Temple hotels is simply trading too cheaply relative to a realistic range of outcomes...
Rather than putting forth an entire thesis here I'm just going to highlight a couple points that should lead people to further inquiry (this is not investment advice and readers need to do their own due diligence before making an investment):
Management: The current management (K. Rai. Sahi) is excellent & has a solid reputation of value creation at Morguard. The management team that led to the collapse in value from over $30/share to $.50/share pre consolidation has been removed. Morguard currently owns 55.9% of the company and acquired stock most recently in December 2016 at a 6-1 conslidation adjusted price of $4.06/share. Morguard has recently increased the loan available to Temple at prime +2% to 13.5M. To us this signals a commitment to helping Temple bridge any shortfalls/hiccups in financing if it means avoiding value destruction. This is an assumption but one we are comfortable with and one that should help alleviate any pause about outstanding liabilities. The significance of what is now an extremely well capitalized and committed parent has been grossly underestimated in the value of the common of Temple in our view.
Debenture E/F: This is a financial game theory problem but the E debentures were the securities that had all the leverage against the common. They were a $45M obligation vs a $35M obligation and they had the power of knowing that another (significant) liability was lined up 6 months later. It seems unreaslistic to assume anything other than the F debentures being renegotiated at terms similar to the E debentures now that the E debentures have been renegotiated.
Mortgages: The mortgages in default dont have creditors demanding payment and it seems implausible to assume anything other than extensions will be worked out. The lenders on the mortgages aren't in the business of taking activist positions and confiscating property. Appreciating incentives is important to understanding this properly. There is enough cash flow flowing through the business to make extensions and we believe this is by far the highest probability outcome with a well capitalized parent. This is relatively low cost debt and as the debentures are paid down (high cost debt at 7% + a conversion option) cash flow will be freed up. It's a far lower probability that any property is foreclosed on (we admit to not knowing the exact odds here but we modeled at sub 3% after looking at base rates in similar scenarios from the GFC) than vice versa.
Liquidity: Outside the parent as backup, Temple is a collection of liquid assets in high demand areas (Canadian real estate). Much of Temples collection of assets, by our estimates just shy of 30%, have cap rates below 7% and are in some cases loss making entities. Via financial engineering which we believe to be one of management strengths after analyzing Morguard's business practices; properties that are losing money or generating a sub 7% return (the cost of the current highest cost debt) can be sold to pay down high cost debt and free up free cash flow. We are not concerned about receiving unfair prices at distressed levels for these properties as recent asset sales have taken place at approximately the written down level and again Morguard can bridge any financing short falls in order to avoid value destructive asset sales. The consequence of selling properties earning 0% and paying down debt costing 7% will be to further improve the free cash flow yield while reducing debt levels.
Valuation: By our estimates once all the hair is removed (6-12 months from now) and this trades more in line with what we perceive the cap rate to be (7%) this security will be priced 250-300%+ higher than it is today.
This is a significant exposure for us and we are putting our money where our mouths are. The reason for synthesizing the above for an audience here and elsewhere is to encourage the equity to be priced more fairly in order to discourage a take out from Morguard at a paltry 10-15% higher than todays price that some shareholders may accept. While we think this is unlikely at the moment due to the structure of the debentures, we would feel more comfortable that this outcome would be avoided if the equity was priced more reasonably with respect to the range of outcomes in front of Temple. Additionally we dont view share repurchases as a prudent use of capital at this time because of the heavy debt load and as such don't compromise the return on our investment by taking actions that may increase the share price.
Reminder: This is not investment advice and each investor should do their own due diligence before making any investment decisions.
Disclosure: We have a position in Temple and have/will trade its securities.