Supertel: Recovery Or Disaster?

May.30.12 | About: Condor Hospitality (CDOR)

Supertel Hospitality Inc. (SPPR) is in a very fragile position at the moment. With potential to either rebound or liquidate, it is in our best interest to develop as much insight as possible as to where the company is headed. We will start by looking at how the company got into this situation.

While the entire market was affected by the economic downturn, the nature of Supertel Hospitaly's hotels resulted in it sustaining more damage than the rest of the sector. As a hotel REIT which focuses on small and/or extended stay hotels in non-prime locations, the demand for hotels of this type is heavily affected by gas prices, unemployment, and construction projects.

Gas Prices:

As many of its hotels are in small towns and relatively far from major cities and airports, customers must drive long distances to get there. Since high gas prices deter this kind of traffic, the recent prices have adversely affected business. A decrease of over 15% in the price of crude in the past 2 months portends relief.

Unemployment:

With hotels charging as little as $30 a night, SPPR's consumer demographic consists mostly of the lower and middle classes. Due to unemployment and underemployment, many people who used these low price hotels for lodging can no longer afford to travel.

Construction:

Extended stay hotels rely on customers who require lodging for a period of approximately 2 weeks-3 months. (short enough to preclude a more permanent residence and long enough to make ordinary hotels too pricey). A major component that creates this type of demand is construction projects. With the downturn of the economy, construction has diminished and along with it the demand for extended stay hotels.

The net result of these components is low occupancy (57.9% continuing operations occupancy in 1Q12) and reduced ADR. As the economy recovers and these factors correct themselves, we can anticipate a recovery in the demand for SPPR's hotels. However, the presently diminished revenue stream makes paying the high coupon on its preferreds difficult.

Issue

Shares Outstanding

Par Value

Liquidation Preference

Annual dividend $/share

Preferred A

803,270

$10.00

$8,027,000

$0.80

Preferred B

332,500

$25.00

$8,312,500

$2.50

Preferred C

3,000,000

$10.00

$30,000,000

$0.625

Common

23,070,387

$0.01

n/a

$0.00

Click to enlarge

Having a 1Q12 adjusted EBITDA of $0.2mm, it appears that SPPR cannot sustain its quarterly preferred dividends totaling $837,216 unless conditions improve. So far, management has made some crucial moves that have allowed the company to survive and have a shot at recovery.

Trimming the fat

SPPR recently changed its hotel management structure from centralized to regional, which CEO Kelly Walters believes contributed to the 14.9% increase in POI this quarter. Additionally, administrative costs have decreased slightly as compared to 1Q11. As another cost saving maneuver, Supertel recently sold 2 economy hotels for $2.86 million-- which, admittedly, is a very small sum. However, hotels of this type are simply not profitable at the moment. Since SPPR is not in a position which affords holding onto weak positions until their values increase, it was a way to cut losses. Supertel has over 20 similar properties poised for sale if given the opportunity to do so effectively. Through these sales, and the acquisition of a Hilton in Maryland for $11.5mm, SPPR is starting a transition toward mid-scale hotels which have proven more resilient to adverse economic conditions

How did a company struggling to make dividend payments afford a $11.5mm acquisition? Generally, small companies (particularly those that are in trouble), have difficulty obtaining loans or are forced into high interest rates, yet SPPR was able to source $30mm though the issuance of its Preferred C at a rate of only 6.25%. The preferred C, along with a warrant for 30,000,000 shares of common, at a price of $1.20, was sold in a private deal to Inversiones y Representaciones Sociedad Anonima (NYSE:IRS). Additionally, IRS got to appoint 4 directors to the board. This deal was mutually beneficial in that it provided SPPR with a badly needed cheap source of capital and IRS got a large portion of ownership. Essentially, IRS is banking on Supertel succeeding so that it can profit from the 10 to 1 conversion on the Preferred C and the warrant.

The road ahead of Supertel is hard to predict. Many factors would have to fall into place for recovery, but management is taking steps in the right direction. While the common remains a risky proposition, Preferred B (SPPRO) provides an opportunity for incredibly high yield. Having recently been priced at $24.00, small portions of it can reasonably be had for over 10.4% yield. Of course, this tremendous yield comes with risk as it will only last if the company survives.

Disclosure: 2nd Market Capital and its affiliated accounts are long SPPRO and SPPRP