Current Price: $5.42
Offer Price: $10.0
Expiration Date: Q4 2020
This idea was hinted by Brian.
Ashford Hospitality Trust intends to carry-out capital restructuring and has launched a tender offer to exchange all of its preferred shares into common shares. Consideration stands at $7.75/share in cash or 5.58 of AHT shares per each preferred share - equivalent to $$10.5/share at current prices. The cash option is only for 17% of the total outstanding preferred shares. The offer subject to financing (the cash portion of $30m) and still needs to be approved by common shareholders and the meeting is set for the 30th of October. Borrow for hedging is available on IB at 2% annually. The transaction seems likely to get terminated or amended, however, with 80% spread the setup looks quite interesting and the margin of safety might be sufficient.
There is no minimum tendering condition and AHT will accept any amount of preferred shares tendered. The company has 5 different classes of pref shares (G series are the cheapest currently):
It is not clear how the shares (both common and preferred) would behave in case common shareholders fail to approve it. If the offer is terminated due to the absence of financing, then the prices of both common and preferred shares are likely to drop with a larger move on the common ones. In this case, hedged positions should still generate juicy returns.
There are two key remaining conditions: (Update: see comment on the 27th of October - both conditions have been waived)
- Common shareholder approval of the charter amendment to convert preferreds into common shares;
- Pending capital raise to finance the cash portion of the transaction.
The first one requires the consent of 2/3rds of total outstanding common shares and the meeting date is set for the 30th of October. The proposed conversion would dilute the common shareholders by 90%. Moreover, there is pressure from activist (owns 9.4%) that has started a proxy fight last month by strongly opposing the transaction. However, in the most recent letter (Oct 21st) indicates a somewhat changed tone from the activists - they are now pushing for the increase in the cash portion of the consideration instead of opposing the transaction outright.
Earlier this month (6th of Oct) shareholders have already satisfied another condition and approved the issuance of common shares - the majority of total voting consent was required and 67.8% have voted in favor. However, as only 60.1% of the total outstanding shareholders have participated in the vote, the charter amendment vote was adjourned (till the 30th Oct). Looking at the approval ratio of the previous vote, it seems that nearly all of the outstanding shareholders would have to participate in the new vote to pass the charter amendment.
The important thing is that if the current offer fails, the company will be left in a rather tight spot with a non-zero chance of potential delisting, asset sale at negative equity value (bellow mortgage), or even bankruptcy. This would leave common shareholders totally screwed as AHT sits on a mountain of debt ($4.1bn property level), while the senior preferred equity ($586m) already trades at an 80% discount to its par/liquidation value. On the other hand, the share issuance vote has already showed that shareholders are ready to choose the better of the two evils and approval is still possible here. The transaction has already received favorable recommendations from ISS and Glass Lewis during the recent proxy fight with the above-mentioned activist.
Moreover, management seems very much incentivized to keep the company alive for as long as possible. Essentially the same people that sit on AHT's board also manage/own AHT's asset manager, which generates a majority of its revenues (67%) from various AHT management and property fees.
The transaction is also subject to financing condition - pending raise of $30m equity or debt. The funds have not been secured at the beginning of October (the company even extended the expiration of the offer from the 9th of Oct to the 30th of Oct because of that). At the end of Q2, the company still had $165m of cash (+$95m in restricted cash), however, most probably these funds are not available for preferred cash-out, as AHT continues to burn significant amounts of cash, has asked for forbearance on it's mortgages as well as deferral of advisory fees to the external manager.
- Conditions are not satisfied and the transaction fails. It is a bit hard to guess how common and preferred shares would react in the short term after such an event.
- Borrow costs might increase or become unavailable, which could result in a short squeeze and wipe out short positions - 25% of AHT float is already short. It seems that there have been a number of short-lived spikes in the price of common shares during the last month.
- The offer could be extended or amended again. This is a risk for both hedged (longer timeline, larger borrow fees) and unhedged positions (common shares declined after the announcement of the previous extension on the 2nd of Oct).
Quick Thoughts on Margin of Safety
Assuming the transaction goes through, for unhedged positions (only longing the preferreds) to start losing money, common shares need to drop to below $1/share. While this is definitely possible due to substantial dilution (preferreds will covert into 90% of all outstanding shares) at these levels equity of the whole company post-transaction would be valued at only $140m. I am ignoring the cash balance as of Q2'20 as it is likely to be burned during the upcoming quarters.
However, if the company manages to stay afloat until the industry recovery (estimated in 2023), the value of the business is likely to return to historical levels. At the end of 2019 AHT had net equity value of $530m (market value of prefs and common less cash) and was paying out $86m/year in preferred and common dividends. From this figure, we still need to deduct the expected cash burn during the next 3 years as well as assume that the company will find ways to finance this deficit. During Q2'20 the company burned through a total of $106m of cash, however, a major part of it went for various debt-related expenses, and the actual operating cash burn was closer to $36m. This amount is also likely to be inflated due to various COVID-related costs, so overall the cash burn (ex debt service) during the two upcoming years is unlikely to exceed $200m (on top of the cash balances still present as of Q2'20). Deducting the expected cash burn from the 2019 enterprise value still leaves $190m valuation headroom.
Obviously, this is a very simplified exercise, however, it provides a useful reference point of where the shares could be trading post recapitalization. $330m enterprise value results in $2.35/share, which is way above the $1/share price per common required for the unhedged positions to breakeven.
Also worth mentioning, that according to the activist, the majority of AHT properties are close to breakeven, and the cash-burn (as well as the resulting value transfer) might turn out to be way lower than estimated above.
Cygnus Capital believes that approximately 30% of AHT’s hotels are likely at or very near property level breakeven, including debt service. The remainder of AHT’s hotels appear to need a 10-15% increase in occupancy to achieve this goal.
Timeline Of Events
- 20th July. An initial preferred-common conversion offer is announced with a consideration of $9.75/share in cash (maximum 13% of the total consideration) or 2.64 AHT shares. Conditions include $30m capital raise and 2/3rds of pref shares tendered.
- 9th September. The offer is launched with amended consideration of $7.75/share in cash (maximum 17% of the total consideration) or 5.58 AHT shares. The same conditions remain.
- 17th September. Cygnus Capital reports a 7.8% stake and issues an open letter opposing the conversion. The shareholder states that the offer is premature in light of the recovering hospitality industry and sufficient available liquidity to "wait and see". Cygnus also criticizes the governance matters of AHT/AINC (the external manager) and proposes alternative paths to consider, such as asset sales, refinancing, raise of short term debt, merger with stronger REIT, etc.
- Until the end of Sept. Proxy war between Cygnus and AHT continues (more information on AHT answers/business provided in the section below).
- 28th September. Proxy firm ISS supports AHT management position and recommends voting in favor of the preferred-common conversion.
- 30th September. Glass Lewis joins the recommendation stating that it will help the company to simplify the capital structure and enhance pro format market access: "While certainly not unfettered by steep dilution to common shareholders, these benefits may be expected to contribute favorably to AHT's ability to secure fresh sources of financing on more attractive terms than may presently be available, thereby potentially providing a more diverse array of avenues to improve liquidity, offset operational shortfalls and stabilize the Trust during a still unpredictable industry rebound.". Interestingly, Glass Lewis also criticizes Cygnus campaign of "dubious analytical relevance" noting overly positive market recovery assessments, underestimation of ongoing cash burn, etc.
- 1st October. AHT received a delisting notice from NYSE due to lower than $50m market cap during the 30-day trading period and shareholder's equity being lower than $50m. AHT shareholder's equity as of Q2 was negative $38m, down substantially from the $197m in Q1 mainly due to decreased cash balance and investment in hotel properties (impairment charges). The company can regain compliance in the 18 month period, however, it also has to submit a plan of definitive actions in 45 days since getting the notice.
- 1st October. AHT signs forbearance agreement for $1.2bn property debt and states that it already has forbearance for 69% of the mortgage debt balance.
- 2nd October. Cygnus raises its stake to 8.3%.
- 2nd October. AHT extends the offer expiration date till the 30th of October to allow additional time to meet the financing condition. The company waives the minimum requirement of the 2/3rds of preferred participating in the tender.
- 6th October. Common shareholders approved the share issuance condition, however, not enough votes participated to pass the charter amendment condition (60.1% of total shareholders participated, while approval from 2/3rds of total outstanding was need). The vote for the charter will be reconvened on the 30th of October.
- 7th October. Cygnus issues another letter (all the same points).
- 20th October. Cygnus raises the stake to 9.3% with new common share purchases at $1.38 - $1.77 prices.
- 21st October. AHT asks and gets the 30-day deferral for the advisory fees (about $4m per month).
- 22nd October. Cygnus issues another letter and, interestingly, it seems that the tone of the activist has changed and now it actually offered recommendations to encourage participation in the offer. Cygnus states that it believes that the offer of $7.75/share in cash is a "fair offer", however, to incentivize the participation of preferred shares, the management should increase the cash portion of the consideration and reduce the stock portion accordingly.
Ashford Hospitality Trust
AHT owns 116 hotels, 24.7k rooms in 30 states of the US.
Like any other hospitality REIT, it was severely hit by the COVID-19 outbreak. Q2'20 saw 89.4% revenue fall YoY and EBITDA loss of $43.5m (vs $143m EBITDA profit in the same period last year). The company keeps almost all of its hotels still operating, which results in an immense cash burn ($106m during Q2'20). The company has taken the various cost-cutting initiative, cut the workforce, temporarily decreased management salaries, etc. and also suspended common and preferred share dividends ($7m and $10.6m respectively). However, in the recent proxy fight (September), the company has mentioned that its monthly expenses (debt service and corporate expenses) are still very high and stand at $17m ($51m/quarter).
As of Q2 AHT was left with $165m of cash + $95m restricted cash, however, the later is not fully available:
The vast majority of the restricted cash is comprised of lender and manager held reserves. The Company is currently working with its property managers and lenders in order to utilize lender and manager held reserves to fund operating shortfalls.
So given the cash reserves left and the ongoing expenses, it seems that the company won't be able to survive for very long. This was also mentioned in the Q2 report:
If our cash utilization going forward is consistent with the second quarter of 2020 and we do not raise additional capital, it is possible that the Company may utilize all of its cash, cash equivalents and restricted cash within the next twelve months
The company also has $4.1bn of property-level debt. Apparently, since this April, all properties went default. Q2 report:
Beginning on April 1, 2020, we did not make principal or interest payments under nearly all of our loans, which constituted an “Event of Default” as such term is defined under the applicable loan documents.
September 21st letter:
Nearly all of our approximately $3.8 billion of property level debt has been in default at some point in the past six months as the properties have not been generating enough cash flow to pay the interest expense on our property level loans.
As of the most recent update (1st Oct) the company has managed to receive forbearance on 69% of its mortgages, however, that is only for 6 months, while the recovery period for the Hospitality industry is uncertain at this moment (Glass Lewis states that rebound to 2019 levels is not expected until 2023-2024). Asset sale also seems hardly an option due to a combination of post-COVID discounts and low demand. AHT states that certain peer hotels are currently on sale with a 25% to 40% discount to pre-COVID values, which would leave most of AHT properties with negative equity value. This is also illustrated in the September presentation (30% discount to pre-COVID price):
Therefore, as asset sale and liquidation is not really an option, the company argues that the best way forward is to eliminate preferred equity overhang, which should provide AHT with somewhat easier access to capital to raise funds.
AHT management and AINC
AINC externally manages two hotel owners - AHT and Braemar (luxury hotels and resorts). Braemar has only 13 hotels in its portfolio, therefore it seems that activists claim that AHT generates 67% of AINC revenues could be legitimate.
All three entities were founded and are chaired by Mr. Monty Bennett, who together with this family and affiliates owns 68% of AINC and about 10% of AHT. The conflict of interests was frequently mentioned by Cygnus and even noted by ISS:
Over the years, unaffiliated shareholders have been subjected to egregious governance-related practices and transactions that seemed to benefit one company in the Ashford group at the expense of another, all of which one could argue were in part to perpetuate the influence and control of the Bennett family over these entities.
This year Mr. Bennett and Ashford companies also came under bad light as it appeared that they were one of the biggest receivers of the COVID outbreak-induced small business protection program. All three companies received $126m intended for the survival of small businesses. As a result, the companies received subpoenas from the SEC and returned the money, but the investigation is still ongoing.
Despite that and also all the points stated by activists and ISS, I believe this management should be very incentivized to push the conversion forward, which is positive for the trade.
Nonetheless, it should be noted that if things go south, the agreement with AINC virtually makes liquidation as a non-viable option, due to substantial agreement termination fees:
An orderly liquidation of the Company would likely trigger a termination fee under our advisory agreement with Ashford Inc. (NYSE American: AINC). This termination fee could be significantly higher than the existing liquidity of the Company and we believe this fee would be senior to both preferred and common shareholder claims, potentially wiping out both shareholder classes.
Aside from the 9.6% owned by the management, other major shareholders of AHT include index fund manager Vanguard - 10.6% and Renaissance Technologies - 6.7%, which are likely to support the transaction given the recommendation from proxy firms.