Temple Hotels: potential distressed debt opportunity

I came across this name while looking for what I call two pillar stocks.  That is stocks where both earnings and book value support the same valuation.  The following company appeared on the screener and as I dove in to research I found what might be interesting from a debt but not equity perspective.  I found this fascinating enough to write it up, although I should mention a caveat.  I'm not a distressed debt expert by any means, and I was searching for equity bargains and found this.  In the world of distressed opportunities there might be better investments.

The slogan for Fort McMurray, Alberta is "We Have the Energy".  They still do have the energy, the problem is it's captured inside sand pits and no one is willing to dig it out.  This is of course a result of the global oil slump.  The term "oil slump" what what talking heads use to describe the terrible predicament where it costs less to heat a home, less to gas up a car, and less for anything made with oil.  Consumers aren't complaining unless they are shareholders in an energy or energy related company.  The energy companies themselves have been hit hard, but the trouble doesn't stop there.  Companies that rely on energy business, or the business of energy workers have taken a toll as well.

Temple Hotels (TPH.Canada) is one of those companies whose operating results and stock price graph are mirror the drop in oil prices.  The company owns 29 hotel properties across Canada that have a slight over 4,000 rooms.  The company's largest presence is in Fort McMurray, Alberta with 891 rooms there.

Fort McMurray was a relatively obscure backwater town in Northern Alberta until the late 1960s when the sand natives used to waterproof canoes was able to be refined into oil.  An oil boom began and continued into 1981 with the city's population peaking at 31,000.  As oil prices fell so did the fortunes of Fort McMurray.  The town lay near dormant until oil started to climb again in the 2000s.  And like the California Gold Rush the Alberta Oil Rush was on, only instead of wagons and settlers it was F-150s, Silverados and unattached men living in hotels and RVs working in the oil fields.  The population boomed from 38,000 in 2001 to 61,000 in 2011, the good times were back indeed.

Temple Hotels took advantage of the boom by purchasing multiple hotels in the Fort McMurray area.  Their hotels had high occupancy in the boom years from workers traveling in and out of the area.  Their portfolio of hotels included both extended stay locations and short term locations.

A potential problem for hotel companies is they have high levels of operating leverage, and for Temple Hotels they piled on significant financial leverage as well.  As occupancy rates fell with oil prices the company's profits fell too.  The company paid $.48 per share in dividends in 2013 and 2014.  They have since suspended that dividend and shares trade for less than $1.

A traditional investment thesis might be as follows: eventually oil will recover and so will Temple's profits.  Shares can be purchased at a giant discount and shareholders just need to be patient enough to wait for an oil recovery.

The problem is the traditional thesis doesn't work in Temple's case.  They operated with a boom time mentality and didn't save up for rainy days.  The company's leverage, the tool that allowed them to build their empire has now begun to work against them.

The company's hotels cost a total of $743m to construct and have an appraised value of $751m.  It's worth noting that 40% of the company's rooms are in Alberta, with 22% (891 rooms) in Fort McMurray.  The rest are spread throughout Canada and operate under well known brands such as the Thunder Bay Days Inn, Mississauga Hilton Garden Inn, TownPlace Suites Sudbury and others.

Outside of Alberta the company has a very diversified portfolio of brand name hotel properties.  The problem is with excessive leverage even a small downturn in revenue can lead to catastrophic results for the company.

In the latest financial report the company stated that they are in breach of multiple covenants on a portion of their debt, but they expect to restructure the terms or pay off the offending debt.

For equity holders the company does not appear to be a sound investment.  They have a market cap of $74m and shareholder equity of $87m.  Equity is being quickly eroded by portfolio impairments, and the company is in breach of their covenants.  I have no doubt the company's hotels will continue

So where is the opportunity?  In the company's near term traded convertable debt.  The majority of Temple Hotel's debt is in mortgages related to individual hotels, but they do have $138m of convertable debt outstanding.  There are four series of convertible debt outstanding, C, D, E and F.

The company's C series has an outstanding value of $22m and matures in December of 2016.  Management notes that it will be a challenge to find funding to pay off all of their convertable debt issues.

In the most recent quarter the company earned $13m in operating income against $8m in interest payments on their debt.  They have FFO of $.10 per share and AFFO of $.07 per share.  They company also just completed a $39m rights offering with the explicit intent to repurchase their own debt, something they've been doing for quarters now.

The company's one year convertables are trading with a 13% yield and appear to be the safest for a number of reasons.  The first is the company is still able to pay interest on the debt and has been while in a prolonged slump.  With occupancy rates at 62% they are deep into recession level territory.  And yet they still have positive cash flow, cover their interest charges, are investing in remodeling hotel properties and continue to operate.

It will be difficult to find funding to repay all $138m of convertable debt over the next two years, and that's why the Series C is trading for $95 whereas the Series F is trading for $72.

If the company can limp along another year Series C bondholders will receive an 8% coupon, plus a 5.25% gain on redemption.  Not bad for holding a year.

Overall the company has $85m in debt coming due between Sept 2015 and Sept 2016.  Of that $38m is related to three mortgages that have the defaulted covenants.  My guess is the company will use the rights offering proceeds to pay off this debt.  They noted the rest of the debt maturing in the current 12mo period can be refinanced at existing terms.  That leaves the issue of retiring or refinancing the Series C debt.  The company currently has $11m in cash on hand and should generate close to $20m in cash for 2015.  Additionally management has shown that they're willing to sell properties to fund near term needs.  Ultimately this is terrible for shareholders, but not bad for bondholders.

Are there easier ways to make 13%?  Probably? I'm sure some equity investors are wrinkling their noses at this post, but how many equity investors did 13% last year?  Successful investing isn't swinging for the fences hoping to crack a lucky pitch.  Rather it's looking for opportunities with likely positive outcomes and unlikely negative ones.  The worst case scenario for an investor here is that Temple Hotels declares bankruptcy and bond holders are dragged into court and forced to wait years for a recovery.  Although according to financial statements if the company were to liquidate their portfolio at current values even equity investors would see gains.  Investors with a higher risk appetite might venture further out on the curve, or enhance or protect this position by combining the bond investment with options on the common.

Disclosure: No position


13 comments:

  1. Great post, Nate. Another possibly compelling idea are the Fortress Paper convertible debentures of '16, currently trading at ~90. They're primarily a dissolving wood pulp producer ("DWP"). DWP prices for the grades they produce have come under pressure, however, the company has currency tailwinds (costs primarily in CAD, sell in USD) and has decelerated their cash burn. Current cash is greater than the FV of the converts due in Dec '16 and management is motivated to pay it off with cash as the former CEO (still an insider) has a significant stake in the equity.

    Regards

    ReplyDelete
  2. There's another piece to Temple you didn't mention, and that's the possibility of a takeover by Morguard, a big Canadian real estate company. Morguard has been buying shares aggressively for most of 2015, and now owns nearly 40% of the company.

    https://www.morguard.com/news-knowledge/news-article?newsId=122907

    ReplyDelete
    Replies
    1. Nelson,

      I saw this on the holdings page but didn't know what to make of it. It's an interesting aspect for sure.

      Nate

      Delete
  3. Thanks Nate. One thing worth mentioning for US investors is that it is almost impossible to buy the Canadian Debentures even though they trade on the TSX. Interactive Brokers won't buy them. Perhaps Canadian investors have an easier time of it?

    ReplyDelete
  4. Can someone post the cusip/other identifier of Temple convertible?

    ReplyDelete
    Replies
    1. 879854AA5, 879854AB3, 879854AC1, 879854AE7

      Delete
  5. Found it: TPH.DB.C/E/D/F

    ReplyDelete
  6. You can also get a ~13% YTM (~8.4% current yield + ~5% annual increase to par in 8/19) on RFTA and a similar or higher yield on a few other US exchange traded debt securities. RAS, the issuer, has a raft of issues but it is still paying common dividends and the common trades at ~.5x book after multiple writedowns.

    ReplyDelete
  7. It will likely will be years after a bk restructuring/liquidation to get your money out of this and you will get nowhere near par value. In the liquidation the company will get pennies on the dollar because oil is not going to rebound any time soon so that hotel is not worth anywhere near book value. Oil demand from China is in the initial stages of further declines, yet supply seems to have no intention of letting up. The oil markets will do the exact opposite of what everyone is hoping for. No rebound, not anytime soon.

    ReplyDelete
    Replies
    1. Maybe so, maybe no. I happen to agree with you somewhat, and yours may be a well-founded opinion, but don't mistake it for fact...

      Delete
  8. I have not looked at this beyond what Nate posted, and specifically I have not looked at any prices of the various series. However, there might be a potential arbitrage -- buy the Series C and sell short Series F. And then might be a chance to do it again with Series D if C is repaid.

    ReplyDelete
  9. I appreciate all of these ideas. However, they are all academic in nature, as it is not possible to buy the Temple convertible notes as a US investor through a US broker. Has anyone actually purchased any shares? If so, please share. As no one has yet reported actually making a trade I believe that that confirms my experience that it is not possible.

    ReplyDelete
  10. If oil price will not recover, there is no clients.
    In such case, the value of hotels is 0. Nobody will by them even if the construct cost is 750MUSD.
    When we drive, we can find so many hotels closed since 30 years everywhere. It could be the same for Temple in the future.

    ReplyDelete