Seeking Alpha

CBL & Associates Drops The Preferred Bombshell

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About: CBL & Associates Properties, Inc (CBL), CBL.PD, CBL.PE
by: Michael Boyd
Michael Boyd
Long/short equity, contrarian, medium-term horizon, mid-cap
Summary

CBL & Associates suspends preferred dividend payments. Great move for helping aid the potential long-term viability of the business, bad news for preferred owners.

The entire thesis for the preferreds was collecting paychecks until the refinancing maturity wall. This gave preferred investors a free call option on success in 2023. That thesis is blown.

Preferreds vs. bonds has been a big debate in recent quarters. Recent price action settles which was the better bet.

It has been some time since I commented publicly on the situation at CBL & Associates (CBL) although the name has been a fairly frequent topic of conversation for me on Seeking Alpha over the years. Whether that be my postulation that the common equity might be worth absolutely nothing on a net asset value (“NAV”) back late in 2018 (“CBL & Associates: Is The Stock Worth $0?”) or the multiple research notes outlining the issues surrounding their upcoming refinancing (e.g., "CBL & Associates: Refinance Thoughts"), I frequently got a lot of flak for being very bearish on this one and mall REITs as a whole. Some investors I believe struggled with the concept that this situation, predicated by severe and constant same-store NOI declines, made this an atypical REIT and consequently a poor investment. That has been bore out lately, as despite an outright rosy performance from REIT benchmarks, CBL & Associates continues to circle the drain. I’ve tried to constantly stress a couple of issues that should keep all but the most speculative investors away:

  1. How small the capitalization of the common equity and preferreds are in relation to the size of the enterprise (liquidation/NAV risk).
  2. How tight financial covenants are and how bond price trading indicated a poor chance of maintaining going concern status (refinancing risk).
  3. How important access to capital is, the likely cost of the redevelopment, and how metrics like price/FFO are incredibly deceiving at REITs with repeated negative same store sales comps (value trap).
  4. The lamentable track record of management on guidance and how shady practices (utility overbilling lawsuit) should keep you away (leadership risk).

All of the above is still true, and in fact more true, today. While I think the decision to suspend the preferred dividends was the right one for the firm in the long run and I was actually taken aback that a proper decision was made, it has unfortunately caught some owners out in the open with no protection. While I think investors had the right idea in moving up the capital stack, unfortunately they did not move up far enough. Suspension of the preferreds (CBL.PD)(CBL.PE) began to look more and more likely given poor results and outlook, cemented by trends in bond prices over the past year. Unfortunately, this major risk factor was not one that was mentioned much in bullish coverage on Seeking Alpha. In fact, I think the entire bull thesis for the preferreds could be boiled down to just two sentences:

At current prices (e.g., 20% yield), I will recover all or nearly all of my investment by the time of the maturity wall. This means that I get a free call option on CBL & Associates surviving a bankruptcy or a long shot at some recovery in liquidation.

Sound familiar? It should. But now, with the suspension taking place so early in the thesis, nearly the entire value proposition of the preferreds is gone. I’ll go out on a limb once again and say that I think the suspension is going to stay in place until the refinancing is done, successful or not, likely in 2023. I'm a big advocate of not locking oneself into losing positions. Why keep an open position where the entire thesis has been broken? In fact, the goal posts have been moved so much that the bull case for the preferreds now rests on a successful refinance - a view that was originally just treated as a free call option. Now investors have to pay for that option and I don't think the drop has been severe enough to make that gamble worth it.

The issues facing CBL & Associates are not ones that can be fixed with a $45mm cash infusion in 2020. Even the most ignorant CFO or activist investor (Exeter Capital / Michael Ashner) would not suspend preferred payments for chump change like that. Without a miracle, the preferred payments are gone for several years. Options are low. The suspension was their last option in the capital structure to raise money (other than asset sales/turning in keys on cash flow negative malls) since raising both equity and debt is now out of the question. CBL & Associates will pour every dollar into getting itself into the best possible position in 2023 in order to avoid having to ask for a debt exchange or filing for bankruptcy.

Management Lets Down Shareholders Again

Many got lured into this because of the prospect of common dividend reinstatement - the preferreds cannot see a suspension so long as the common is receiving payment. Recall that the common dividend was initially suspended under the terms of a class action settlement earlier this year. Once again, I feel I have to reinforce how negative of a signal that lawsuit was. The suit alleged that CBL & Associates overbilled thousands of its own tenants for electricity bills for years for millions of dollars and then covered it up by inserting a clause into lease agreements requiring tenants to waive their rights to audit electricity bills. Somewhat ironically, this was only discovered because a CBL & Associates mall went into foreclosure and was taken over by a lender. A third-party management company was brought in to manage the mall for the lender who found the discrepancy.

As an author running an energy-focused advisory platform, I'm all too familiar with the court system and its games. I just do not see that here. As one of the final judgments, the court went so far as to partially certify a nationwide RICO class before the settlement: That means racketeering via a criminal organization. In my opinion, that's not a step any judge or prosecutor would take without substantial evidence, particularly in a segment of the market not known for legal wrangling. CBL & Associates, of course, denies all allegations of wrongdoing and its settlement reflected that. That does not mean that shareholders could have, and should have, taken a "where there is smoke, there is fire" viewpoint.

As fellow Seeking Alpha contributor Marel pointed out in one of his recent notes, a resumption of the dividend in the common was a bullish trigger for the preferreds. Even the resumption of a token dividend amount would have alleviated quite a lot of the fear.

One could reasonably argue that it is in the best interest for preferred shareholders if the company retains as much cash as possible, hence not pay a common dividend. Whilst I agree with this premise, I also believe that restoring the common dividend, even to a tiny/symbolic amount, will act as a psychological boost to preferred shareholders on the reasoning that 'if the common dividend is restored, the preferreds have more clarity' and away from the reasoning 'the common dividend got eliminated, preferred dividends are next'.

Early in 2019, dividend resumption looked more likely. For those keeping a watchful eye on management statements however, investors could see the clear degradation in statements surrounding dividend policy. As retailer bankruptcies kept cropping up and results continued to disappoint, management was put under a lot of pressure to do something drastic. While I think Exeter Capital / Michael Ashner were a contributing factor to the decision to suspend payments on the preferred stock via the recently formed “capital allocation committee,” I think management was already leaning that way earlier in the year anyway. At least this way they have an excuse to lean on rather than misleading shareholders throughout the year and slowly walking back expectations with careful wording:

As we said in our release on the settlement, our intent is to reinstate the common dividend in January and we will review taxable income projections for 2020 later in the year to determine the appropriate level.

CEO Stephen Lebovitz, Q1 2019 Conference Call

Finally, as we indicated in March, we will be reviewing our 2020 taxable income projections in the fourth quarter to determine the dividend level for next year.

CEO Stephen Lebovitz, Q2 2019 Conference Call

As we stated, our priority is preserving cash flow for use in executing our broader corporate strategy, which will ultimately allow us to create more value for shareholders. With this in mind, we expect to pay the minimum required common dividend, if any, to distribute taxable income.

CEO Stephen Lebovitz, Q3 2019 Conference Call

How Bonds Traded Through All Of This

The “Bonds vs. preferreds” argument that dominated discussion lately looks pretty much settled. As the preferreds have been absolutely blown out this year on an absolute basis, especially after the recent drop, bonds have held relatively firm. Why shouldn’t they? The suspension raises cash that will be invested in the business to help the odds of a successful refinance: North of $150mm if the suspension remains in effect until 2023. Even if that refinance is not successful, cash that would have gone out the door to owners of preferred stock is now kept and retained on balance sheet to help improve liquidation value in the event of a bankruptcy. Even money invested in no/negative IRR projects would still have greater value than zero.

As always, bondholders are celebrating the equity owners getting taken to the cleaners, even if it does send a pretty negative signal on the overall health of the business. However, take note that the bonds still trade at a 15% yield to maturity, indicating significant fear among creditors on 1) ability to roll over debt and 2) underlying asset quality. While the credit markets can be wrong, I’ve found them to be far better appraisers of both asset value and long term business viability than equity markets. It's one thing to see a market like energy master limited partnerships ("MLPs") where bond pricing has remained stagnant, or even improved, as the equity valuations have been blown out over the past few years. It's another entirely when bond markets do signal bankruptcy. Given how the bonds have traded, being long either the common or the preferreds was an absurdly contrarian call that required overall market consensus to be materially wrong.

While there has been speculation that the mall space has been over-shorted, primarily via the BBB- sub-segment of CMBX 6 and CMBX 7 credit default swaps that has cascaded over into equities, I’m not convinced bears are wrong here. And importantly, they do not have to be right that the business is not long- term viable. They have to be right that lenders will believe the business is not long-term viable in 2023. No credit extension means bankruptcy liquidation or reorganization. That’s an important puzzle piece that investors continue to miss when thinking about this in terms of free cash flow, funds from operations, or other traditional value measures.

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.