Current Price: $10.06
Offer Price: $10.00 – $12.00
Expiration Date: 10th December
This tender offer expires in two days, however, your broker might have a different deadline for participating in this tender offer. There is a guaranteed delivery clause.
Closed-end fund NexPoint Strategic Opportunities (NHF) has launched a tender offer to exchange 30% outstanding shares at $10-$12 per share. The consideration will be paid 80% in newly issued preferred shares and 20% in cash. Preferred shares will be tradeable with a liquidation value of $25/share and with 5.50% annual dividend yield. The outcome of this trade depends on the final tender price (between $10-$12) as well as the market price of the newly issued preferred shares. If preferreds trade at par value ($25/share or 5.5% yield), then the tender offers 19% upside at the upper limit vs 1% downside at the lower limit. There is an odd-lot priority.
The tender has a high likelihood of getting priced materially above the lower limit:
- NHF is trading at a substantial (43%) discount to NAV and management is trying to close the valuation gap by selling non-RE assets at close to book value and then converting the company to REIT (the process has already started). It is likely most of the shareholders will wait for the conversion to play out instead of cashing-out in the tender offer.
- The offer is value accretive for non-tendering shareholders as common stock is acquired at a large discount to NAV.
- Management owns 8.5% of NHF and does not intend to participate in the offer.
- The tender offer is large for c. 30% of all outstanding shares. If the offer is undersubscribed it will automatically get priced at the upper limit.
- 80% of the tender offer consideration will be paid out in preferred shares with no established market price as of yet. This likely limits the visibility of the upside from this trade and will discourage the participation of at least some of the shareholders.
Preferred shares have a reasonable chance of trading close to $25/share (i.e. close to 5.5% dividend yield):
- You can find current yields on other REIT preferred stocks here. Most of these trade at 6%+ yields (which would translate into $23 or lower preferred price). However, yields on storage (PSA and NSA) and single-family rental (AMH) REIT preferreds stand at/below 5.5%. These two sectors are where 50% of NHF real estate portfolio is focused (chart below). So with that in mind, there is a reasonable chance investors will price the newly issued preferreds close to par value. A similar conclusion has been made here.
- The preferred dividend seems to be very safe – during H1’20 NHF generated $19m of net investment income and $29m during 2019. This compares to $6m planned annual dividend for the preferreds and $19m for the remaining common shares (at a current rate of $0.6/share).
- Recently NHF preferreds received investment-grade (BBB) rating. However, it is worth noting that other REIT preferreds with investment-grade ratings are trading at higher yields than 5.5%.
- Preferred shares have more than sufficient asset coverage in case of liquidation.
Conversion to REIT
Earlier this year, in August, NHF shareholders have approved to change the company from CEF into a diversified REIT. The conversion is expected to take place in 2021 and in order to complete it, the company will have to sell its non-real estate assets (about 30% of the portfolio). It’s likely that it will be sold at/close to NAV and will act as a catalyst to close or at least significantly narrow the current discount between NHF NAV and its share price. The latest NAV stands at $17.70/share and the fund currently trades at 43% discount to NAV. The fund has a rather unfocused/messy portfolio (see here) with 60% of the assets classed as Level 3 (i.e. no available market quotations), so some of the discount is definitely warranted. However, pre-covid this discount stood at only 15% on average (during 2018-2019).
The conversion to REIT would offer multiple benefits such as considerably higher liquidity, inclusion in various indices, and appeal to a wider investor base. Also, REIT structure opens doors for higher leverage, while it’s worth noting that Nexpoint (NHF asset manager) primarily specializes in RE, so this change will allow them to use their competencies more efficiently. Finally on average REITs trade at better valuations than CEFs.
Given materially lower historical discount, upcoming asset sale and pending conversion into a REIT there seems to be plenty of upside and catalysts for non-tendering shareholders. Also, the current exchange offer is expected to increase NAV/share for non-tendering shareholders (by 10% if all shares are accepted at the upper limit) which should further limit their willingness to participate in the offer.
Below is NHF portfolio composition as of Q3’20: