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Real Estate Preferred Dividend Play with Appreciation Opportunity

|Includes: EPR Properties (EPR)
Entertainment Properties Trust, 5.75% Series C Cumulative Convertible Preferred Shares (NYSE “EPR-C”) are currently trading at approximately $20 per share. At the current price, the securities are trading at a discount of 20% to redemption value and yield over 7% annually.  Assuming that FFO will exceed or return to previous levels seen even below the peak of the market, the security will potentially be able to be sold at or closer to par value of $25 per share or higher through a open convertible option within five years. EPR has paid dividends for over 10 consecutive years; even if they are reduced EPR-C is senior to any common equity dividends while also senior in liquidation. The market is currently valuing three other classes of EPR preferred securities at or above par value anticipating limited future capital loss risk for equally senior classes. The REIT has a low long term debt ratio providing a secure investment with additional capital appreciation opportunities and protection from inflation enhanced by a below par purchase.
 
Company Background
Entertainment Properties Trust (NYSE: “EPR”), is a real estate investment trust focused on owning entertainment and entertainment-related properties, including megaplex movie theatre complexes. As of December 31, 2009, the trust owned 95 megaplex theatre properties (including four joint ventures), and nine entertainment retail centers located in 33 states and Ontario, Canada. In addition, EPR owned a metropolitan ski area located in Bellefontain, Ohio, 10 wineries and eight vineyards located in California, and 22 public charter schools located in eight states and the District of Columbia.
 
Key Facts
·         Senior Position. EPR-C receives cumulative senior payment of dividends to common equity. In the event of liquidation, the preferred shares (including EPR-C) rank equally with other preferred shares and senior to the common shares of the company. This provides for lower risk, greater bankruptcy protection and security. 
o   Preferreds will be subordinate to bond holders and other creditors. 
·         Strong Dividend History. According to S&P Stock Reports, EPR has paid dividends since 1998.
o   EPR-C is cumulative preferred security, which generally means that prior to common shareholders receiving a $0.01 distribution all past and current dividends to preferred shareholders would need to be paid. 
o   To the extent preferred shareholders are not paid current, their cumulative payment of all current and past dividends is priority to common shareholders future distributions.
·         Conversion Options. The preferred shares are convertible any time at the holder's option into 0.3504 common shares of EPR at an initial conversion price of $71.34 per common share.  At this conversion, EPR-C would be worth $25 per share. Purchasing EPR at a 20% discount or $20 per share implies that the conversion option will be “in-the-money” at a price of approximately $57.00 or only a 22% premium to closing value reach as of 11/1/10.
o   2010 projected FFO of $3.15 per share would need to rise by 20% to $3.75 per share to reach this “in-the-money” price based on a 15x FFO multiple (current FFO multiple is approximately 15 times).
o   2006 FFO was $3.79, approximately 18% less than EPR’s peak FFO reached in 2008.
o   Share prices reached over $69 in 2008.
·         Low Debt Ratio. At December 31, 2009, EPR had total long-term debt of $1.14 billion, or about 37% of total capitalization, lower than most REIT peers in our coverage universe according to S&P Stock Reports.
o   Fixed charges were covered 2.2 times, more than adequate to meet current obligations, according to their analysts.
o   Over the last 9 years the % of LT Debt to Capitalization has averaged 45.55%.
 
Risks
·         American Multi-Cinema, Inc. (NYSE:AMC) has leased approximately 43% of the trust’s theatre properties at the end of 2009. AMC Entertainment Inc is rated “B” by S&P.
·         Although EPR-C is listed on the NYSE, there is limited trading volume often ranging from 5,000 to 10,000 shares per day range. Bid/ask spreads will range up to $0.15 per share; limit orders are encouraged to avoid more costly spreads.
·         Entertainment Properties Trust (NYSE:EPR) is rated BB by Standard & Poors.
·         In the event of a bankruptcy preferreds are junior to creditors including debt holders. As of 2Q 2010, total liabilities were only 45.4% of total assets. 
 
EPR-C Versus other EPR Preferreds
·         Redemption Options. Class B and D have redemption options whereby on or after January 2010 and May 2012 both classes can be paid off by EPR at a par value of $25. Although these two classes offer yields above 7.5%, there is little opportunity of appreciation above $25 due to the redemption rights and current prices trading at less than a 3.5% discount to par values.
·         Conversion Options. Class E currently trades at over 14% above par value. EPR does not have a redemption option on Class C or E and both these two classes can convert their shares to common shares at a pre-determined conversion ratio at anytime. Right now, this option is out of the money. In order for the conversion to make sense, shares need to rise to about $63 per share. Class C will be able to be converted at a profit if the share price reaches $57 per share and offers a higher internal rate of return (NYSE:IRR) regardless of the future growth of FFO for EPR. 
o   Based upon current multiples on FFO, if FFO increases back to 2006 levels, then the convertible option will be “in-the-money” and future increases of the common stock price will drive value of EPR-C.
 
Conclusion
EPR-C offers a strong high-yield preferred security investment opportunity; through a purchase at below the issuing or par price additional upside is created through a convertible option, which also limits the downside of future inflation through quantifiable share appreciation.
 
The Content included above does not constitute an offer, solicitation or recommendation to acquire or dispose of any investment or to engage in any other transaction.  The author currently owns a long position in EPR-C.
 
Sources: S&P Stock Reports (EPR) and quantumonline.com


Disclosure: Long position in Entertainment Properties Trust, 5.75% Series C Cumulative Convertible Preferred Shares (NYSE EPR-C)