Local Shopping REIT (LSR.LON) – Liquidation – 53% upside

Current Price – 28.37p

Expected Proceeds – 43p (current NAV)

Upside – 53%

Expiration Date – TBD (expected in H2 2018)

LSE Filling

This is a liquidation idea of a company listed in UK. Liquidation time-frame is around 2 years and potential upside to NAV is 50%. Trading liquidity is very low and bid/ask spread is wide. The key documents to familiarize yourself with the situation are annual report linked above as well as management’s response to activist campaign.

(Thank you Scott for heads up on this one)

 

Background

Local Shopping REIT (LSR) is a small-cap retail property REIT with assets across UK. It is listed on London Stock Exchange. The company is in liquidation mode since 2013 and currently trades significantly below NAV (28p vs 43p per share).

So far the company has sold 56% of the portfolio since the start of liquidation plan in July 2013 (360 properties sold for £69.6m in aggregate value). This was done via over one hundred individual transactions, including one large transaction of 253 assets for £79.3m. Recent property sales have been broadly in line with the book values.

Despite significant reduction in property portfolio so far, LSR is operating profitably and generates cash – book value has increased over the last year. This is partly due to successful overhead cuts which management plans to continue.

Management expects to sell the remaining properties during the upcoming two years – updated liquidation timeline is below. Recently borrowing facilities have been extended till the end of 2019 to fully accommodate the liquidation timeline.

Liquidation timeline

As can be seen from the table above, liquidation will be skewed towards 2018 when majority of the portfolio is expected to be sold in a single transaction.

More details on the liquidation timeline can be found in the beginning of the 2016 annual report.

 

Risks and Mitigants

1) Remaining portfolio might be liquidated below BV – while this is always a possibility, I take comfort that so far more than half of the portfolio has been liquidated at around BV (individual property prices ranged between +25% to -25% from BV). Also valuation is supported by 9% rental yields which have remained stable over the last few years. Vacancy rates have also been quite stable at around 11%. Remaining properties would need to be liquidated at a higher than 17% discount to BV for this trade to start loosing money. Thus downside seems to be fairly protected.

2) Remaining portfolio is skewed towards smaller properties – in one of the letters management indicated that 50% of the remaining assets are valued at less than £120k. While this might sound alarming, the actual portfolio distributions in terms of total value in each of the price ranges is relatively unchanged since 2013 – (see info tables in annual reports for details). Thus the assets sold are quite similar to the assets remaining in the portfolio. Also properties valued at less than £200k comprise only 29% of overall portfolio value (vs 26% in 2013).

3) Like-for-like rents are decreasing – over the last few years (also including 2016) like-for-like rents have been drifting downwards at a rate of 2% per annum. This might be due to the fact that company is hardly investing anything in property renovation/improvements during liquidation stage. I do not believe these slight drops in rent will have material affect on property valuations.

4) Liquidation is already taking longer than expected – initial plan was to liquidate by 2017 (at least judging from the fee structure for external adviser Internos). In May 2016 management indicated that discussions are ongoing to sell all of the remaining assets for one interested party and that the whole process should be completed by the end of 2017. That proved to be fruitless and management came up with the liquidation timeline indicated above. This timeline might easily be extended further.

5) Brexit – this is a big unknown and it not clear what kind of effect it will have on property prices – as indicated above if property prices fall by more than 17%, then NAV drops to less than 28p per share. A somewhat mitigating fact is that since the end of Sep 2016, LSR managed to sell 22 properties (aggregate value £2m) at 1.75% premium to BV – so portfolio property prices do not seem to be affected by the upcoming Brexit yet.

6) Cash burn during liquidation might eat into NAV – so far the company is operating profitably and generates cash. Overheads have been successfully reduced in line with declining portfolio. Minimum fees for external manager Internos  will also disappear in mid 2017, interest payments will decline with continued debt repayments. Thus cost structure is likely to get leaner going forward. By my estimates in 2017 company will still operate above cash break-even (excluding asset sales) and then in 2018 the cash burn is likely to be under £1m (c. 3% of NAV). If liquidation is extended till 2019-2020 then additional cash-burn might eat 10% of NAV.

 

Other bits and pieces

Activist investor Thalassa Holdings accumulated 23% stake in the company during autumn of 2016. Their average buying price was 34p-35p per share (20% premium to current prices) – couple larger holders sold their stakes to Thalassa at these prices. Thalassa then launched proxy fight but did not achieve any support whatsoever from other shareholders. Thalassa track record so far has not been great and its share price (also listed in London) has dropped significantly since 2014 highs.

Representative of another large shareholder Damille Investments (22%) just got appointed as one of the three directors of the company.

Internos fee structure – fees paid to external adviser will decline materially in mid 2017 when minimum asset management fees expire (currently at £0.9m per annum) and only 0.7% fee of gross asset value will apply. On top of that the terminal fee (5.7% of cash returned to shareholders) hurdle rate stands at 45.5p currently and will increase to 49p next year – thus this hurdle will never be reached. This might have two affects: (1) Internos will request renegotiation of the fee structure or (2) Internos will be incentivized to sell down assets asap as it gets 0.5% fee of all asset sales. Otherwise Internos would be earning only £0.5m a year from AUM fee.

23 COMMENTS

  1. Fengming Wang

    I assume we need to use the pound sterling to buy this one right? I use IB too. If I buy this stock, I will automatically borrow the pound by selling the dollar in my account, right? And there should be an expense ratio on this. Any idea of how much is the expense?

    Also, if that’s the case, we face another risk of declining Pound and rising dollar.

    1. dt

      Yes, you would buy this using GBP and you would be exposed to currency risk if no hedging is applied.
      With IB margin accounts hedging happens automatically – you will have a short position in GBP and long position in stock (USD will not be sold unless you specifically do this). With cash account it is different as you are not allowed to have short positions neither in stocks nor currencies (at least per my knowledge).

      Interest rates on margin loans can be found here:
      https://www.interactivebrokers.com/en/index.php?f=1595
      For GBP it is currently 1.726% per annum.

  2. Brian Morse

    Hi. I’m from Canada. Anyone know the tax implications when a company is liquidated like this? TY in advance.

  3. dt

    Further property sales have been announced yesterday:

    http://www.londonstockexchange.com/exchange/news/market-news/market-news-detail/LSR/13140418.html

    “During the round of auctions in February 2017, the Company sold 22 properties for an aggregate price of £3.53 million, against an aggregate book value of £3.86m. As indicated in the annual results statement, the Company’s sales programme is currently focussed on smaller properties and those that are management intensive with higher non-recoverable costs or geographically dispersed.”

    So properties sold at 8.5% below book value, however these were some of the smallest properties in the portfolio (average one for GBP160k) and the discount applied might not be representative of the value of remaining assets. And even if all of remaining assets do indeed sell for 8.5$ discount to book, there is still plenty of upside left (discount of 17% necessary for the trade to brake-even).

  4. over2u

    Also noticed that Company has assets write downs in its P&L for around $1.5-2.0m each year, so it means that book value of the assets went down as well.

    1. dt

      Are you referring to changes in fair values of investment properties? These were high only in FY2015 (GBP1.6m). Keep in mind that company is hardly investing anything to maintain properties, so it is natural that their value depreciates.
      In any case, if liquidation happens within the next two years, these value adjustments will not be immaterial to the investment thesis.

      1. over2u

        Yes, I am. For FY2016 it is GBP 1.0m. But completely agree with you that it should not significantly influence the outcome.

  5. dt

    Further property sales take place at 4% premium to BV after sales costs:
    “During the round of auctions in March 2017, the Company sold 15 properties for an aggregate price of £3.64 million, representing a 9.0% premium to carrying value before sales costs, which are estimated to be 5.1% of the prices achieved. Sales costs include agent’s fees, legal fees and associated irrecoverable VAT relating to non-elected properties or residential elements.”
    http://www.localshoppingreit.co.uk/investor-relations/rns-announcements/rns-announcement/13181600

  6. dt

    More property sales take place at a premium to BV:
    “During the round of auctions in April 2017, the Company exchanged contracts for sale on 3 properties for an aggregate price of £0.38 million, representing a 27.7% premium to carrying value before sales costs. During the same month, the Company also completed or exchanged for sale on a further 11 properties via private treaty for an aggregate price of £1.45 million, at a 2.2% premium to carrying value.

    The sales costs associated with these disposals is estimated to be 4.2%, including agent’s fees, legal fees and associated irrecoverable VAT relating to non-elected properties or residential elements. This will result in an estimated 2.1% realised gain on sale for these 14 properties.”

    http://www.localshoppingreit.co.uk/investor-relations/rns-announcements/rns-announcement/13211407

  7. dt

    LSR reported half year results last week. Property sales were known already and the key takeaways in my opinion are:
    - Book value per share remained unchanged;
    - Operations are still profitable despite despite reduction in number of properties. LSR generated GBP0.6m in operating cashflow before WC adjustments, equivalent to 0.7p per share. This was mostly driven by reduced interest payments;
    - Admin and property expenses increased – these expenses are likely to be elevated during the liquidation stage. However, operations still remain profitable and these higher expenses do not burn the book value;
    - Vacancy rate increased to 12.4% from 10% last year.

    http://www.londonstockexchange.com/exchange/news/market-news/market-news-detail/LSR/13221779.html

  8. dt

    Some further property sales have been announced. This time at a loss to book.

    “During the auctions in May 2017, the Company exchanged contracts for sale on 8 properties for an aggregate price of £0.82 million, representing a 4.0% discount to carrying value before sales costs. In addition, the Company has completed or exchanged for sale on 2 further properties for an aggregate price of £0.22 million, at a 1.6% premium to carrying value.

    The sales costs associated with these disposals is estimated to be 6.9%, including agent’s fees, legal fees and associated irrecoverable VAT relating to non-elected properties or residential elements. This will result in an estimated 9.6% realised loss on sale for these 10 properties.”

    http://www.localshoppingreit.co.uk/investor-relations/rns-announcements/rns-announcement/13242845

  9. dt

    Losses on property sales continue:

    “Since the last sales update in May 2017, the Company has completed or exchanged contracts for sales on 17 properties for an aggregate price of £1.57 million, representing a 1.8% discount to carrying value before sales costs. All but one of these sales were by auction.

    The sales costs associated with these disposals is estimated to be 5.5%, including agent’s fees, legal fees and associated irrecoverable VAT relating to non-elected properties or residential elements. This will result in an estimated 7.3% realised loss on sale for these 16 properties.”

    http://www.localshoppingreit.co.uk/investor-relations/rns-announcements/rns-announcement/13259470

  10. dt

    Further property disposals at a loss to carrying BV:

    “During the round of auctions in July 2017, the Company exchanged contracts for sale on 19 properties for an aggregate price of £3.3 million, representing an 8.1% discount to carrying value before sales costs. Since the last update on the property sales programme, the Company has also completed or exchanged for sale on a further 4 properties for an aggregate price of £0.56 million, at a 3.4% discount to carrying value.

    The sales costs associated with these disposals is estimated to be 4.1%, including agent’s fees, legal fees and associated irrecoverable VAT relating to non-elected properties or residential elements. This will result in an estimated 11.2% realised loss on sale for these 23 properties.”

    http://www.localshoppingreit.co.uk/investor-relations/rns-announcements/rns-announcement/13305169

    There seems to be a trend now, that every subsequent auction is completed at an increasingly larger discounts. Worth noting that currently disposed assets are smaller ‘non-core’ properties and valuation on the largest part of the core portfolio might turn out to be different (especially as it will be not an auction, but rather a negotiated transaction). Since the current liquidation program was announced £18m of properties have been liquidated out of £20m planned, suggesting that these auction type liquidations are almost over.

    “Since the sales programme was accelerated (as announced in December 2016), the Company has disposed of a total of 126 properties, for an aggregate gross sales price of £17.8 million. The gross loss on these sales has been 1.8% below valuation.” (1.8% is gross loss, before the sales costs).

  11. Michael

    I don’t see any distributions yet. Based on your latest comments, I understand that sales are largely in line with expectations. Since almost 1/2 of the time since the idea was posted and the proposed liquidation date has passed, but stock price has increased only ca. 7% (out of a total of 53%), I conclude that the current expected IRR return based on current prices is significantly higher than the original one. Or not? Did any other parameters or risks of the trade change?

    1. dt

      There have not been any liquidating distributions yet, the company at the moment is simply selling out the non-core property portfolio. The key event will be sale of the core portfolio during H1 2018, therefore I would not say that half of the time towards liquidation has already past (see timeline in the write-up).

      Lately property sales have been done below the book value (check the last few comments), however this might not be representative of remaining portfolio value trends, as these are auction sales and pricing dynamics are likely quite different from the expected core portfolio sale. Still recent sales below book value is obviously worrying.

  12. thinleyw

    Hi,
    I’m looking at the “Internos fee structure” section. I don’t see any mentions of the annual performance fee of 20% of the recurring operating profits above a pre-agreed target recurring profit. Any reason why you excluded it from your calculations?

    1. dt

      I do not remember exactly why I excluded it, but it might be because operating profits are negligible and will be even lower with reduced property portfolio. Also, if I recall correctly this fee has not been paid in previous years either (potentially because the hurdle rate has not been reached) – at least that is the conclusion I made looking at overall Infernos compensation, majority of which was comprised of minimum AUM fee.

      1. thinleyw

        Thanks. Also, I know you valued Expected Proceeds as Current NAV but I think one should take into account the transaction costs for property disposals (5%).

  13. dt

    Further property sales have been announced – 8% discount to NAV on vacant or partially vacant properties:

    “Since the last update on the sales programme, the Company has completed sales, or exchanged at auction, on a further 22 properties for an aggregate sale price of £2.6 million, representing a 3.7% discount to carrying value before sales costs. Many of these assets were fully or partly vacant (32% by area, in aggregate).

    The sales costs associated with these disposals is estimated to be 4.2%, including agent’s fees, legal fees and associated irrecoverable VAT relating to non VAT-elected properties or residential elements. This will result in an estimated 7.9% realised loss on sale for these 22 properties.”

    http://www.localshoppingreit.co.uk/investor-relations/rns-announcements/rns-announcement/13424653

  14. dt

    LSR issued annual results. Key takeaways:
    - NAV decreased slightly from 0.43 to 0.42 – this was expected as property sales on average took place at small discounts to NAV.
    - Excluding losses on property disposals and revaluations, operations were profitable and generated GBP1.4m in cash, equivalent to 1.7p per share. For 2018 reduced Internos management fees will produce savings of c. 0.3m-0.5m, however this will be offset by reduced income from the property portfolio.
    - Company expects to be debt free by end-June 2018.
    - On a negative side, LSR has been unsuccessful in finding buyers for the bulk portfolio sale comprising 70% of the assets. Apparently the offers received have been ‘substantially short’ of management’s expectation. Now instead of bulk portfolio sale company will continue piecemeal assets sales through auctions aiming to dispose 75% of portfolio by the end of 2018.

    The last point is definitely a concern. It clearly shows that NAV might be overstated and suggest that liquidation process will take at least one year longer.

  15. dt

    I thought a bit more about LSR situation, particularly the wording around bulk portfolio sale. From the annual results:

    “The Company has over the past six weeks marketed a portfolio through Allsop LLP. This portfolio comprises larger and multiple-occupancy properties, reflecting approximately 70% by value of the Company’s total property assets. Whilst a portfolio sale is our preferred route for disposal of these assets, the indicative offers that have been received have fallen substantially short of the proceeds that the Board believes can be achieved through sale by auction or in smaller concentrated private treaty disposals.”

    Over the last year property sales through auctions took place 1.6% below NAV and had 4.7% sales costs – so a total discount to NAV of 6.3%. So my understanding is that offers received were at even larger discounts to NAV otherwise management would have agreed.

    Couple scenarios:

    1) Remaining properties are sold at the same 6.3% discount (including sales tax) to NAV and liquidation takes till mid 2019. Then current investors would receive 37p per share or c. 10% IRR. This is probably the best case scenario in the absence of recovery in UK retail properties.

    2) If portfolio is liquidated at 15% discount to NAV (which looks quite reasonable judging by offers being ‘substantially short’ of expectations) then existing shareholders would only breakeven.

    There is likely to be further turmoil and uncertainty in the markets when the 2-year deadline for Brexit cut-off approaches (March 2019). LSR liquidation will now most definitely span beyond this date. There are also no signs yet of retail property market recovery (http://www.savills.co.uk/research_articles/173549/220537-0).

    So in a year since I took the position in LSR, properties have been disposed at larger discounts than expected, management was not able to find buyers for bulk portfolio sale (i.e. risk that NAV overstated property value has increased), NAV declined slightly and liquidation will now take longer exposing the trade for longer period of political and economical risks related to Brexit and continued shift to online retail.

    Due to this I have decided to close LSR position resulting in 11% profit over the year.

Leave a Reply

Your email address will not be published. Required fields are marked *