The Local Shopping REIT – Part 2

Recap

Last month I posted a short summary describing why I thought LSR represented an interesting short term, arbitrage bet. The short version was: LSR traded at a substantial discount to its NAV and the largest shareholder had announced they may make a bid for the remaining shares. At the time, the stock was trading around 27p with a NAV (which consisted mostly of cash) of approximately 33p. Therefore, my bet was simply that the largest shareholder would likely make a bid somewhere around the NAV level and we could make ~20% within a month.

 

What’s happened since?

Fast forward to Wednesday of last week (6/2/19) and the largest shareholder announced an offer equal to roughly 33p – bang on what I expected. I had a limit order in the market at 33p and for some strange reason, someone decided to take my whole line… hey if markets can be irrational on the buy-side, then I guess they can be on the sell-side too!

What I didn’t expect was for the offer to be structured as a cash + scrip deal. I didn’t consider this because:

  1. Thalassa has sufficient cash on its balance sheet to finance the deal
  2. Thalassa trades at a substantial discount to its NAV

It’s this second point that I find most strange – Thalassa is issuing stock at a large discount to its NAV, to buy another company at a price equal to its NAV… Unless I’m forgetting something from my Finance 101 course, that is a totally illogical decision and is highly dillutive to existing Thalassa shareholders.

 

A lose-lose deal?

The structure of this deal is so bizzare that I actually emailed Thalassa’s Chairman (and largest shareholder) to ask him if there had been some sort of mistake (which went over like a lead balloon…)

Let me explain why I find this structure totally illogical and if anyone can see an angle that makes economic sense, please comment below.

Thalassa currently has ~25.6m shares, of which 7.7m are held in treasury. It last reported a book value of £24m which mostly consisted of cash and its stake in LSR. Therefore, I calculate the NAV as:

Book value: £24m

Treasury shares: 7.7m x £0.70 (THAL last sale price) = £5.4m

Total shares outstanding: 25.6m

NAV per share: { £24m + £5.4m } / 25.6m = £1.15

So at £0.70 THAL is currently trading at 60% of NAV

 

Now the deal is structured with a “mix & match” clause that allows shareholders to adjust how much they receive in shares of THAL and cash (up to a limit). To remove speculation, I’ll assume 100% acceptance rate of the offer (it could actually be anything above 90% as that would then invoke a squeeze out) to calculate the impact this acquisition has on “new THAL”

At 90%+ acceptance, LSR shareholders would receive 14.64p in cash + 0.26 THAL shares for every LSR owned. This would result in £9m of THAL’s cash being spent and 16m shares being issued.

New THAL book value

= Old book value – £9m + 61.5m shares in LSR + treasury shares

= £24m – £9m + £20m + £5.4m

= £40.4m

 

New THAL NAV

= New book value / { old shares + new issuance }

= £40.4m / { 25.6m + 16m }

= £0.97

 

Therefore, by structuring the deal this way, Thalassa would actually decrease its NAV from £1.15 to £0.97

 

So this really is a “lose-lose” deal – existing Thalassa shareholders will likely see a material decrease in their NAV, while LSR shareholders will only receive a portion of their cash back and be stuck with an illiquid holding company, that clearly doesn’t care about shareholder value…

 

If I’m already out, why do I care?

Complex situations like this are my bread and butter as they often create opportunities for profit. In this case, I think the poor deal structure and illiquidity of the underlying shares, may have created an interesting setup.

Because the spread between the current market price of LSR and the implied deal value is so large (in excess of 20%) there is a reasonable chance that most of the purchase price could be recouped through the cash portion of the offer:

If the overall acceptance rate of the offer is 80% or less and 100% of those that do accept choose the “full cash” option, I estimate >2/3 of the purchase price will be returned via cash. This would dramatically reduce the risk associated with selling your new THAL shares on the market at a reasonable price.

 

Let me explain further:

The deal is capped at £9m in cash and 16m new THAL shares

The total number of shares not owned by THAL is ~61.5m

So, if we assume an 80% acceptance rate, this implies they need to purchase 49.2m shares

If everyone elects to take the cash offer, it will hit the cap of £9m and everyone will receive a pro-rata share – £9m in cash, divided by 49.2m shares, equals 18.2p in cash per LSR share. Given the current price is ~27p that means you would receive 67% of your initial purchase price back in cash.

 

Judging by the excessive spread, I would guess that most LSR shareholders are not happy with the deal structure and the acceptance rate may be quite low. Using the table below, you can make your own assumptions and see what % of your purchase price may be returned via cash:

LSR

 

What’s the worst case scenario?

Given the range of outcomes is extremely broad in this deal, I think it makes sense to try and come up with a bounded range – the best outcome and the worst outcome.

The best outcome is easy – receive full cash offer worth ~33p for a 22% return

 

The worst case outcome is a little more difficult to calculate, and involves some assumptions. The key variable is the price at which you can eventually sell your new THAL shares. In this branch of the decision tree, 100% of the remaining shareholders would accept the deal, but decide on the full cash option. This This would result in you receiving 14.46p in cash + 0.26 new THAL shares per LSR share held. The only positive argument that could be made is that currently THAL shares are “cheap” trading at a substantial discount to its NAV, which is mostly cash. I believe they’re also pursuing a buyback (but I don’t have the mental capacity to discuss the logic of performing a buyback, while concurrently issuing shares…)

 

To calculate the downside, the following algorithm is used:

Total value received = 0.1464p + { 0.26 x (THAL sale price) }

 

If we assume the increased selling pressure causes the THAL price to fall a whopping 50% our total value received would equal:

Total value received = 0.1464p + { 0.26 x 35p)

Total value received = 24p

ROI = -12%

 

The following table provides a range of ROI’s based on various THAL price assumptions:

THAL movement THAL value Cash value Total value ROI
0%        0.1820        0.1464        0.3284 22%
-10%        0.1638        0.1464        0.3102 15%
-20%        0.1456        0.1464        0.2920 8%
-30%        0.1274        0.1464        0.2738 1%
-40%        0.1092        0.1464        0.2556 -5%
-50%        0.0910        0.1464        0.2374 -12%

 

I think assuming a 50% decline in the THAL share price is a reasonable “worst case scenario” which means our maximum expected loss is ~12%. You also don’t have to sell on day 1 and can hold out in the hope of a better price…

 

Therefore, at current prices, we can construct a reasonably attractive risk reward of 2:1. Given I think it is more likely that we will receive closer to full value (due to acceptance rate and THAL sale price assumptions) I think this stacks up as a potentially attractive situation.

 

Even within a terrible, lose-lose deal structure you can sometimes find opportunity.

 

Disclaimer: This is not investment advice. Do not use any of the above to justify an investment. Figures, assumptions and overall logic may be flawed. I have a position in LSR.

2 thoughts on “The Local Shopping REIT – Part 2

  1. Thal / LSR is a horrible deal – though congrats on your profit.

    THAL management are not to be trusted – they effectively disenfranchised minorities.

    There is substantial resistance to this going through – if you mail me your e-mail I will send you an article on this.

    Like your ideas though.

    Rob

    Like

    1. Agree it’s a terrible deal for all parties involved and I raised my concerns with THAL’s board. What’s interesting is that the way it’s structured I believe resistance could be positive to those who accept and select the “more cash” offer. The lower the acceptance rate, the higher proportion of cash you will receive

      Like

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