’t something I was banking on. The ultimate irony is that I was getting paid a higher coupon than the REIT units, yet having the security of a debt investment – isn’t safe yield what you’re supposed to be investing in a REIT for?

This soap opera was made even better with Melcor’s response, which included:

Melcor REIT confirms that the first it has been made aware of the November 4th , 2020 letter from Firm Capital was today.

And a few hours later, they went to clarify:

Further to our press release from earlier today, we have investigated the matter and discovered that the original letter, dated November 4, 2020 and sent to us via email by FC Private Equity Realty Management Corp. (Firm Capital), was caught in our spam filter and did not reach any of its intended recipients.

Caught in the spam filter! One wonders if they received any other solicitations that ended up in the spam bucket as well. A tough claim to believe.

I am loaded with plenty of microwave popcorn to watch this debacle unfold.

The end of Temple Hotels

Temple Hotels (TSX: TPH) is finally going to be removed from the public markets for CAD$2.10/share by majority shareholder Morguard (TSX: MRC).

Temple has been the target of a slow motion takeover which, in 2015, was effectively finalized by Morguard by the assumption of its asset management agreement, and repurchase of debt securities. After, they proceeded to raise capital through rights offerings which resulted in Morguard accumulating a 73% stake in the company. An entity associated with Clarke’s (TSX: CKI) Armoyan, owns 17% of Temple and agreed to be bought out by this price.

I said a long time ago I was wondering what the heck Morguard was doing meddling with Temple given Temple’s financial statements – even after injecting a bunch of equity capital, the company still appears to have sub-standard financial metrics. Four years after this slow motion takeover, my thoughts still persist. It’s one reason why I wasn’t exactly looking at the prospect of buying equity at CAD$1.80/pop, which was the trading price it was very thinly trading at for most of this year (heaven forbid if I was forced to participate in another rights offering).

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!