Wheeler Real Estate Investment Trust: Update On Recovery Potential For Preferred And Common Equity

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The Owl
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Summary

  • On December 20th, 2018, Wheeler announced a suspension of the preferred shares dividends, resulting in substantial downdraft of preferred share pricing, bottoming in late December.
  • Since then, valuations have recovered for both publicly-traded preferred shares series by nearly 50%.
  • In this article, recovery potential for all tiers in the capital structure is updated, based upon the Q1'19 earnings report.
  • This analysis shows that, while there is no longer a full recovery for preferred shares based upon net book assets, a recovery greater than current market value should be secured.
  • Unfortunately, the chances of any recovery on common shares continue to decline as there are insufficient assets to satisfy the senior preferred-share liquidation claims (at face value), much less to cover dividends accruing for those preferred shares also having a senior claims.

Author's Note: This article is intended for investors oriented towards value-deep, value-distressed asset investing. Those seeking moderate- to high-risk value investments may have an interest in this article. Investments in this company at any level of the capital structure are unsuitable for those seeking retirement income, and I strongly discourage purchase of securities related to this company for retirement income accounts, where a focus on risk aversion should be paramount.

All tables and graphs have been produced by the author using source data, either from the Wheeler Financial Trust IR Website (where the Wheeler SEC Filings were found and from which most information was obtained, including the 10Q for Q1'2019, found here) or from the Yahoo Finance Website (for current or historical market price data).

Conclusions:

1. While remaining possible, recovery for common shares (NASDAQ:WHLR) appears increasingly unlikely as net book assets continue to decline as the Wheeler team wrestles with financing and deleveraging of the Trust.

2. The publicly traded B (NASDAQ:WHLRP) and D (NASDAQ:WHLRD) shares appear to have net assets available to support a partial recovery nearing 90%, relative to market prices for the two preferred shares series at 60% of face value. Current net book asset recovery exceeds the current market price by nearly 50%, so there remains upside even if recovery does not reach full face value.

3. Since there do not appear to be net book assets available to pay off full face value of the preferred shares, the preferred dividends which are accruing at a rate of $3.5M per quarter do not appear likely to be covered in the long run. However, the growing backlog of preferred dividend accruals makes it ever less likely that the common shares will ever see a recovery, so these accruals are significant in security selection.

4. Expect one dividend in arrears to be paid to holders of B and D Shares in January 2020. The dividends for the remaining three quarters are expected to continue to be accrued into 2020.

5. As dividends are expected to remain in arrears, with only one quarter's dividends paid for 2019, it is expected that the 6-quarter period in dividend arrears will be satisfied, enabling D Share holders to vote to elect two Directors to Wheeler's board. This is critically contingent upon holders of 20% of the D Shares to request the option to elect two Directors in the 2021 Election; otherwise, this option is forfeit, so an awareness of this requirement for D holders is critical.

6. It continues to appear to this analyst that, while the D Shares may be redeemed at full face value plus accrued interest in 2023, the B Shares may be left "holding the bag" in four years, leading to a restructuring proposed to convert B Shares to "new equity" in order to create a stable capital structure. This scenario was discussed in an earlier article on Wheeler ("Is There an Equity Restructure Endgame Possible?"). This scenario is by no means a certainty, but if I were on this board representing the common shareholders, I would be pressing for this option.

Recommendations:

  1. Hold the Preferred D Shares if owned currently, but hold off buying these shares if one intends to buy as I expect opportunities in the future to buy at lower prices. Consider selling a part of this position to create dry powder for future repurchase at lower prices, as this analyst is doing.
  2. Deep value investors can monitor the market pricing of Wheeler D Shares and buy at $10-11/share.
  3. Sell B Shares (to cash or convert to D Shares) as there is an insufficient difference in value to justify continuing ownership of B Shares relative to D Shares at current relative market prices.
  4. Avoid common shares as a vehicle to speculate in a Wheeler recovery at this point as they appear unlikely to recover significant value.

The Balance Sheet:

In order to begin to evaluate potential for recovery for Wheeler common and preferred shares, let's look at the balance sheet as reported on May 1st, 2019, for the quarter ending March 31st, 2019:Balance SheetThis sheet indicates that, while there remain positive net assets for owners of the equity generally, there is currently no assets to which common shares can lay claim after the senior claims for the preferred shareholders are satisfied.

Since there does not appear to be net book assets available to support the value of the common shares, let's take a look at the balance sheet to highlight the net book assets available to the preferred shareholders:BS Preferred RecoveryNow, we see that there are $22.19 of net book assets for each B or D preferred shares. This $22.19 is below the $25 face value, so recovery would not be complete, but it is substantially above the current market value of $13-15/share for either the B or D Shares. This "waterfall" represents the recovery on face value only, excluding the impact of accruing dividends.

The A Shares have a face value of $1,000, so that recovery based upon available net assets is calculated as well. A Shares, being pari passu with B and D Shares, should share equally in any recovery and that recovery must be included in any calculation. However, since the A shares are not publicly owned, as far as I can tell, I will focus future comments on those publicly traded B and D Shares, even as the commentary would apply equally to the A Shares proportionately.

In addition, dividends will continue to accrue at a rate of about $3M per quarter until they are made current, as can be seen in the following table:Preferred DistributionsHowever, there is one more nuance to be included, as stated in Wheeler's latest 10Q filing:

Dividends on the Series D Preferred Stock do not bear interest.

If the Company, fails to pay any dividend within three (3) business days after the payment date for such dividend, the then-current dividend rate increases following the payment date by an additional 2.0% of the $25.00 stated liquidation preference per share, or $0.50 per annum, until we pay the dividend, subject to our ability to cure the failure. On December 20, 2018, the Company suspended the Series D Preferred dividend. As such, the Series D Preferred shares began accumulating dividends at 10.75% beginning January 1, 2019 and will continue to accumulate dividends at this rate until all accumulated dividends have been paid.

Because of the language, this additional payment applies to all dividends paid on the D Shares (but not on the B Shares) accrued and not paid after January 1st, 2019, which includes the payment for March 31st but not the payment for December 31st, leading to the following dividend accrual and recovery schedule:

Preferred Accumulationswith the total recovery outlook, based upon book assets and including dividends accruing to the preferred shares:

Recovery Waterfall This "balance sheet" reflects a waterfall for the total monies due preferred equity holders, including face value plus accruing dividends, including the D Share dividend adjusted for the accruing dividend. Given the adjusted dividend, the dividend accruals will increase quarterly to ca. $3.5M. While not a crippling amount, it makes it more and more difficult for Wheeler common shares to catch up to the growing senior claims of the preferred capital tier in order to secure a recovery on the common. This is reflected in the "negative" $2.27 recovery for common shares, with the "negative recovery" increasing quarterly.

Of course, if the preferred shares cannot be ultimately redeemed at face value, accruing dividends will ultimately not be paid. However, as dividends continue to accrue, it makes common recovery ever less likely as the need to exceed market sales of properties relative to book values ever higher and ever less likely. The $22.19 offers the total recovery available for asset values at book value, so the gap in market price sales needed to exceed book value grows over time to an unrealistic level, making any recovery for common shares less and less likely.

Factors determining how long that might be are discussed below.

Takeaways:

1. Common shares appear unlikely at this point to secure a recovery based upon net book assets.

2. Current preferred share recoveries hover around 90% of face value ($22.19) in comparison to market prices of 60% of face value (ranging from $13-15/share currently).

3. If face value cannot be completely recovered, then accruing dividends will ultimately not be paid. However, even if not paid, accruing dividends represent a claim senior to those for common shares, so dividends accruing make it ever less likely that common shares can command a recovery in the future.

Cash Flows:

Current level of cash flow makes solving this problem even more difficult:

Cash FlowSo, we see that Wheeler is generating about $2.7M of Cash Flow from Operations (CFfO). Net of about $0.3M in capex, presumably maintenance capex, Wheeler is generating about $2.4M in cash net of necessary capex available to reduce debt. Round to $2.5M per quarter and you can estimate a $10M capacity of cash flow to reduce leverage from operational cash.

Ability to reduce debt beyond $10-ishM per year is dependent upon asset sales. Note that dividends on preferred shares, at $3.5M per quarter, would sum to $14M per year, and the cash generated from operations would be more than completely absorbed simply by dividend payments for the preferreds. In this case, suspension of the preferred dividends and limiting dividend distributions to the minimum necessary to maintain a REIT status will be key in creating the ability to deleverage as needed.

In the view of this analyst, the dividend suspension is necessary to provide the cash to address deleveraging needs. As such, I believe that only the minimum dividends essential to maintain REIT status will be paid. With $650K in Net Income for Q1, generating a run rate of $2.6M for 2019, one dividend payment for the preferreds ($3M) will cover the net income requirement for maintaining a REIT status for Wheeler.

Takeaway: Expect one dividend payment to be paid for the B and D Shares in January 2020, summing to ca. $3M for all three preferred share series combined.

Deleveraging in 2019:

So, the good news is that the Revere Loan has been paid in full. This was one of two challenging leverage issues facing the Wheeler team.

The bad news is that the KeyBank Line of Credit issue remains to be addressed, but must be as described here (Wheeler 1Q'19 10Q, "Subsequent Events" section, p 28):

On April 25, 2019, the Company entered into a First Amendment to the Amended and Restated Credit Agreement (the "First Amendment"). In conjunction with the First Amendment, the Company made a $1.00 million principal payment on the KeyBank Line of Credit and will begin making monthly principal payments of $250 thousand on May 1, 2019. The First Amendment, among other provisions, waives the Overadvance (as defined in the Amended and Restated Credit Agreement) and replaced the Borrowing Base Availability (as defined in the Amended and Restated Credit Agreement) with an interest coverage ratio. Additionally, the KeyBank Line of Credit shall be reduced to $27.00 million by July 31, 2019, $7.50 million by September 30, 2019 and the interest rate increases to Libor plus 350 basis points on August 31, 2019 if the outstanding balance is not below $11.00 million.

So, roughly $40+M will be due to be paid to Key Bank in 2019, reducing the current $51M down to $11M by August and $7.5M by the end of September. As we discussed above, one should expect about $10M from Operations to be generated, so cash from operations will fall far short in delivering the cash needed to provide these payments. This has a couple of implications:

First, the need to deliver far more in deleveraging than can be delivered in operations suggests strongly that the preferred dividends will be delayed and accrued, other than what is absolutely necessary to maintain a REIT status. This was reflected above.

Second, this suggests that more asset sales will be needed to fund the $40-ishM in debt repayments required by Key Bank. Expect these asset sales in 2019 to take place to provide the funds needed. I believe that a partial payment on the $40+M will be adequate, as Key Bank has been patient with Wheeler, but also expect that a significant portion of this sum will be paid down during this year.

Delays of preferred dividend payments will not prompt a legally supervised restructuring, but a failure to work with Key Bank to deliver on this agreement can result in a filing, which would be catastrophic for common shareholders and limit recoveries for preferred holders. Therefore, expect the priority to be on addressing the Key Bank repayments to ensure the goodwill of the bankers with whom the Wheeler team is working and to ensure that Wheeler avoids the need to file. Preferred shareholders ought to support this effort.

I do not expect a filing in 2019 even if Wheeler comes up short, but I also expect to see more non-core asset sales to fund reductions of the Key Bank facility. This is why I expect to see the minimum preferred dividends paid for 2019, only what is absolutely needed to retain REIT status, with the remaining cash held back to address deleveraging and redemptions.

D Shares Can Elect Two Directors When Dividends are Six Quarters in Arrears:

A corollary to my expectation that only one dividend will be paid for 2019 is that the D Share holders should have an opportunity to elect two directors in the 2021 cycle. Given that the 6-quarter period of dividends in arrears will be reached in Q4'20, based upon this analysis, D holders may well have an opportunity to elect two directors to Wheeler's board in the 2021 cycle.

Holders of WHLRD must be made aware that the directors can only be elected if 20% of the D Share holders request such an action. Failure of 20% of D Share holders to request the directors will result in a loss of the opportunity to secure two Directors being nominated or selected to look after the interests of the preferred (actually D Series) holders.

WHLRD holders ought to put on their calendar a reminder to request their Directors being nominated and elected come Q4'2020. Otherwise, they will lose an important protection afforded them in their covenants.

What Is the Owl Doing Now?

I wrote a pair of articles early in the first quarter of this year on Wheeler Real Estate Investment Trust:

"Is There an Equity Restructure Endgame Possible?" (cited above) and

"After a Suspension of the Dividend, Now What?".

In the latter article, I indicated that I was buying the D Shares unless the B Shares hit a significant discount. In fact, the B Shares did hit a significant discount, and I bought B Shares to supplement my D Share position at very attractive prices below $10/share.

On May 24th, with those same B Shares up about 25-30% in four months, I elected to sell those shares in order to de-risk my Risk Portfolio, lock in gains and generate cash to use for future purchases. With my typical indicators JNK and HYG starting to roll over in market price, I want to create some dry powder to use if prices get better.

In addition, I have sold two-thirds of my D Share holdings to create yet more dry powder, as I believe better prices for these securities may be ahead as credit goes through another trying period. I am not negative on WHLRD in the long-run but believe that there may be a pullback sufficiently large to justify trading around the move, replacing the shares sold over the past week with lower-priced shares in the coming months.

If I am wrong and WHLRD moves higher, I will simply sell my remaining position, take profits and move on. However, if I am correct and we have another tactical hit for high-yield assets, resulting in lower prices for the D Shares, I will come back in to repurchase at lower ($10-11 target price) prices on those D Shares.

I do not plan to repurchase B Shares as the protections for the D Shares are vastly better. While there will be a substantial incentive to redeem the D Shares by 2023 (enabling the B shares to receive dividends at the same time), I believe that a bulk of the value for the preferreds may be employed in redeeming the D shares at face value plus accrued dividends, leaving the B Shares with significant less value post the D Share redemption.

I have argued in earlier articles that the B Shares are likely to be involved in a voluntary restructuring to recapitalize Wheeler. This will be a less attractive outcome than a "face value plus accrued dividends" redemption for the D Shares. Therefore, the shares that I continue to own will be the D Shares exclusively, and if I repurchase any Wheeler securities, it will also be only D Shares that I will repurchase, looking for a 2023 redemption (or, alternatively, very high coupons in years after 2023). I recommend that approach to other adventuresome investors, experienced in deep value investing, who may have the stomach for a deep value investment which will still provide substantial upside opportunity.

This article was written by

The Owl profile picture
2.8K Followers
I am a private investor, focused on value investing through balance sheet analysis. I am not a financial professional nor do I work predominantly in finance. I am a Business Development professional, working to develop new offerings into strong businesses.

Disclosure: I am/we are long WHLRD. 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: No guarantees or representations are made. The Owl is not a registered investment adviser and does not provide specific investment advice. The article is for informational purposes only. You should always consult an investment adviser.

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