Lantern Hotel Group - ASX:LTN

For my first post I will explain my investment in Lantern Hotel Group. I bought shares in Lantern in June and September 2012. Below I explain my reasoning/thought process at the time.

With this investment I was taking advantage of a soon to be completed rights issue and buying in at the same price as the rights issue and some professional investors who were underwriting the placement. On its own that doesn't seem like a terrific reason to buy the shares but as I explain below, multiple other factors made this opportunity enticing. 



HISTORY - Why this opportunity was available


Lantern Hotel Group, formerly known as ING Real Estate Entertainment trust ("IEF") was a property trusted listed in 2004. During the boom years ING, the large Dutch financial institution, expanded into asset management in Australia. Part of this included running several ASX listed property trusts including IEF. IEF listed in 2004 at $1.00 per share.

To boost assets under management, the trusts went on a purchasing spree, buying numerous assets throughout Australia and New Zealand, in IEF's case hotels. As you can imagine, many hotels were purchased for above market prices making numerous hoteliers very wealthy.

When the GFC hit, IEF was overleveraged and suffered accordingly, dropping from a high of $1.35 in June 2007 to 12 cents in June 2009.

At this stage in IEF's existence it was a passive real estate investment trust (REIT) and owned a bunch of hotels scattered across Australia and New Zealand.  It leased all the hotels to operators and collected a rent roll. This all fell apart in early 2011 when its largest tenant was placed into receivership. Pretty much everything that could go wrong did.


NEW MANAGEMENT – Out with the old

On top of all of IEF’s other problems, ING announced in February 2011 that they planned to exit asset management in Australia and that IEF would change strategy. Management would be internalised and the fund would be restructured into a listed hotel operating business. In this regard, IEF announced that subject to shareholder approval Bodiam RE, a subsidiary of Torchlight (IEF’s biggest shareholder) would be taking over as responsible entity for the fund in early 2012.

Bodiam decided best way forward was for IEF to internalise management and staple a unit of Bodiam to each IEF share. IEF would also raise $15m to fund the purchase of the operating assets of the main tenant (in receivership) to allow IEF to begin operating some of the hotels it owned. The $15m raising was underwritten by Torchlight – existing shareholders were able to purchase .6 shares for every share they owned at 4.2 cents per share. As many shareholders were deep underwater they did not take up their rights and Torchlight took up their shares.


 OPPORTUNITY

With the rights offered at a substantial discount to the funds net tangible asset (NTA) backing per share, I took the opportunity to buy in on market at 4.2 cents. The figures below show the net tangible assets per share and gearing post capital raising. 

In my opinion the shares offered a good risk/reward opportunity given the price of 4.2 cents per share, the NTA of 10.54 per share and the post raising gearing of 57%, which while not ideal was not fatal to the future of the fund. 

Net Tangible Assets per Share – Post capital raising

Net Tangible assets / shares on issue = Net Tangible Assets per Share

102,456,000 / 971,951,888 = 10.54 cents per share

Gearing – Post capital raising

Total  Liabilities / Total Assets

136,488 / 238,944 = 57.12 %

 Market Capitalisation
Shares issued x Share price
971,951,888 x 0.042 = $40.8m

Opportunity

Trading at 0.041 cents per share, 39% of NTA

Upside potential as IEF moves closer to trading at NTA

Potential gain of 157% if IEF were to trade at NTA

  

CATALYST – IEF’s unloved asset, the Penrith Panthers

While it’s nice to buy a share trading at a large discount to its NTA, it’s quite possible for it to trade at a large discount for a long period of time – look at some of the smaller listed investment companies as a perfect example of this.

That is why it was nice to see some potential catalysts existed which would help IEF move closer to trading at NTA. To understand these better one had to take a closer look at IEF’s balance sheet.

 IEF’s balance sheet consisted of two main assets

1)      Hotels

-          Hotels in Australia and New Zealand 
-          NZ  hotels were classified as noncore and were to be sold

2)      Penrith Panther assets

-          $65m loan to the Penrith Panthers 
-          49.9% ownership of Panthers Property Unit Trust

In its past life, IEF lent the Penrith Panthers NRL club money to fund the purchase of hotels/clubs around New South Wales. These were branded Panther's hotels and targeted Penrith/NRL supporters. Given IEF's restructuring, the relationship with the Panthers was no longer a key focus and the loan and holding in the unit trust were tied up capital which could be put to a better use. Unlocking this capital would assist IEF in trading closer to NTA.


 Catalysts for rerating

1)  Pay down of debt/reduction in gearing so fund can pay dividends

-          Reduce debt through repayment of loan from Panthers Investment Corp  
-          Market not valuing IEF’s loan to Panthers Investment Corp  
-          Hidden asset – repayment of loan will crystallise value and reduce gearing

2)  Turnaround of operations so hotels trade profitably 
-          Use proceeds from capital raising/profits to reinvest in hotels
-          Hotels have not had sufficient capital works due to over leveraged past nature of fund
-          Reinvest to bring hotels up to required standard
-          Use operating profits to pay dividends/buy back shares

IEF’s Penrith Panther Assets

 

Panther’s Loan

• Loan term was extended to 30 June 2013
• Loan is currently earning interest at 9.854% for IEF
• Interest rate increases by 3% on 13 July ever year
• Loan is secured with first ranking mortgages over all of PIC’s properties
• PIC has $270m of property plant and equip on its balance sheet – Loan is well secured
• Incentive for Panthers to refinance and pay back IEF given high interest rate and 3% step up

Units in Penrith Panthers Unit Trust (PPUT) 

• IEF owns 49.9% of PPUT
• Recently announced to ASX that IEF has agreed with Panthers Investment Corp (PIC) to sell IEF’s 49.9% share in PPUT back to PIC for $24m
• Settlement deferred to 30 June 2014
• Interest charged at 9.854% - steps up 3% on 13 July every year until settlement
• Secured by first ranking mortgages over PPUT properties and fixed and floating charge

 Panther’s position

The Panther’s board made it clear in their 2012 financial statements that the club was overleveraged and would sell assets to pay back debt. All of PIC’s assets except for their main club house premises were classified as noncore and would potentially be available for sale to pay back debt. This would benefit IEF significantly as repayment of funds loaned to PIC would allow gearing to be reduced/additional hotels to be purchased.

Quotes from Panthers board members

Pro forma IEF balance sheet with Panthers repayment and sale of NZ assets

Through the repayment of the PIC loan and proceeds from the sale of the New Zealand hotel portfolio, IEF’s gearing falls substantially. I assumed in the above table that all proceeds were used to pay down debt. This assumption is unrealistic as in reality IEF were likely to use some of proceeds to purchase new hotels.

I am agreeable with IEF purchasing additional hotels as long as gearing is reduced to a level that enables IEF to pay dividends out of operating earnings as this will assist the share price to be rerated. 

At the time of my share purchase i thought the Panthers refinance would happen sometime during the next 18 months. I was pleasantly surprised when it was announced that Penrith had paid back all funds outstanding to IEF in February 2013.

POTENTIAL ISSUES – the down side

While the large discount to NTA is a plus, if the hotels are overvalued on the books the upside is an illusion. The table below shows the book value of IEF’s hotels over the past few years.

While the cap rate on some of the hotels looks low, majority have been written down since purchase. It is possible that some of the hotels will need to be written down further which could reduce the upside but I am comfortable with majority of the current valuations.

Saying that, the Brisbane hotel does look overvalued.  Coming from Perth, I am familiar with the venue and while it is well located being close to the Perth CBD ,I feel that the $13m valuation is generous. IEF leases the Brisbane hotel to a third party operator. Based on the current cap rate, the implied annual rent is over $1m per year. I struggle to see how any operator could make a profit with that level of rent let alone Perth’s extortionate wages.

SKIN IN THE GAME

On the upside, the new directors have been purchasing shares on market and have fairly substantial shareholdings overall. This does give me some comfort that they also see value at the current price.

Director on market purchases

Director overall holdings

END GAME- Buy Buy Buy

Talking in whole company terms for a moment, being able to buy $100m worth of equity backed by trading hotel assets for only $40.8m does seem like a good deal. As at the time of the rights issue, IEF was trading at a large discount to its NTA. Catalysts existed which would assist in helping bridge the gap so IEF traded closer to NTA e.g. repayment of the PIC and PPUT loans. Torchlight - the funds largest shareholder and people behind the new responsible entity - would only make meaningful returns by an increase in IEF’s share price – meaning their goals are aligned with shareholders. Finally the new directors have been making large on market purchases and as everyone knows directors only buy for one reason - to make money.

Given the above, i thought IEF was a good opportunity and bought in.