A major acquisition was just announced by Wheeler Real Estate Investment Trust Inc., (NASDAQ:WHLR). The company finally closed on the major game changing acquisition that it had been pursuing for some time. Bells are ringing and accolades are pouring in, along with promises of a rosy future. But what about the lenders? Do they share that upbeat attitude or do they have other ideas? What about the shareholders? Especially the shareholders that purchased initially at $6 dollars a unit and saw the distribution cut and the price drop?
Company management has raised the cash flow estimate (available for monthly distributions) from $.11 per unit to at least $.16 per unit (an annual rate) by the end of the second quarter. That kind of announcement at least sounds good and gets investors cheering. Plus this kind of acquisition shows growth. While management did issue more units, the total units issued was less than 2% of the units outstanding and therefore would not dilute any potential earnings that much. In short the acquisition was supposed to be accretive from the start.
But Mr. Market yawned through the whole celebration. The stock closed April 13, 2016 at $1.29 per share. That was up a whole six cents, and the yield is still 17%. That is not quite the reaction that an investor would expect from a game changing acquisition. Rapid growth such as what this company has experienced in the last eighteen months creates its own challenges. This company needed to add personnel to handle more than double the number of properties that it had just two years back. Plus there was upgrades to inspect, and the market would like to see evidence of the effectiveness of the upgrades and property management changes. It is actually quite remarkable that the company has been allowed to expand as much as it has over the last two years, and is probably a testament to the reputation of the CEO. But now it is time for the advertised future performance to demonstrate itself.
An acquisition this large tends to have a lot of one time charges. Those charges happen both at the purchasing process and then later when the management decides to upgrade the properties in the hope of increasing future income. In fact the CEO did mention at the fourth quarter conference call that traffic was beginning to increase in the newly acquired properties, and that management was increasing the rents as leases renewed. The rent renewal process will be a slow one that is spread over several years but the upgrade expenses happen right away.
Plus this company has never earned its distribution. There has always been a reason for one time charges and losing money. Frankly the market is probably losing its patience with all these excuses even though the company has more than doubled in size over the last eighteen months or so. The market probably expects the whole process of reporting losses along with excuses of how this time it is different to repeat itself. However, for the first time in a long time, management is reporting an increase in cash flow even with all the costs going with such a large acquisition. The distribution is still not covered, but now the company is as close to covering the distribution as it has ever been. The market is going to be expecting more progress than just that, however. The market wants to see this company not only cover the distribution but also thrive and grow with the current portfolio.
The lenders for their part are also signaling that they want results too. This acquisition will have a higher interest rate than the others that were done in the past. This is a beginning of a tightening process that will reverse itself after the appropriate track record becomes apparent.
There were several firsts in this deal besides the size of the deal. The company went to an alternative lender for about $8 million to decrease the necessary down-payment. When one reviews the rent as a percentage of the purchase price, it is obvious that the $8 million will be at best a breakeven for the company unless the company can sufficiently upgrade the properties or otherwise increase the rental income to exceed the 8% loan rate.
The majority of the money loan, more than $60 million went on the company's revolving credit line. The first thing the company needs to accomplish is to replace this loan with mortgages. It may have to sell some properties to reduce the leverage associated with this acquisition so that the lenders are comfortable with the amount of leverage. Then the lenders would give a mortgage rate that would allow the company to make money on this purchase. For the time being, the credit line is ok, but with long term assets such as these, a long term mortgage loan is far more desirable and prevents a profit squeeze should interest rates rise.
The company's main bank, Key Bank (NYSE:KEY) did show some hesitation in this process. In the past Wheeler had obtained a mortgage for the properties that it purchased. This time, the bank gave Wheeler a loan, but the loan is on a much tighter leash with the revolving terms. This is a signal that the bank has done enough business with the company until certain progress markers are met and the bank sees a satisfactory track record. Clearly Mr. Market took note of this.
While the company in the past received some good mortgage conditions and was allowed to more than double its size while getting those good terms, it is clear that those good terms have limits. The bank is not signaling that Wheeler is distressed, it is merely putting on the brakes for a business relationship that was growing very fast. From here on in, growth will get more expensive in this relationship until Wheeler management demonstrates some excellent management ability with the assets already acquired.
Wheeler has some fairly sophisticated investors with some representation on the board. Those investors mainly invested at about $2 per unit, and are very unlikely to accept a long term loss. The CEO himself allowed the value of his stake to be cut in half. Against that he has sold his personal properties and management company to the REIT. However, successful people such as Jon Wheeler, CEO, do not usually lose money and he has stated in the long run that he expects his stake in the company will make money. With all the new shares out there issued at far less than the original offering price, that goal appears to be a long shot and very speculative. However, the coverage of the monthly distribution now appears to be a realistic goal and a start. The activist institutions have a larger stake than Jon Wheeler could fire him should the need arise. With the lenders now beginning to politely rein in the credit, the CEO should stay focused on operational results for the first time in a very long time, if ever.
The CEO does hold out the hope of a unit price recovery and distribution recovery for the original shareholders as well as for his stake. However, at the present time, that would be an extremely ambitious goal as well as a very speculative goal. Achieving coverage of the monthly distribution to the market's satisfaction would reward new shareholders handsomely. The long term original shareholders could be waiting for quite a while to get back to break even.
Disclaimer: I am not an investment advisor and this is not a recommendation to buy or sell a security. Investors are recommended to read all of the company's filings and press releases as well as do their own research to determine if the company fits their own investment objectives and risk portfolios.
Disclosure: I am/we are long WHLR.
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.
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