Current Price – 28.37p
Expected Proceeds – 43p (current NAV)
Upside – 53%
Expiration Date – TBD (expected in H2 2018)
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)
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.
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.