Summary
- The first tender offer for Wheeler Preferred D shares was unsuccessful, as expected, but now the terms have changed.
- Given the revised incentives around the tender offer, I believe it is more likely that holdouts will break ranks and tender their shares.
- Many risks are present in this situation, and I encourage anyone evaluating an investment to do thorough due diligence.
If you're looking for nanocap drama, look no further than the Wheeler REIT ( WHLR ). For background, refer to this initial WHLR article outlining the background of this distressed REIT. In the November update , I expected that the WHLRD tender would fail and/or a sweetened offer would appear. Both have occurred, with only 22% of D shares being tendered by the December deadline. Sure enough, this has been met with a revised offer including an extra 0.5 common share of WHLR per WHLRD tendered, and a few more juicy nuances. The stakes have certainly been raised since the last tender - let's dive in.
Game Of Chicken
The revised terms of the new tender offer begin a game of "Chicken" among the preferred holders. Under the revised tender , only 67% of the outstanding WHLRD shares will be accepted for tender. The remaining 33% (tendered or not) will convert to new WHLRD shares with practically no rights, and automatic conversion to half a share of common at $10 (capping their value at $5 if converted). The remaining WHLRD would likely trade near the toothless WHLRP issue, implying 90%+ downside to current price.
To this end, if 100% of WHLRD holders accept the tender, everyone will be left with 33% of their position in mostly worthless remaining WHLRD shares. If exactly 67% of outstanding shares are tendered, those who elected to tender will be able to exchange their full position. Holders are now pitted against one another, potentially incentivized to tender their shares while convincing others to decline the offer. Will prior holdouts "swerve" to avoid an almost full impairment of their investment?
WHLRD Potential Conversion
Presumably, WHLRD holders initially rejected the $16 face value of new WHLRZ notes in anticipation of being able to "put" their shares to the business for over $30/share of common come September 2023, or realize the full value of their rights at a later date. Given this - why do the shares trade at a ~60% discount to their conversion value? There are a few key issues:
- Assuming a $1 share price on conversion date, converting 1% of the outstanding D shares would create ~1m new shares of common stock, a 10% ownership position. REIT ownership is capped at 9.8% , forcing any material holders to take a very slow approach as they convert their units. 1m shares is also nearly 100x the average trading volume in WHLR common stock (10k shares/$15k weighted dollar volume), raising questions about who the buyer would be for even a small amount of converted WHLRD shares.
- Given the overhang, the common price would likely crater if these conversions begin, especially as current common shareholders would be pressured to sell prior to the cascade. If initial conversions are done at $0.50, holders would be even more limited on their ability to convert into common.
- Using a rule of thumb for trading, if a WHLRD holder's goal was to convert ~25% of the average daily volume, this would be around $4k of WHLRD face value per day. With a liquidation preference in September around $120m, it would be impossible to convert D shares without years of laborious slow conversion and cratering the common price. Perhaps D holders could get enough borrow to short common shares and then convert to cover, but borrow is likely to be very tight given the size of the trade needed versus the current market cap. And if a holder begins to build a short position in the common now to hedge their conversion, they would run the risk of a tender being approved and the common shares spiking.
- Another issue is the 200m of authorized common stock available for issuance, likely to be hit quickly in the above scenarios. Once hit, the remaining D holders would need a shareholder vote to increase the number of shares to be issued, which seems unlikely and may force residual WHLRD holders to take a worse deal than what is currently being offered.
- Therefore, if no WHLRD tender can be agreed before September 2023, WHLRD holders will be stuck with a limited ability to convert their shares, a ticking clock to convert before the outstanding share cap gets hit, and limited ability to hedge their conversion via shorting the WHLR common. The holders that have previously been aligned are now opponents in the tender and would remain opponents upon conversion being possible.
- I don't see much incentive for Management to barter for a successful tender, beyond bringing this saga to a close and saving their reputation as activists. Management has a large interest in WHLRL notes, which have a superior conversion mechanism to the WHLRD shares (after 100k WHLRD shares convert, the WHLRL notes can be converted at a 45% discount to the lowest price at which the WHLRD shares were converted, resetting lower as the process continues). This likely results in a cascade of dilution ending with WHLRL holders being in position to own the majority of common stock in WHLR and remaining in the driver's seat.
Tender Value
In another twist, Steamboat Capital Partners filed a letter to WHLR on December 20th highlighting the issues they have with current Management. They suggest that the common shares would be worth over $11 in a buyout, even giving full face value to the current preferred issues. Perhaps that's why Steamboat has begun buying common in the open market. Using Steamboat's same valuation table, and now assuming this tender goes through, the common would be worth even more than $11, making the 0.5 share of common added to the tender...kind of valuable. At $11, this pushes the "value" of the tender over $20. Considering the difficulty of a future WHLRD conversion, the current tender offer may be the best value WHLRD holders can expect. Additionally, the revised offer allows for WHLRZ to convert to common at $12.50/share, giving it more option-like upside than before.
Steamboat and JCP have both had their cases against WHLR dismissed during 2022, suggesting further litigation from preferred holders would be fruitless. Given the numerous WHLRP shares issued as WHLRL dividends this month, I expect a WHLRZ tender offer for the WHLRP's as the next logical step after the WHLRD overhang is resolved, and that this tender would be successful given the revised share register of WHLRP. Without these overhangs, I would expect the common shares at WHLR to re-rate substantially.
Therefore, I am becoming increasingly convinced the revised WHLRD tender could be successful as holdouts break ranks and try to get the best value for their shares. Holders can see that continuing to hold out may not result in a better outcome.
Other Wrinkles
SR Equity Ventures has nominated a slate of directors to stand at the next WHLR annual meeting. Current Management is well entrenched, so I doubt this slate ends up being successful. The nominations did not come with a plan for Wheeler in the event they are elected, so expectations should be tempered even if their election is successful.
Taking a minute to consider if new leadership is necessary at this stage, consider what has happened to date:
- Current Management funded about 80% of the WHLRL notes , despite being offered to all common shareholders at the time. In hindsight, many hate these notes, but do so without having put their own capital on the line at the time to support the business.
- Occupancy, rates, the Cedar acquisition, and recent refinancing deals have all been strong wins for shareholders, suggesting the business itself is being managed well. Despite fears to the contrary, CDR preferred shares continue to have their dividends paid.
- WHLRD holders point to the face plus accrued dividend value of their shares as the starting point of negotiations, but they trade nowhere close to this and were being sold for $16.50 prior to the installation of current Management. Perhaps $15-20 is in fact fair market value for these notes and the tender is fair, or fair enough.
Risks
WHLR and its associated securities remains an incredibly risky situation, and I strongly encourage anyone evaluating an investment to fully review the terms of the different parts of the capital stack and how they interact. The complete dismantling of the WHLRP issue was a result of holders not realizing the common shares could vote to remove their dividends, and the CDR preferred selloff came after both management teams carefully avoided the transaction being deemed a legal change in control. Please do careful diligence before getting involved in this situation.
One example of the many ways you could still get hurt here, beyond the possibility of cascading dilution, is a rights offering like the WHLRL notes. A similar vehicle could possibly be used to maneuver around WHLR preferred shares, and current debt indentures seem to allow for certain transfers between subsidiaries (i.e. Cedar) and spin-offs. Proceed with caution.
For WHLRD holders, the risks of not tendering are enormous and could result in almost full impairment of their investment as soon as next week. I have numerated them above and strongly suspect it will be in WHLRD holders best interest to tender in this round. Investors holding out for an increase in shares offered (unlikely due to this NASDAQ rule ) or an increase in debt offered (unlikely under recent refinancing minimum net worth covenants ) are likely to be disappointed.
Another angle that could be taken here that may scare WHLRD holders is the recent Impact Mortgage litigation . The same law firm used by current Management, Cadwalader, was able to use a vote by one class of preferred shares to strip rights from another. Could the WHLRP class attempt this with the WHLRD shares prior to the September dilution apocalypse? Not seeing this tender approved is one way to find out.
Conclusion
Drama at WHLR continues with the initial failed WHLRD tender, three updated Form 13s, and the dilution cliff from WHLRD drawing ever closer. Looking at the facts as they stand, I'm trying to present a likely outcome untainted by years of bad blood. How this game of chicken concludes is anyone's guess, and I look forward to another lively comment section. Thanks for reading!
For further details see:
Wheeler D Tender Revision - A Corporate Game Of Chicken