The Bank Investor's Handbook Free Chapter: Are Banks Risky?

Three years ago to the month I wrote my most popular post "A Banking Primer" laying out the basics of banking and bank investment.  The post started with the following statement: "There are two types of value investors, those who invest in banks, and those who don't."

In the ensuing three years I've received numerous emails asking for details on how banks work and how to analyze and value them.  I've been asked for book references when people want to learn more.  The problem is there aren't any great books for investors who aren't neck deep in the banking world.  I have a stack of bank investing books on my bookshelf.  Most could be used a ballast for a ship in a pinch.  The text is just as dense as the physical object.  These are books not meant for mere mortals to read.

A good friend and I started to toss the idea back and forth of writing a new type of bank investing book.  A book aimed at investors who are interested in learning, but not interested in being flooded with details.  This book isn't for bank experts, you already know this material and could write a similar book.  The book is for anyone who is interested in learning more about banking, what makes it unique, why banks are attractive investments, and how to look at bank stocks.  There are no discussions of how to hedge interest rate risk with Treasury options.  And no discussions on how to value mortgage backed securities.

Think of this book as a startup guide to banking.  We want to provide enough information to get you interested and looking at banks.  But we are not writing a sleeping aid either.

The book is underway and we hope to have it released in the next few months.  In the meantime in exchange for your email address to keep you posted on the book we're giving away a sample chapter, Are Banks Risky.  A note of fair warning, this is not the final edit of this chapter, what is included in the book could be different based on your feedback and comments.

Signing up below you'll receive a free chapter and we'll keep you up to date on developments in the book.  I intend to send a few short emails to the list with our progress, and list subscribers will be the first to know when the book is released.  Subscribers might also be privy to discounts and deals, who knows, why not sign up and see?

Sign-up and receive the chapter "Are Banks Risky?" from the upcoming Oddball Stocks Bank Investor's Handbook

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George Risk - a potential double hiding at NCAV

This write-up appeared in the latest issue of the Oddball Stocks Newsletter.  The newsletter is the premium version of this blog.  The newsletter is published six times a year and is loaded with oddball stock write-ups that are exclusive for subscribers.  Each issue highlights multiple oddball stocks, bank equities and includes a post by a guest writer.  Subscribers also have access to a subscriber-only forum where we discuss ideas related to the newsletter.

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George Risk Industries Inc. (RSKIA) – The recent turmoil in the markets has hit small cap stocks harder than the broader market and George Risk is no exception.  The company is located in Kimball, NE and manufactures a wide range of sensors and switches.

The company owns two small manufacturing plants located smack dab in the middle of Nebraska.  Both plants are relatively modest facilities in very small towns.

George Risk, the grandfather of the current CEO, Stephanie Risk, founded the company in 1965.  Prior to Stephanie taking control her father, Ken Risk, was CEO.  All three have managed to grow and expand the company.

I remember buying the stock around six years ago in the $4 range.  The memory is clear because I was working on building a position in the days right before and after our first son was born.  It took a number of days to build a full position, but it was possible.  Shares continued to rise with the company’s earnings and I sold out at over $7 a share in 2012.  It was a stereotypical oddball investment.  At the time of the initial investment the company was selling for less than their net cash and securities, was profitable and growing.  All I needed to do was buy and wait.

In the six years since I invested in the company I’ve loosely followed their quarterly reports and price.  The price reached a high of $9.04 in 2014 but since then has fallen to $6.55 as the company itself has continued to grow.  When I purchased shares in 2010 revenue was $7.8m a year.  In 2015 the company earned $11.9m, a growth rate of 8.8% a year.  This isn’t a high-flying growth stock, but 8.8% revenue growth is knocking the cover off the ball for a company that not only traded below its net current asset value (NCAV), but net cash and securities.  Their revenue growth has been great, but earnings growth has been even higher at 17.8% a year over the past six years.  Earnings per share have doubled from $.26 in 2010 to $.59 in the TTM.

And yet, with this sort of underlying growth the stock price has remained stagnant since 2012.  The company is once again trading right at NCAV, which is $32.44m, while their market cap $32.9m.  So what’s the problem?

The company’s problem is that they are successful in a small niche, but have almost no reinvestment opportunities.  The company has a 57% gross margin and a 20% net margin, enviable margins for any business.  Yet, there are few if any outlets for their excess cash.  They own simple facilities and their intellectual property walks out the door each evening.  The company dominates its niche, but is also stuck in that same niche.

In turn, the majority of their NCAV is stuck in cash and an equity portfolio.  Both cash and securities have continued to grow over time.  When I initially researched the company I thought the cash pile was a tax-efficient way for Ken Risk to grow a retirement portfolio.  He could build up a sizable kitty inside the company and then live off the dividends in his golden years.  If that was Ken Risk’s dream, however, it went unfulfilled as he died suddenly in 2013 and sadly didn’t get to see his golden years.  His daughter Stephanie, the former CFO, took over as CEO in his absence.

If you would have asked me in 2010 if I thought the event of Ken Risk’s passing would unlock value I would have said yes.  Unfortunately, it hasn’t.  The underlying company continues to operate as it has, but nothing else has changed, especially the share price.

Shareholders are right to be worried about the cash and investment portfolio.  It’s money the company controls, not shareholders.  A nice change is that the company paid out more than 100% of their net income as a dividend in the first six months of 2015.  During that time they earned $1.2m and paid out $1.7m in dividends.  If they continue this they will slowly liquidate and pay out their excess cash and securities holdings, but who knows if that will occur.

The eternal question is whether the company is worth more than their current price.  I can understand why the market is pricing the company the way it is.  While the operations are great they are small and stuck in a niche that they appear to be unable (or perhaps unwilling) to grow out of.  The company is also saddled with all that excess cash and the investment portfolio and the Risk family owns a majority stake in the company.

If management was serious about having the value of their business recognized by the market they’d pay out a dividend equal to 75% of their market cap.  Subsequent to such a dividend shares would be trading at approximately $1.50, and a company with 17% earnings growth and $.59 per share in earnings wouldn’t trade at $1.50 for long.  In such a scenario it wouldn’t surprise me to see shares rise to $7 or more, especially if earnings and revenue continue to grow.  The only thing stopping this scenario is entrenched management that seems content with business as usual.  

Is screening completely worthless?

Screening for investment ideas is universally derided.  Value investors hate it, growth investors hate it, it seems everyone hates screening.  We're told screens never turn up good ideas, and screens are a one way ticket to value trap heaven, or a million other things.

The unanimous view that screens are worthless has led to a predictable result, almost no investors screens for stocks anymore.  In the past few years I haven't spoken to anyone who proudly admits to screening, myself excluded.  A few investors will mention in passing they use it as part of their strategy, but the importance is downplayed.

I believe that screening is just another tool in an investors toolbox.  Each tool has a role, and if we try to use a tool incorrectly we'll end up frustrated or with incorrect results.  A drill is great to bore holes, or twist a screw, but I've never tried to use the butt of my drill to hammer in a nail.  Yet that's exactly what investors try to do with screens, and inevitably they come up frustrated.

Imagine I gave you a giant bucket full of a variety of coins.  I told you "find me the most valuable coins in the bucket."  How would you proceed?  Because the bucket is big, and no one has endless time you'd probably try to create a search strategy.  The first step might be to divide the coins into respective groupings based on denomination.  Quarters in one pile, pennies in another.  From there you'd want to focus your efforts on the pile with the most potential.  If pennies from before 1920 are valuable you'd probably disregard the nickels and quarters and start looking at each penny.  But even within the pennies you wouldn't look at every one, you'd just scan the dates for anything before 1920 and put those into a pile.

If you found pennies minted before 1920 then you'd probably search through that much smaller pile for the ones in the best condition.  But what if you didn't find any pennies from before 1920?  Maybe you'd start to look through the dime or nickel pile.  This process would be repeated until you found the most valuable coins in the bucket.

Screening for stocks is the same as searching for valuable coins in a bucket.  The problem is people expect it to be something different.  They expect a stock screener to be like a magical tool that will sift through all the coins in the bucket and find the most valuable ones automatically.  

At the most basic level a screener is a tool that's used to limit the universe of stocks that an investor needs to search.  It doesn't eliminate searching or analysis, but it helps reduce the work load.

In our society there's a macho factor to doing tasks by yourself.  I get this, I'm a DIY-er, but it's not for the macho factor, but because I like to save money.  For many though it's a source of pride.  "You bought your Christmas Tree at a nursery? Ha. I walked through the snow in the woods to cut it down myself!"

There is a benefit to knowing how to do something yourself.  There's a cost savings usually associated with it as well.  But there's also a time component.  While it might be cool to rebuild an engine in the garage it also takes a lot of time.  If engine repair is a hobby and it's enjoyable then it's probably a good use of time.  But it doesn't make sense in most cases for a highly paid professional to take off a week and try to learn how to rebuild their engine when someone else can do it for them allowing them to focus on their work.

Investing like most things in life is about results.  We congratulate our kids for how hard they worked on the field, or how hard they worked in class, but if they're working hard and failing something is broken. Likewise hard work can lead to good performance, but it's no guarantee.  If a company is cheap the stock doesn't reward the investor who read every 10-K for the last 30 years any more than the guy who coat-tailed and purchased given they buy at the same price.  That's what's great about investing, but also frustrating.  One investor can put in loads of work, while another barely scans the financials on Bloomberg and if both invest at the same price and the stock rises 50% both investors gain 50% regardless of the work effort before committing capital.

Outside of investing screening/filtering/searching is hailed as a great innovation.  Instead of having to leaf through volumes of the encyclopedia one can type a few words into Google and in seconds find the answer they were looking for.  The amount of data and availability of it is greater now than it's ever been.  And ironically investors are now ignoring tools that help them sort through this data easier preferring a tedious manual approach.

There are a few man criticisms of screening that I want to address.

Garbage in garbage out

The biggest weakness of a screen is the underlying data.  If the underlying data is crummy then any tool built on top of it will be equally crummy.  This is intuitive.  How could a tool with underlying bad data produce good results?

The challenge is when investors want to run a screen across an investment opportunity set where little good data exists.  In this case the best research is picking up the phone and calling anyone who will talk.  I'd say this sort of scenario exists in maybe 1-3% of all investment situations, and if you find yourself in that situation a screen is not the right tool for the job.

Before running a screen make sure the data source used for the screening tool is sound.

Screens are historical not forward looking

A lot of investors are out searching for investments at inflection points, or for investments with catalysts that will catapult shares to the moon.  If you're looking for stocks where something abnormal needs to happen for value to be realized or created then no tool will be of use.  Investors in these situations rely on past patterns and gut feelings.  Will Sears retail turn around?  Past results indicate it's unlikely, but Lampert and Berkowitz have stuck their fingers in the wind and decided otherwise.

Thankfully for most traded companies the future will resemble the past.  A bad management team that has destroyed value will most likely continue to destroy value going forward.  Likewise a good management team that has grown a company will likely continue to grow it in the future.  The future is uncertain but in the business world no one likes change.  Changing suppliers is difficult, changing processes is difficult, changing a business is difficult.  Most business is biased towards sameness.  

Screens uncover bad investments

When a tool is used incorrectly it shouldn't be surprising if the results are incorrect.  The purpose of a screener is to limit the universe of potential investment opportunities one needs to research.  It's not to find a good investment.  The more strict a screen the more likely it will turn up garbage.

I have tried to craft extremely complicated screens in the past and the result is always the same.  I'll end up with three companies that match, and none of those three companies are worth investing in.  

What screeners are good for

Screeners work very well when one is looking to narrow down the investable universe.  For example, if I know I want companies with revenue why would I waste my time evaluating zero revenue companies? Rather it'd be easier to run a screen and ask for all companies with revenue greater than zero.  Is it possible I'll miss some company that the market thinks has no revenue but really does?  Sure it's possible, but I recognize and have accepted the fact that I will miss thousands of good investments because I don't have time to track 66,000 stocks worldwide.

I've had a lot of success pulling lists of stocks with broad criteria such as "stocks trading for less than book value." Or "stocks with insider ownership that are profitable."  These are not complicated screens, but they reduce my time weeding through companies I'd never consider investing in in the first place.

Screens are also paradoxically good at finding a very specific match.  When I built CompleteBankData one of my goals was to provide a search mechanism that would allow a user to search over 1,700 pieces of industry specific bank metrics.  While investors scoff at the ability to find something quickly non-investors cherish this functionality.  Bankers can find direct competitors in a few minutes, users can find potential clients that match their ideal customer profile, and researchers can find institutions that have certain characteristics.  The ability to search through an enormous pile of data and find an exact match is eye-opening.  Our users no longer have to open the metaphorical encyclopedia, they now have something similar to Google.

My parting thoughts on screening are varied.  I'd encourage investors to look at screens because no one else is anymore.  If you are looking for bargains it's helpful to look where no one else is.  Everyone is looking at VIC, Seeking Alpha, SumZero, hedge fund holdings and message boards.  But no one is screening to source original ideas.  There is value in going where the crowd isn't.

On another level some people like to work for the sake of working.  Maybe you like to read annual reports in companies you'll never invest in.  Or maybe you just like to analyze companies to pass the time.  Or maybe you have a boss that requires it.  In these cases screening doesn't make sense.  It's like the person who spends an entire Saturday and $50 changing their oil when it could have been done in 15 minutes for $20.  If you enjoy the process then why not?

For myself I want the results, and I want shortcuts.  I'm busy enough as it is, and if investing didn't have shortcuts then I'm not sure how I'd have time for other activities.  I'm a firm believer in the "work smarter not work harder" school of thought.  I've built my business and my life around this.  That with intelligence and proper tools I can get more and better things done.  I believe that screening to reduce the universe of potential investments makes sense for me.  If you're interested in reducing your workload, or spending more time analyzing rather than searching then I'd consider looking at screens again.

For the naysayers I'll leave with this last thought.  I've had a 3-bagger and a 10-bagger both discovered with screens.  They've had value for me at least, and I'm content to be digging where others aren't, especially with a power tools when the masses prefer to dig with their hands.

Importance of your own due diligence

Outsourcing is alluring.  Let someone else do the research and ride to success with little to no effort.  The problem is when everyone relies on everyone else leaving no one to do the primary research.

There is a term "hedge fund hotel" that's used to describe a stock with a shareholder register littered with well known hedge fund names.  Funds all pile into the same names because they like the characteristics of the stock, but also because other popular funds are in the name.  The cycle is self perpetuating, as more funds enter a name it attracts even more funds.  Many of these funds do their due diligence before investing, but it wouldn't be a stretch to say that some have outsourced their thinking to others in the group.  The thought is if there are a number of great investors in a name it makes sense that they've all done their research, and if these popular investors have all researched and determined an idea is great that little additional due diligence is necessary.

The spectrum of due diligence extends from "Bill Ackman is invested so I will too" all the way down to examining invoices and receipts before investing (in a private company, but also possible in a small public company).

There is a natural tension between doing enough research to determine an investment is worthy of a portfolio position, and doing too much.  Research and due diligence experience diminishing returns.  In my view the determining factor on how much due diligence an investor needs to undertake is determined by the size of the position in the portfolio as well as the absolute size of the position.

For smaller positions it's reasonable to research a stock without ever leaving your easy chair.  This includes reading quarterly and annual reports, reading conference call transcripts and Googling the company.  A lot of investors, especially value investors get caught up in reviewing the notes for a company.  I think it's important to read annual reports and notes, but I've never seen an investing situation where minutia in the notes was the determining factor for investing or not.  Additionally I've found many cases where Googling can turn up information about a company that's much more impactful than a note about how the company computes their pension or handles inventory accounting.

It's helpful to think outside the box.  Companies release periodic financials, but that doesn't have to be the only source of research.  Consider reading employee reviews on Glassdoor or contacting current and former employees directly on LinkedIn.  Glassdoor is perfect for the armchair analyst.  Glassdoor has salaries and reviews for most companies in the US.  The site is anonymous and employees tell the world what they'd never tell HR in an exit interview.

Employee salaries and management perception is important.  You cannot have an average or above average company if employees universally hate management and are underpaid relative to peers.  If you are looking to avoid duds in your portfolio you need to invest in companies that have at least an average workforce. If a company has a below average workforce the company will need to work that much harder to produce results on par with peers.

Beyond Glassdoor there is a lot of information available online in non-traditional places.  On we have hundreds of financial details that never appear in a bank's financial statements.  Many of these can be pivotal pieces of information that could make or break an investment.  We also have a lot of information that highlights banks that have the potential to torpedo a portfolio.

Another treasure trove of information is the court system.  I've referenced the Horsehead Holding (ZINC) investment in the past, but it's worth mentioning again.  A friend pointed out that the company was involved in multiple lawsuits in Allegheny County on the public record a year before their bankruptcy filing.  This information would have tipped off investors to their imminent failure almost a year ahead of time.  Courts require companies to disclose details they wouldn't otherwise disclose.  Horsehead Holdings was suing their suppliers and contractors for not knowing what they were doing.  They were also involved in a lawsuit with a competitor for poaching the designer of their manufacturing plant.  A PACER subscription to scan for lawsuits can be incredibly valuable.

The last and at times most valuable source of information regarding a company is management itself. Without management there is no company.  Managers hold the pieces of a company together and push employees towards a singular goal.

Bad management can destroy shareholder wealth in a few quarters.  Benjamin Graham believed that the quality of a company's management was reflected in their financial statements.  This is something I agree with, but it has limitations.  A company with continual losses and perpetual secondary offerings does not have a star management team.  Likewise a company with a seemingly high ROE might not have a great management team either.  Sometimes it's worth peeking behind the financials to see who's really running the show.

The best way to gauge management is by talking to them.  Either picking up the phone or talking in person.  For large cap companies management is inaccessible to individual investors, but that's not the case with smaller companies.  It's very easy to pick up the phone and talk directly to the CEO or CFO of a microcap company.

A lot of investors shun talking to management because they feel they'll be fed a rose colored view of the world.  Or that management is biased towards their own company, or that a CEO is just a sales person.  All of these things are true, and they should be, and if they aren't don't invest.  If a CEO isn't out selling their company I don't have much confidence in them.  Likewise senior management should believe in what they're doing and believe they're the best at it, if not they need to find another job.

The job of the investor isn't to hear management's narrative and invest based on it.  But rather to use management to fill the gaps in their investment thesis.  Sometimes financial statements don't describe a situation accurately.  For example Kopp Glass (KOGL) appeared to have a large pension problem based on their financials.  The company's CFO had a much different view on the situation.  When I spoke with him he said the pension was the last thing he worried about, the payments were fixed and he had a model capturing all scenarios.  He had other issues he was worried about, and I would have never understood that if I just relied on the company's financial statements.

Talking to a company's management on the phone is valuable, but it's even more valuable to talking to them in person.  Body language is an important element of communication.  Sometimes people will give two answers to the same question, the verbal answer, and the body language answer.  If you're on the phone you only hear the verbal answer, but in person you get both.  And both is important when the answers don't agree.

The problem is it's hard to find the time to fly around the country visiting companies.  I try to attend as many annual meetings as I can in person.  At these meetings management makes themselves available to discuss issues with investors.  And meetings are a chance to observe the body language as well as the verbal language of management.

Another solution is to attend an investment conference like our Microcap Conference in Toronto at the Hilton April 11th and 12th.  At this conference there will be 40-50 companies presenting to investors and taking questions.  But beyond that we also set aside time for one on one meetings allowing investors to sit face to face and ask management questions or offer suggestions directly.  If you've ever sat and thought "I wish management would do this.." a one on one session is the perfect opportunity to suggest a change to management in a non-hostile setting.  If you're interested in registering you can do so here.

The key to any investment is doing your own due diligence.  Don't invest in a company just because someone else has, regardless of how great of an investor they are.  We never know exactly why someone else invested in a position, or what their goal is with the position.  Conducting your own due diligence gives you the information and confidence needed to investor your own money in a stock.  Also consider the size of your position, and then conduct the appropriate level of diligence for that position.  If you have a $100,000 portfolio and are investing in 20 stocks it probably doesn't make sense to fly to Wichita to tour a plant.  But if you are putting $15,000 or more into a position it's worth the time to go beyond the financials if possible.  In the end you are responsible for the money you invest, and conducting an appropriate level of due diligence can result in gains and protects against losses.

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