Note: I hold a significant number of the Condor Hospitality (NASDAQ:CDOR) Preferred A and B Shares. In addition, these shares represent a large percentage of the holdings in my non-retirement, investment account.
On Jan. 2nd, 2015, I published an article, "Big Gains Coming for Supertel Hospitality Preferred A Shares: Strong Conviction Buy As My Best 2015 Idea", the ticker symbol being CDORP. This is one of the three preferred share series for Condor Hospitality, the other publicly-traded tranche being the B Series (CDORO). The third preferred share series, the C Shares series, is not publicly traded, as far as I know, and is owned entirely by Real Estate Strategies LLP, or RES, an entity associated with IRSA.
In this article, I highlighted the opportunities for CDORP and argued that it offered a very attractive balance of reward to risk. This security opened 2015 as SPPRP, priced at $5/share and ended the year as CDORP, priced at $7.25/share, an increase of 45%. The symbol changed during the year (on July 15th, 2015) as the company was changing its corporate identity from Supertel Hospitality, an owner of economy and mid-scale hotels, to Condor Hospitality, an owner of upper-tier hotels.
Subsequent to the open on Jan. 4th, 2016, CDORP has declined to a price of $6.45/share at the close on February 10th, 2016. This represents an YTD decline of 11%. Even with this decline, a buyer on Jan. 2nd, 2015, would still be 29% to the good at the market close on Feb. 10th, 2016.
This is my 10th article on Supertel Hospitality/Condor Hospitality. This series of articles follows the quest of Condor's management and its board to restructure the finances of the company. This series began in the summer of 2014, a few months after the payments of dividends on the preferred shares A and B were suspended. During this period, the company has made great progress in selling non-core properties to raise cash and has purchased four hotels, including three since the end of 3Q'15 on which to base a future business with a new business model and a new focus on upper-tier hotels.
My normal quarterly update would include a review of the balance sheet and a running assessment of the degree to which the company's assets support the value of the three preferred share series. However, the 4Q and 2015 Annual Report will not be available for another month, leaving an extended, four-month period from the 3Q report in mid-November through mid-March without an update at a critical juncture.
Therefore, I write this "interim" report, given the long period without a report from the company, to take stock of where the company is along its restructuring path and assess whether it is, or is not, moving towards a prompt recapitalization of CDOR. In addition, I want to answer questions that have accumulated during this long dead time between the two reports.
The question is now: What to do with this security?
Questions to Consider When Deciding What to Do
1. Would it be OK to sell?
2. Are there reasons to stay the course and continue to hold?
3. What do you think the company will do?
4. What is the Owl doing?
In addition, I add one short section...
5. Final comment
...to comment on another article and disagree with one point made in it.
I use these general questions to consolidate and respond to the many questions received about these securities and, again, provoke your own thinking and reflection on your goals for holding these securities, given your personal investing style.
1. Would It Be OK to Sell my CDORP (or CDORO)?
First, no one ever went broke taking a profit, especially a large one. You would have been up 45% at the open on Jan. 4th, 2016; even now, after a substantial market decline during which CDORP also declined, you would be up 29% at the close on Feb. 10th. Given a flat 2015, this would be a solid result, relative to most holdings. One should also consider the less than positive outlook for 2016, especially given the shaky start to the market year (during which time 16% of the gain on CDORP would have been reduced), and I can understand that an investor would want to sell to "git while the gittin' is good".
2. Are There Reasons to Stay the Course and Continue to Hold?
The reasons to continue to hold are the same as they were when you read my article and bought CDORP a year ago (or even the first in the summer of 2014). That is, these securities have the senior claims to current net tangible assets that cover the face value plus all or most of the accrued dividends (and interest for the A Shares), the sum of which are nearly double that of the current market prices for the A and B Shares. This was true in 2015 and continues in 2016 to be the justification for owning them.
The A Shares, selling for $6.45/share, sell for only 54% of the face value plus accrued dividends and interest for these shares (ca. $11.90/share). If you are interested in CDORO, at a closing price of $16.24/share on Feb. 10th, they are selling for 53% of the $30.625/share value of the $25/share of face value and $5.625/share of accrued dividends. While the current net tangible book value would not quite deliver enough assets to cover all of the accrued dividends, the company has been selling legacy assets at a 40% premium to the book value (the last three hotels sold, reported in early January, is the basis for this estimate as well as hotels sold in late 2015) which would deliver sufficient assets to cover face value plus accrued dividends. An updated analysis on the assets available to support the value of these preferred shares will be provided once the 2015 balance sheet is published in mid-March.
This has been the consistent theme throughout this series of articles on Supertel/Condor Hospitality and continues to be the justification for continuing to own the shares. Even if you only capture half of the remaining value of the A or B shares relative to their underlying value, that would still represent 35% or 44% upside relative to the current (Feb. 10th) market closing price of the respective A and B Share Series, yet more than the 29% captured since Jan. 1, 2015. There is still significant additional upside beyond that which has been captured to date.
In addition, these shares continue to accrue dividends and interest at a very high rate. At $6.45/share, the A Shares (CDORP) accrue a 12.4% dividend yield and an additional 2.4% interest yield on the accrued dividends, summing to a 14.8% total yield. The B Shares (CDORO) are accruing dividends at a 15.4% yield at a market price of $16.24/share. Obviously, these dividends are not being paid out, but represent senior claims against the company's assets which will need to be paid first when the company returns to profitability, requiring profits to be distributed if CDOR wishes to remain a REIT (or not pay significant taxes).
This may not take as long as you might think. After a prolonged period of losses extending back to the financial crisis, CDOR had year-to-date income above $6MM at the end of the 3Q'15. REITs are required to pay >90% of income to remain a REIT, so once the company turns the corner, preferred share series holders will be first in line to be paid. I am sure that there are loss carry-forward issues and non-recurring issues that may delay the requirement to make payouts (a lawyer or accountant would need to make that assessment as that will surely be a very technical one), but if Condor ends 2015 with a significant gain, this will herald the potential for positive income in the not-too-distant future; in turn, income brings the requirement for payouts and the resultant distributions to long-suffering A and B Share owners. Let's also keep in mind that RES has tied up $32MM in Condor, and I am sure that it would like to begin to get a payout on its investment and its effort to turn around Condor Hospitality.
One final note: CDOR's headline earnings in 4Q should include a gain in the derivative liability by virtue of the decline in CDOR's value during 4Q, from $1.51/share to $1.25/share. The derivative liability should experience a contraction, creating a gain for the quarter, given a significantly reduced stock price versus the "strikes" used to measure the option values of these liabilities. If current prices hold, the company will experience an even greater gain in 1Q'16 (with the stock declining from $1.25/share down to $0.78/share at Feb. 10th close). The declining common share price will drive down the "option value" of these liabilities, creating significant "gains" in both quarters. However, this does not impact the cash position of the company by one penny, so I will not be excited about these "gains" in the same way as I was not disheartened by these "losses" in previous quarters.
3. What Do You Think the Company Will Do?
It appears to me that CDOR has slowed down the effort to recapitalize the company. This might be a completely erroneous assessment on my part, but it feels like the company has gone quiet about both asset sales and balance sheet restructuring after a flurry of purchase and sales activity plus the aborted swap offer. Perhaps, it is waiting for its 4Q and 2015 Annual Report discussions to lay out next steps or perhaps it is thinking that slowing down the process may lead to a greater likelihood that the preferred owners will be more likely to swap their shares.
Reasons for slowing down restructuring might include:
a. For now, the preferred capital represents "free financing" for the company in the moment, relieving some of the cash flow pressure due to the costs and cash flow impacts of transitioning the strategy. While it may need to pay later, and we will discuss this below, this provides $16MM of capital ($46MM if you include the C Shares) on which it is not paying dividends or interest in current periods.
b. If you assume that all of these shares can be converted to equity at some point in the future, why not slow down the restructuring as this will simply create more equity at the time of conversion? This company has big plans to grow, and the more equity that is in place, the bigger the initial platform it will have to grow and acquire future properties. However, as we will discuss below, that includes a very big "if".
c. There may be a calculation that, as time goes on and more transactions (purchases and sales) are made, a swap will become more attractive to the preferred shareholders. That is, the preferred owners might develop a greater incentive to own common and a greater confidence in the company; therefore, they may be more likely to swap preferred for common shares, which would be an extremely positive development for CDOR.
If they are slowing down, I believe that they will be miscalculating again, after miscalculating on both the capital raise and the previous swap offer. As evidence, I offer the rationale to do it ASAP beyond my desire to receive a quicker payout, hardly compelling to anyone other than I.
Reasons to re-structure now:
a. Now is the cheapest time to attempt or exchange the A and B Shares or redeem them. The A Shares are increasing in value (increasing "liabilities" to the common shareholder) at an ever increasing rate, currently about 9.5%, including interest on accrued dividends while the B Shares are increasing in value at a flat 10% per year. In September of this year, dividends and interest on the A Shares will hit 10% (8% on ca. $2.54/share in accrued dividends and interest, yielding a bit more than 2%, plus the 8% dividend) and exceed that level thereafter. By June 2018 or so, the accrued interest and dividends on the A and B Shares will equal the $8MM or so value of either the A or B Share tranche, and that ignores the $7.8MM due to RES for the accrued dividends on the C Shares. In essence, Condor will then have to reacquire the equivalent of three share series plus address the C Share dividends; looking at it another way, CDOR will have increased liabilities for accrued dividends and interest equal to the $16MM-ish original liability of the A and B Shares. Time is not on the side of this company and the meter is running.
b. Assume that the preferred shareholders do NOT chose to swap their preferred shares. By September 2018, the A and B Shares will have a call on nearly half of the total net tangible book value of the company, up from roughly a third in December 2013, when the dividends were suspended. Again, time is not on the side of CDOR's board and management.
c. The company has now sold about 2/3 of the hotels that it owned in the late 2000s, 39 now from roughly 120. Most of its ability to create new funds has been already consumed. The company has indicated that it plans to hold eight hotels, so the number to sell is 31, roughly 1/4 of its salable inventory six or so years ago. Its ability to create cash by selling legacy hotels is beginning to wind down, so when is it planning to address the elephant in the room (Preferred A and B Shares)?
d. If the company waits to exchange and finds out at that point that the preferred shareholders are not prepared to swap, RES will have three choices: leave the preferreds in place and simply pay high financing costs, take the company into a restructuring and essentially distribute the assets among the three preferred shares pro-rata (with a likely zeroing out of the value of the common), or buy out the shareholders with an additional $20MM of additional capital. I don't speak for RES, but I have to believe that these are all viewed as unattractive options. Furthermore, it has already learned once that it has overestimated the desire of the preferred holders to swap for common, which should also give it pause.
e. The market may be worrying about the same thing and expressing its concern about the suddenly changed slow rate of restructuring as the stock price has declined by 2/3, down from the infamous $2.32/share price in August (on which the proposed swap takes place) down to $0.78/share at the close of Feb. 10th. This is not showing the continued confidence in the plan in which the board may have hoped.
f. This board has attempted to do a capital raise and a previous swap of the preferred shares, both of which were unsuccessful. I am concerned that it is the next proposed swap as badly as it misjudged its last two moves. If so and if it waits, the amount involved just keeps getting bigger to the point where it becomes unmanageable, in my estimation, at the end of 2018.
g. It is worth noting that the accruing dividends and interest are not included as balance sheet liabilities, so a simple "look" at the balance sheet is not sufficient. These liabilities are in addition to what is included in the balance sheet.
h. Finally, CDOR indicated that markets were too volatile to proceed last fall. If anything, they are now more volatile than they were then and do not appear (to me, at least) that they will be getting better anytime soon. I am not a market timer, but it appears to me that the market started rolling over last April, with lower highs, lower lows and an increasing number of stocks (in number, not in capitalization) heading down "from the upper left to the lower right". If the environment is bad now, it is getting worse for the foreseeable future, making restructuring increasingly difficult as it continues to wait. Then (earlier in September '15) would have been better than now, but now will be much better than later.
In addition, other quirky things are going on with the common CDOR. On three occasions in the last couple of weeks, blocks of stock sized well above normal levels have been bought, driving the price up as the flurry of purchases occurs, then settling back down once the "special cause" buying tails off. In one case, nearly 100,000 shares appeared to be involved in these purchases, well outside of typical volumes, with zero not uncommon. Either shorts are covering (which is good), another buyer is coming in to buy significant common (could be good or bad), or RES is buying additional shares to keep its percentage of ownership at the maximum level allowed, even if I understood that it was already at or near its maximum level of ownership under the existing covenants. I am not sure what it is but the volumes of these purchases rise well above recent activity and is a signal for something, even if I do not currently understand what that something is.
Overall, if I were on the board, I would want to get this existential threat to the common shareholders addressed as soon as possible. While that may still be the plan, it does not feel to me as if it is.
4. What is the Owl Doing?
If my premise is correct that the tack being taken by the board is a slowing of the process, then a logical assessment is that the board will be more aggressive towards the preferred shareholders. I may be wrong and I hope that I am, but the apparent slowing of activity towards restructuring (versus moving ahead with the existing strategy) suggests that the board will delay any restructuring and rely on "free financing" from the preferred shares.
It is one thing if the company does not have the liquidity to pay the preferred dividends; however, it is quite another thing if it can pay the dividends and chose not to do so. It becomes a bit concerning for the preferred shareholders, as the number of legacy, non-core hotels are sold down to a small remaining percentage of the original number, yet no progress is made in restructuring the balance sheet.
As such, I am monetizing some A Shares (where prices allow) and using the proceeds to add B Shares (again, where prices have allowed), adding about 25% to my position of B Shares since the beginning of the year (early February) while keeping an approximately level overall position in Condor (A plus B Shares). As such, I will have the enhanced protections of the B Shares and will be able to increase my vote leverage on the change of control provisions. If Condor plans to push harder on the preferred shareholders, it will be important to be in the preferred share tranche with the best protections.
One thoughtful, purposeful commenter made an observation that continuing to stay invested in these securities felt like "dead money" and it appeared to the commenter that the Owl was Captain Ahab chasing Moby Dick. Emotion and pride are deadly to investment success, and this observation made me pause about my real ambitions and intentions for my continued investments in these securities. After considering the remaining upside and the rate at which additional claims are racking up (i.e., the dividend yields at current market prices), however, I continue to believe that they remain attractive investments. Perhaps Ahab is indeed chasing Moby, but Moby just keeps getting to be a bigger and bigger prize.
As for being dead money, the last calculation that I saw on Yahoo Finance on the beta for these two share series were small, with one being slightly positive and one being slightly negative. That is, these two share series were nearly uncorrelated to the market over the period for which the beta was calculated. Given the market action year-to-date and my expectation that we will continue to be going down, being "dead money" and uncorrelated to the market looks like a good deal to me. Can these shares trend down with the rest of the market? Sure, but the investment thesis has always been that there are significant underlying assets to support a much higher valuation and that, in the intermediate future, resolution one way or the other must occur, resulting in the holders' ability to realize that underlying value. The meter is running, and there is a limited time for it to run for the board to retain attractive options for them.
As such, I continue to hold a significant portion of my non-retirement, investment assets (i.e., in my value and distressed asset portfolio) in CDORO and CDORP, even as I migrate the balance to increased ownership to CDORO with better protections and more influence on the ultimate result, simultaneously reducing or attempting to reduce my position in CDORP. Of course, again, I am only prepared to do this at acceptable selling prices (above that on Feb. 10th close) for CDORP.
What the reader chooses to do depends upon the reader's investing style and tolerance for risk at this particular juncture. Either way, CDORP owners have good options: realize a significant profit or look for more in the intermediate term. Whatever is decided, I hope the reader feels informed in a balanced way about Condor Hospitality as well as CDORP and CDORO to make suitable investment decisions.
5. Final Comment
The prolific Seeking Alpha writer, Mr. Brad Thomas, having written over 900 articles, wrote one of them about Condor Hospitality (see here) in October 2015. This article provided a thoughtful overview of Condor as he does with each of these subjects. He also indicated that he felt that Condor was a very risky proposition as a "very risky bird". Parenthetically, the reader may find it amusing that the Owl is writing about Condor Hospitality, "risky birds" and SWANs.
The authors writing about Condor all agree that the common shares are risky, including Mr. Thomas. Be that as it may, his conclusion is one with which I disagree: "I usually don't give gambling advice, but I think a person would be better off spending $1.40 in the slot machine than putting hard earned capital into a share of CDOR".
Now, I agree that CDOR is risky, and I have not recommended its purchase, opting for the preferred shares. Risky yes, reckless no. I don't agree that it is the equivalent of throwing money away. I can frame my argument to rebut Mr. Thomas in three words: J. William Blackham (actually, one letter and two words, but let's not be fussy).
Buying CDOR, admittedly a risky investment, is really a call option on CDOR, having no expiration, on the ability of J. William Blackham to steer the company through all of the shoals past which it must navigate (including people like me) to a better time and place. It is by no means a safe bet and, again, not one I recommend as this is not my personal investing style; however, betting against this guy is also a risky bet. It is by no means the equivalent of throwing your money away, as Mr. Thomas suggests, and it is not a reckless investment. In fact, you have not bad odds that it will pay off handsomely (vastly better than a slot machine) if this is your type of investing. It looks to me more like casino odds than slot machine odds to bet on Mr. Blackham.
Disclosure: I hold a significant number of Condor Hospitality Preferred A and B shares. In addition, these shares represent a large percentage of my holdings in my non-retirement, investment account.
Disclaimer: No guarantees or representations are made. The Owl is not a registered financial advisor no does the Owl provide financial advice. You should always consult a financial advisor prior to purchasing or selling securities.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The disclosure system does not pick up CDORP and CDORO. As stated at the beginning and ending of the article, I have significant percentage of my assets in my non-retirement, investment account in the combination of these two securities.
Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.