Quick Pitch: Sotherly Hotels (SOHOO)

Merger Arbitrage: 12-14% Upside

Credit goes to Grayson for heads up on this opportunity. I was putting on the finishing touches on the write-up when I noticed that Clark Street Value had already beaten me to it. The core thesis is pretty straightforward, and there isn’t a ton to add on top of what CSV has outlined. Still, I want to share the piece below as it’s an interesting setup worth tracking and discussing on SSI. It’s also the first time I’ve come across this kind of conversion/cash-out structure for preferred shares, so it’ll be interesting to follow it for educational purposes.

This is a buyout, in which both the common and preferred shares of the target company are getting cashed out. Curiously, the market is treating the share classes very differently – the preferred shares trade with 12-14% spread to the offer price, while common shares trade at only 5%. There’s no obvious reason for such a wide gap other than the preferreds being obscure, thinly traded, and temporarily weighed down by selling pressure unrelated to the buyout itself. The current spread on the preferred stock looks attractive, and it wouldn’t be surprising to see it narrow closer to the level of the common shares.

Here’s the table with the share classes and corresponding spreads:

Sotherly Hotels is a tiny lodging REIT with 12 properties located mostly in the Southern U.S. The company is being acquired by two private real estate investment firms – Kemmons Wilson Hospitality Partners and Ascendant Capital Partners. Consideration for the common shares is $2.25/share. Since the October 27 announcement, the spread on commons has been stable at 5–6%. The commons are pretty liquid ($800k per day), and the transaction is expected to close in Q1 2026. So the market clearly views it as pretty much a done deal. It’s hard to argue with that, as the shareholder approval should be easy to get, and the buyers seem serious and well-motivated.

The company also has three publicly traded classes of preferred stock – Class B (SOHOB), Class C (SOHOO), and Class D (SOHON). They’re all cumulative, redeemable, perpetual shares, and all are equally obscure and thinly traded. Liquidity has picked up quite a lot since the merger announcement – $150k worth of SOHOO traded yesterday. Each preferred class will also have an option to be cashed out as part of the buyout. However, the press release did a pretty terrible job of explaining what exactly the preferred holders are getting.

Fortunately, more clarity can be found in the 8-K and the merger agreement. The way the preferreds will be treated is: within two weeks after the merger closes, the company will issue a notice to preferred holders, allowing them to exchange their preferred shares for common stock and setting a deadline to do so. Those who choose to convert will receive the same merger consideration as common shareholders – $2.25 per common share on an as-if-converted basis. From the 8-K:

With respect to each series of the Company Preferred Stock, pursuant to the Charter, the Company will, within 15 days after the closing of the Merger, provide notice to the holders thereof that the closing of the Merger has occurred (the “Preferred Notice”). The Preferred Notice will include certain details with respect to the Merger and specify a date (to be no less than 20 days nor more than 35 days after the date of the Preferred Notice) by which the holders of the Company Preferred Stock may elect to exercise a right to convert some or all of the Company Preferred Stock held by such holder into the right to convert, subject to the terms and conditions contained in the Charter, including the share cap as defined therein, into Company Common Stock and receive the Per Company Share Merger Consideration.

From the merger agreement:

Upon the election of a holder of Company Preferred Stock to convert such holder’s shares of Company Preferred Stock into Company Common Stock, in accordance with the terms and conditions of the Organizational Documents upon exercise of conversion rights triggered by the closing of the Merger (“Cancelled Preferred Stock”), such Cancelled Preferred Stock will automatically be cancelled and retired, will cease to exist, will be converted into the right to receive only an amount equal to the product of (i) the Merger Consideration times (ii) the shares of Company Common Stock issuable to such holder in accordance with the Organizational Documents, and will have and represent no further or other rights (“Preferred Stock Conversion”).

The conversion ratio is slightly different for each class of preferred stock. Registration statements with the terms can be found here: SOHOB, SOHOO, and SOHON. For all of them, the conversion ratio is calculated as the lesser of:

• The sum of the liquidation preference ($25/share for all classes) plus any accrued and unpaid dividends, divided by the cash consideration per common share;
• The “share cap,” which varies slightly by class: 8.29187 for SOHOB, 8.5034 for SOHOO, and 7.39645 for SOHON.

Since all three preferred classes carry a hefty pile of unpaid dividends, the lesser value in this case is the share cap. So, as shown in the table at the top of the write-up, SOHOB holders will receive $18.66/share, SOHOO – $19.13/share, and SOHON – $16.64/share. Each class trades at a 12–14% spread, with SOHOO currently being the highest (14%). That is well above the 5–6% spread on the common stock.

My guess is that the difference exists partly because the preferred shares are obscure, management hasn’t clearly explained the terms and mechanics of the payout, and there’s also an extra conversion step that requires preferred holders to contact their brokers. Another factor could be temporary selling pressure. These preferreds used to pay hefty dividend yields of 12–18%, but distributions were suspended together with the merger announcement. Some investors probably decided to lock in the merger-related price pop and simply did not bother to stick around for the arbitrage. Some income funds might have also been forced to exit due to mandates not allowing them to keep holding shares that don’t pay dividends. With limited liquidity, that selling pressure might’ve been enough to keep the preferred spreads wider.

 

Buyout conditions and other details

The main closing condition is majority approval from Sotherly’s common shareholders. It is very likely to pass. The $2.25/share consideration represents a roughly 150% premium to both the pre-announcement price and the common stock’s average trading level this year. Management owns 15%, and three other major shareholders (two hedge funds and one private investor) control another 21%. That private investor, Amos Lubin, increased his stake from 5.3% to 7.6%, shortly before the merger was announced. He likely bought around $0.90/share, meaning he’s sitting on a huge short-term gain.

Approval from preferred holders will apparently not be required. Their consent is required only if the company takes action that materially amends the preferred share terms. That’s not the case here, since any unconverted preferreds will simply remain outstanding (though it’s not clear if they will remain listed or not).

One of the buyers is Kemmons Wilson Hospitality Partners (ref. KWHP). It is a hotel-focused real estate firm founded by the Kemmons Wilson family, which also founded the Holiday Inn chain. According to the fund’s LinkedIn, it has $500m of funds under management, though that figure may be dated. Alongside the merger, KWHP also extended a $25m revolving credit line to Sotherly, meaning they’ve already put real money on the table.

The other buyer, Ascendant Capital Partners, specializes in hospitality and residential real estate. Earlier this year, they launched their second flagship fund, raising $750m. The first fund raised over $300m several years ago. The firm has done notable transactions before, including partnering with Oaktree Capital in 2020 to invest $200m in another lodging REIT.

The merger isn’t subject to financing conditions. The buyers already have funding commitments from Apollo and entities affiliated with Ascendant.

The termination fee is $4m (paid by SOHO to the buyers), which is just 0.85% of the $470m deal EV. But if the buyers back out, they owe double that amount – $8m. This is a seller-friendly setup and a directional hint that both sides are confident the deal will close.

SOHO’s hotel portfolio has minimal geographic overlap with the buyers’ existing assets, suggesting this is mostly an expansion and recapitalization/restructuring play for them. SOHO’s main problem is its massive debt load, which makes it vulnerable in a higher-rate environment and a tough credit market for hotels. Better-capitalized buyers can handle that risk far more easily – they can refinance part of the debt right away and ride out the ongoing downturn without worrying about forced asset sales or liquidity crunches. If the hotel market and credit conditions recover, the equity upside could be huge. The buyers are essentially getting that optionality cheaply relative to SOHO’s historical valuation.

 

Risks

If the merger falls apart, the downside to pre-announcement levels for preferreds is 25%. It could easily be more if dividends aren’t reinstated right away. Still, that’s way less than the potential 60% downside for the common stock. On a risk-reward basis, the preferreds still look meaningfully mispriced relative to the commons.

The company is also currently in default on Georgian Terrace hotel and in covenant default on the DoubleTree by Hilton Jacksonville Riverfront. It has requested a one-year extension for the Georgian Terrace and asked for a covenant waiver for the other hotel. The company is also selling a part of the garage parking ($17m) associated with the Georgian Terrace Hotel to pay a portion of the loan (total property debt is $38m). The default was announced in July of this year, so it seems manageable and the buyers definitely know about it. The risk for the merger seems limited, especially now that KWHP has also provided a $25m credit line for SOHO.

 

More on Sotherly Hotels

SOHO is a self-managed and self-administered REIT. It owns 10 upper-upscale hotels plus two luxury hotel condominium units. Seven of the hotels operate under Hilton, DoubleTree, or Hyatt flags, while the remaining three run under independent brands.

Historical financials are provided in the table below:

The business took heavy hits during both the GFC and COVID but managed to survive each time. After the pandemic, Sotherly had to sell two hotels and carefully navigate debt forbearance agreements to avoid defaults. Performance has since recovered, but this year, revenue per room and AFFO have come under pressure again due to reduced government-related travel (impacted by DOGE layoffs and spending cuts) and softer business and leisure demand driven by tariffs and broader macro headwinds. The government related guests are especially important for the company’s hotel in Washington (Hyatt Centric Arlington), which is the best asset in SOHO’s portfolio (highest occupancy and revenue per rooms).

The perpetual preferred shares were issued between 2016 and 2019, each time to refinance baby bonds to remove maturity and refinancing risk. Dividends on both the preferred and common shares were suspended in 2020 due to COVID. Preferred dividends were reinstated in 2023, but around $22m in unpaid distributions from 2020–2022 remain outstanding. Management has said that the dividends can’t be repaid until the hotel credit market stabilizes, as doing so now would put too much strain on the already leveraged balance sheet.