Expected Liquidation: $8.50 - $9.35
Upside: 1% - 11%
Expiration date: Q3 - Q4 2019
This idea was shared by David.
Spirit MTA is a fresh (spun off May 18’) REIT that been recently hit by the bankruptcy of its largest tenant ShopKo (18% revenue) and appropriation of the rented property by mortgage lenders. Management has decided to liquidate the company and has already agreed to sell $2.5bn of properties which after closing will leave only $56m of debt unencumbered assets (9 rented properties + 4 vacant lots) on the balance sheet.
Shareholder meeting (to vote on the asset sale and liquidation) date has not been set yet, but current asset sale closing is expected in Q3. SMTA guides liquidating distributions to total $8.5-$9.35/share (1%-11% upside from the current levels) out of which $6-$7.75/share will be returned shortly after the initial asset sale.
Management didn’t present any detailed pro-forma numbers so it is not clear what additional expenses and assumptions are included in their distribution estimates. However, there seems to be sufficient margin of safety incorporated in the figures (more details below).
So far liquidation seems to be on good track - aside from sale of Master Trust 2014 ($2.4bn) the buyer for the largest remaining asset Academy Sports + Outdoors ($94m) has also been found. The company paid out two special dividends in excess of distributable cash generated by REIT. Moreover, SMTA has just recovered $24m (out of $35m) on ShopKo’s debt, which is quite impressive given the bankruptcy. On top of that, management has already paid out two special dividends in excess of distributable cash generated by REIT.
Spirit MTA and ShopKo
Spirit MTA is externally managed by Spirit Realty Capital (SCR).
SMTA spin off was done mainly to reduce their exposure to problematic tenants such as department store chain ShopKo (2017 Q4 call):
A key goal was to eliminate certain strategic structural impediments that conduct the result within a single entity. The structural impediments include the need to isolate our ShopKo investment and to better align our asset base with the appropriate capital structures, which will allow for the full maximization of the leverage capabilities of the secured Master Trust structure.
Similar to other B&M retailers ShopKo has been struggling for a long time due to the increased competition from e-commerce. From the pre- and post-spin off SRC earning calls (2018 Q1, Q2, Q3) it was clear that SRC is trying their best to reduce the exposure to ShopKo by selling ShopKo properties, amending their master leases, closing two financing to the tenant and etc. Given that, it is likely that SMTA was intended to be a liquidation vehicle from the very start.
SMTA CEO Mr. Rodriguez interests seem to be well aligned with shareholders. Upon closing of the Master Trust sale he will receive an award of $1m + additional $250k after disposal of the remaining assets (considerable amounts given his annual salary is about $258k + up to 75% bonus). Additionally, Mr. Rodriguez holds about $1.1m of SMTA shares (including currently unvested portion). The only negative is that the asset sale awards do not seem to be tied to the amount or timing of the eventual distributions.
The table below shows NAV calculation as of Q1'19 as well as Q3'19. Numbers for the Q1'19 pro-forma NAV are mostly based on figures provided by management in the asset sale press release, whereas Q2-Q3 expenses/income numbers are derived using Q1 financials excluding ShopKo assets (as per Q1 earnings release). All in all, Q2/Q3 expense levels are likely to be similar to the ones of Q1 as one-off costs related to ShopKo bankruptcy during Q1'19 were likely replaced by costs associated with asset sales and liquidation. I also assume company will continue generate revenues from all of its assets till the sale of Master Trust closes at the end of Q3 (if the sale closes earlier then revenue and AFFO will be lower).
The main take-away of this exercise is material spread of $24m/$60m between my estimated NAV as of Q3'19 and management's estimates of the eventual distributions. While $24m/$60m margin of safety on itself might not seem large enough for a liquidating REIT with $2.5bn in assets, one has to keep in mind that after the sale of Master Trust and Academy Sports + Outdoors properties (for both of which agreements have already been signed) all of the balance sheet will be made out of cash except for $56m of real estate assets. In other words, if management simply gives away all of the remaining assets for free and liquidates the company at the end of Q3, then investors would break-even at current market price levels. Full list of remaining 'Workout Assets' from the proxy:
Management gives two data points on these 'Workout Assets' (Academy Sports + Outdoors needs to be excluded from the table above) - annualized contractual rent of $6.5m and annualized property cost leakage of $2.3m. It is not explained what is meant by cost leakage, but I am guessing depreciation is the biggest part of that figure. This would mean that 'Workout Assets' generate in excess of $5m cash before corporate overheads and so receiving BV=$56m in a sale of these assets does not seem like a stretch.
Obviously, part of the $24m/$60m spread will be consumed by expenses beyond Q3, by final liquidation costs, asset sales below BV, CEO severance/bonuses and etc (almost all of which are hard/impossible to estimate for outsider), but I think margin of safety is sufficiently large in this case.
After Master Trust sale, ongoing expenses will be drastically reduced - management fee will drop to $0.25m per quarter and other expenses should amount not more that $1m per quarter - G&A stood at $2m in Q3-Q4 of 2018, when company was not burdened by ShopKo bankruptcy and strategic review. Thus even if it takes couple more quarters to sell the 'Workout Assets' cash burn from overheads is likely to be immaterial. Also properties remaining on the balance sheet will still be generating income which might partially/fully offset these costs.
All in all, I think it is reasonable to expect that eventual liquidating distributions will be closer to management's indicated the upper limit (or at least within the range), providing 11% upside to current prices.
- If Master Trust sale to HPT fails then liquidation will be cancelled or significantly prolonged. Alongside HPT there were numerous other interested parties out of which 3 have made indicative proposals and one was interested in acquiring part of Master Fund, but for a 8.25% cap rate (vs current offer of 7.1%). Thus obtaining similar value for the Master Trust assets might prove difficult. I do not think SMTA shareholders will vote down the transaction and HPT seems to be locked in the purchase unless there is a breach of representations and warranties.
- Master Trust sale price is subject to adjustments (based on closing date property, credit and working capital) and expected net proceeds of $450m will be disproportionally effected by any adjustments to the sale price due to leverage. These adjustments might be both positive or negative for SMTA.
- Liquidation costs and other expenses might turn out larger than management expects in their distribution guidance, however margin of safety seems to be sufficient.
- The remaining 'Workout Assets' might get sold materially below BV or with unexpected delays, however the amount of annualized rent these assets generate seems to support the BV valuation.