Condor Hospitality Trust (CDOR) is one of my longer holdings and a periodic featured stock in my articles. The company recently announced they are considering all "strategic alternatives" including the possibility of a sale, merger or large capital raise to buy a significant property portfolio. The former SuperTel has not only completely transformed their own portfolio of hotels with only one legacy hotel remaining, the company has also reworked their capital structure. The capital structure is now a more standard and balanced mix of common stock, debt and one class of preferred stock. Even after gains over the past month, the stock is not over-valued and sports a solid 7.4% yield. However, Condor is a very small player in the publicly-traded hospitality REIT space, as evidenced by their small market cap of $135M, high administrative costs and low revenue per employee compared to their peers. While the potential for CDOR to scale as an independent company, in this article I will lay out why CDOR would be a good acquisition target for another hospitality REIT or private equity who could scale the company's successful operations.
Why I'm Long, Merger or Not
In my opinion, Condor Hospitality has flown under the radar (ok, there won't be more aviary play on words, I promise) as the company brought in new leadership, re-engineered the capital structure, sold off legacy poorly performing low-end hotels and assembled a modest portfolio of select-service hotels. From a nearly disastrous financial position as Supertel with outsized debt, a very confusing and limiting multiple classes of preferred stock, and a portfolio that wasn't performing, the company is now conservatively financed similarly to peers. FFO/AFFO and RevPar are all trending upward, based on a portfolio of young properties "flagged" with industry standard select-service brands like Marriott, Hyatt and Hilton. CDOR has pursued a strategy of buying one of the newer select-service properties in a second-tier MSA, avoiding the most expensive top MSAs where competition has driven costs and cap-rates higher.
Since recapitalizing the balance sheet, the debt to equity ratio has stabilized, and all but one class of preferred stock has been redeemed. CDOR resumed paying a common stock dividend, and currently yields 7.4%, with a payout ratio in the 60-70% range. This conservative payout provides some buffer for rising interest rates, however RevPar for the existing portfolio improved 4% recently. This is also reassuring and to me, provides a reason to hold the stock in my REIT portfolio regardless of the decision made during the strategic alternatives discovery process.
Mergers and Acquisitions in the Hospitality REIT Sector
Last spring, Dane Bowler wrote a good article for SA on a merger in the sector. His article, as well as other news reports and articles, pointed out that many larger REITs were looking to grow by buying entire portfolios or merging with other REITs. This would allow them to acquire large groups of properties in one transaction with known financials in what was becoming a more and more competitive environment. Individual deals for quality properties were attracting more bids, and costs were increasing. Mr. Bowler mentioned Condor Hospitality as one of the potential targets. One negative he pointed out was the lower RevPar CDOR has compared to others. The purpose of this article is not to refute his point. However, there are two things to point out about CDORs RevPar. First I have had to learn more about hospitality terms and levels as a novice REIT investor and analyst. Comparing CDOR and Hersha Hospitality's (HT) (my two current hospitality holdings) RevPar would be erroneous. As a select-service REIT, CDOR naturally has a lower RevPar than a more upscale portfolio like HTs. Also, CDORs quarter over quarter RevPar is improving-to me a more valid indicator as it shows good management, economic indicators and pricing power.
While CDOR wasn't the most promising of the REITs he discussed, it was one of the top four listed by discount to NAV. While some of that discount has evaporated in a recent stock run-up, the premise he makes that hotel REITs trade at a discount to NAV while individual property sales are more expensive remains true. So an acquiring REIT or private equity company could quickly gain an attractive portfolio in one transaction instead of 18 time-consuming purchases at a premium.
And Condor does have an attractive portfolio that would likely quickly diversify and broaden another REIT. After selling all but one of the legacy hotels and recycling the capital, CDOR has a portfolio of 18 select-service hotels that is relatively "young" portfolio as well, meaning most major improvement and renovation projects are out a few years or even a decade. While building this portfolio, CDOR has purposefully sought properties in smaller MSAs. Most of the properties are in Texas and other Southeastern States in towns like Atlanta, Tallahassee FL, Jacksonville FL and Lexington KY. My personal experience is select-service hotels thrive in these markets, normally being full of business and military travelers during the week and families on the weekends. Condor continues to seek more properties to add-one goal of the strategic review process is to potential expand the portfolio more rapidly. Unlike only two or three years ago, the purchaser would get a focused and performing portfolio of select-service hotels.
The Arbitrage Opportunity
Condor is a micro-cap stock, with a market capitalization of $134M, one class of preferred stock with a total face value of $9,250,000 and roughly $130M in debt. Enterprise value is $269,250,000, and by definition would be the total amount of capital needed to replace the entire capital structure with new funds. To me this is an academic point, and the real cost to an acquirer is likely some premium to the market cap. If the deal and covenants allowed it the acquiring company would get a portfolio capable of serving the debt, continue the outstanding class of preferred stock, and could potentially purchase the company for cash or a stock-for-stock swap.
Many REITs have been purchasing their common stock in the open market for the past few years. Sticking with HT as it is the one I know best, for the past three years, there has been an authorization to repurchase at least $300M in common stock per year. While HT has moved the other direction, this is merely for example-plenty others have been net repurchasers and often at larger dollar amounts than it would take to purchase 100% of CDOR's common and the preferred shares if necessary.
Here's the math, with a 20% premium, just a ballpark takeover sweetener built in to today's stock price:
Market Cap of $134.6M times 20% premium=$161,200,000
Anyone have $161M and change lying around? Give me a call!
With 1908 rooms from recent company reporting, this works out to $84,486.37 per key, a reasonable multiple to acquire a quality portfolio that is servicing it's debt, comes with leadership and management structure, and management agreements with industry-leading brands. The 20% premium would reduce the dividend yield to 6.2%, still better than some hospitality REITs. As CDOR still has low revenue per employee, scaling as part of another REIT would likely offset the premium as well.
For a private equity investor, CDOR presents an interesting target as well. It is likely their cost of capital is much lower than the current dividend yield, and with the strong coverage and improving RevPar, purchasing CDOR, retaining Mr. Blackham as CEO and leveraging this purchase to add other hotels or combining other hospitality REITs could be a strategic move. While this isn't a "HT and CDOR" article, simply based on my own holdings, combining these companies would create a $1.2B portfolio with very strong management for both tiers. Other combinations are out there, and there are many firms with $1B or more in "dry powder". Berkshire-Hathaway for one, with a history of buing well-run companies, retaining good management and allocating capital if the new acquisition has better returns. Many others with large amounts of cash and/or float, low costs of capital, and long-term perspectives could also see the value in this approach.
While I have no special insight into the process and priorities of CDOR's strategic alternative research, I would imagine a merger or outright sale will likely be considered. If these come to fruition, a premium to today's stock price will likely be realized. If not, I am content holding a well-performing company paying a 7.4% dividend with strong management and a winning strategy.
Best wishes for investing success!
Disclosure: I am/we are long CDOR, HT, BRK.B.
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: This article is meant for research purposes and not an offer or recommendation to buy or sell specific securities in your specific circumstances. Investors should consult a properly licensed broker and do their own research prior to investing in stocks and other securities.