Author’s Note: This article is intended for investors oriented towards value-deep, value-distressed asset investing. Those seeking moderate- to high-risk value investments may have an interest in this article. Investments in this company at any level of the capital structure are unsuitable for those seeking retirement income, and I strongly discourage purchase of securities related to this company for retirement income accounts, where a focus on risk aversion should be paramount.
The Board of CBL & Associates Properties (CBL) has been actively restructuring the balance sheet of the company to reduce the excessive and unsustainable debt load. Currently, the out-sized debt relative to the assets, cash flow and EBITDA is too great to allow CBL to continue as a viable enterprise. Starting in late spring, the Board has made a number of moves, most notable being a proposal to swap of all unsecured debt tranches for $50M in cash, $500M secured debt and 90% of proposed New Equity in CBL, in order to strengthen the balance sheet. Key highlights from this effort have been covered in a recent update on Seeking Alpha (“CBL Enters Restructuring Support Pact with Noteholders“) and won’t be repeated here.
Two key filings were produced by CBL during the past week. The first was the issuance of the 10Q on August 17th, followed two days later by an 8K containing an updated description of a Restructuring Agreement, targeting reduction of unsecured debt, proposing a swap for a smaller amount of secured debt, plus a significant amount of equity, to reduce the excessive leverage on the CBL Balance Sheet.
In this article, the contents of these two reports will provide the basis for updated estimates on what future recoveries might be available for both the Unsecured Noteholders and the holders of the two Preferred Shares Series, the “D” Series (CBL.PD) and the “E” Series (CBL.PE). As discussed below, I own a significant position in the “E” Shares.
From this article, one will have one estimate of those relative recoveries and the relative risks of each security type so that one can make an informed decision about which of the two securities might be better for a risk buyer of assets (or if either is appropriate).
One key point which has come up recently: the analysis presented below is premised upon the terms of the RSA as it stands on August 19th. This author has some concerns that this agreement will not survive in its current form. It appears that the actual creditors share these concerns, based upon the 8K filing disclosing the notice of acceleration of certain Operating Partnership (secured) obligations on August 25th which has come up during the preparation of this article. Therefore, the situation is dynamic and the estimates provided below on total recoveries may evolve as the discussions continue into the presumptive October 1st filing. Of course, if a fundamentally changed agreement emerges, a fundamentally different analysis is needed. So this analysis is based upon the latest version available as issued on the 19th of this month so we can at least create a comparison based upon the latest input that we have.
Having said that, the core premise of this article is that the secured lenders will secure a 100% return on the face value of their secured debt instruments (or take over the assets providing the underlying security). This analyst believes that it is excessive optimism to suggest that the Senior Secured Creditors will compromise their holding values until the loss-absorbing capacity of the junior securities (Unsecured Notes in the case of a breakdown of the process, Preferred Shares, common shares and the New Equity into which they will be converted) is exhausted. These creditors can force an involuntary bankruptcy, if the Debtor fails to live up to their covenants, then use the Seniority Rules in that process to enforce losses on junior securities before the first penny of impairment occurs for the secured credit. So the analysis uses as a premise that there will be no significant debt forgiveness for the secured credit.
One could stipulate that the value of the secured credit must be increased to compensate for the changes proposed by the Debtor. First, I don’t believe that to be a probable remedy for a number of reasons, either. Some of the more probable remedies, such as accelerated payment or increased interest rates, would not impact this analysis directly (doesn’t change net assets, in principle, as accelerated payoffs would offset assets like cash with a like amount of secured debt reduced, not impacting Net Assets).
As I always say, anything can happen, but it appears to me that the two key variables for the relative recovery for the Unsecured Notes and for the Preferred Shares appear to be:
a. the exact nature and amount of what is offered to both securities in this process in exchange for the respective securities, and
b. by how much or little market values for the entire portfolio vary relative to their Net Book value
with a multitude of other potential variables representing smaller (and offsetting) values in comparison.
It is on this basis that this analysis is made.
Balance Sheet Input for a Recovery Analysis
We start with the Balance Sheet for CBL at the end of June 2020:
What was reported on August 19th is that, not later than October 1st, 2020, CBL will enter into a court-supervised restructuring of the company to complete a refinancing of the Balance Sheet. The Balance Sheet provided above is the most recent “jumping off point” to estimate what impact the restructuring may have on a recovery by the Unsecured Noteholders, Preferred Shareholders and common shareholders.
A “recovery analysis” at this point is still fraught with many uncertainties. This author’s typical approach for these estimates is to assume the lower end of recovery, especially for highly variable elements, even eliminating those elements for which there is a broad range of outcomes. In this way, estimated recoveries represent values of the lower end of the range and any additional recoveries represent upside. This tends to provide some margin for safety and any surprises or deviations from the expected tend to be upside surprises.
For this analysis, the author is:
a. Eliminating any asset value for receivables (tenant and other), mortgage and notes receivable (both small and hard to determine if recoverable) and Intangible Lease Assets to exclude those elements for which significant uncertainty about recovery for those elements exists, assuming a zero value for each of these elements.
b. Eliminating any impact of the proposed warrants on recovery for any of the securities. It is not sufficiently clear to this analyst exactly how they will work and how they will be distributed for me to have sufficient confidence in any calculation or estimate. Therefore, additional impact of these warrants on recovery for any security represents additional upside to what is presented below.
c. As stated above, a third premise is that no debt forgiveness or other modification to the value of the Senior Secured credit impacts their current carrying or face values. Again, debt forgiveness would be additive to these numbers.
All of these assumptions reduce potential recovery, so this analysis should reflect potential recoveries closer to the lower end of the spectrum of potential outcomes.
Estimates made here on recoveries for the Unsecured Notes and the Preferred Shares will be based solely on distribution of New Equity at this point, with the impact of the Warrants and recoveries from the receivables and intangible assets representing potential future upside, but not included in this analysis.
As indicated, we start with a modified balance sheet, starting with the 2Q Balance Sheet above, then removing those assets for which there could be significant uncertainty about their actual recovery:
a. Cash, Cash Equivalents and Securities for Sale, which I lump together as Cash & Liquid Assets, and
b. Consolidated and unconsolidated Real Estate Investments at Book Carrying Value.
This allows for a very simple, pro-forma balance sheet to be created:
In turn, this simplified balance sheet provides a clear foundation to illustrate how the proposed debt swaps will strengthen the Balance Sheet. The first step in the process involves showing each of the individual debt tranches (in the left column). As this has been done, amortization discounts to face value and adjustments to carrying value have been eliminated to reflect the actual face value of the debt instruments. In turn, since it is the face value that must be redeemed, not the carrying value, the liquidation value of those individual debt securities is reflected to best represent “real net assets” after satisfying the liabilities.
Once all of the debt tranches are shown, those being added and subtracted can be more clearly seen and understood. This is preferable to making multiple transactions in a single, consolidated line on the balance sheet, thereby making it more difficult to track what is done. This approach creates an “easy to use” reference to illustrate the impact of the proposed swap, shown in the right column relative to the current state on the left:
1. The swaps achieve, obviously, the effect of reducing liabilities, thereby increasing Net Book Assets which flow to the equity portion of the sheet. Net book assets are increased by $825M (based upon face value excluding any amortization discounts carried on the sheet), comprised of a Net reduction of $875M in debt ($1,375M in unsecured notes offset by a new secured debt instrument of $500M) but also a $50M outlay of cash to the Unsecured Noteholders that reduces the assets on the Cash line. Net Book Assets are increased to $1.2B on which the New Equity can be based.
2. Prospectively, there will be no cushion for the secured debt with the elimination of both the Preferred Shares and Unsecured Debt capital tiers. With no instruments remaining in these capital tiers, those cushions to absorb additional impairment for that secured debt will have been stripped away, so the first penny of impairment (e.g., by market values in aggregate dropping below the total liabilities) will impact immediately secured debt. That makes the newly created secured debt tranche not as “secure” as many typically are.
So, with the creation of this $1.2B in Net Book Assets, this newly created equity can be used to be distributed to the Unsecured Noteholders, Preferred Shareholders and common shareholders as the New Equity. Except………….
Readers are immediately going to jump in and say, “Owl, you moron, don’t you know that Net Book Value does not equal market value or even close! This analysis is worthless as it is based upon Book Value………..”
The answer is yes, of course, I understand the difference between book and market value, but market assessment on these properties is wildly varying by analyst, so……….
Is it possible to estimate the market value of the respective recoveries for the Unsecured and Preferred Share tranches to create a quantitative assessment for what these two instruments can return back to their holders?
Estimating Book Value Recovered for the Unsecured Notes and the Preferred Shares
What we “know” as “facts” or use as premises, for this analysis:
a. there are $1,213,174K in book assets to be distributed, per the sheet above,
b. the Unsecured Noteholders will receive rights to 90% of those book assets as New Equity (or $1,091,857 in Book Assets),
c. The total cost of the three tranches of Unsecured Notes is estimated to be 37.5% of $1,375M or $516,256K, based upon eyeballing their trading trends (on FINRA) for these tranches,
d. the Preferred and common shareholders will split the remaining 10% in some fashion yet to be identified,
e. the commentary on this Restructuring (see referenced article above) speculates on a range for the Preferred Shares of 5-10% (or $60,659 to $121,317K), and
f. the D and E Series Preferred Shares were selling very near $0.71/share at the close on August 24th (on Yahoo Finance); for 25M Preferred Shares at $0.71/share, $17,750K.
Therefore, recovery is found here for:
Unsecured Notes: $550,000 in secured debt and cash + $1,091,857 in New Equity = $1,641,857, divided by nominal purchase price of $516,256, one recovers 318% of Book Assets of the nominal purchase price.
Preferred @ 5% Equity Received: $60,659K/$17,750K or 342% of nominal purchase price.
Preferred @ 10% Equity Received: $121,317K/$17,750K or 683% of nominal purchase price.
So the full range of potential recovery for the Preferred Shares, based on Net Book Assets, is greater than for the Unsecured Noteholders.
The reader can begin to see the problem with the claim that the Notes are a better investment than the Preferred Shares.
At which point, the reader will say “There he goes again, using those worthless book values”, so now let’s apply a market discount to the recovery of both securities to see how they react to changes in relative market value, probably the way to best assess “real” recovery.
Estimating How Variations in Market Value Impact Recoveries for the Unsecured Notes and the Preferred Shares
We do not know what the market discount on CBL’s assets will be in aggregate over time. What we do know is that both the Noteholders and the Preferred Holders will be “paid” in the same New Equity units, so whatever that discount is, will apply equally to the units that the holders of both Notes and Preferred Shares will receive.
This allows this analyst and the reader to see how the recovery changes over a variety of market discounts, bounded by 0% to 30%. The 30% bound represents the point at which there is no Net Book Assets remaining; that is, liabilities will exceed the market value of the assets, wiping out the equity in the New Equity units (if that were to occur). Below 30%, the equity interests are wiped out and the debt begins to become impaired, which represents a different relationship.
I have limited this analysis to range between book value and a 30% discount even though, in principle, the market value of the real estate could exceed book value. The reader is free to extrapolate to higher recoveries which can be done easily.
The equation used to calculate Market Recovery starts with relationships established in the simplified balance sheet found above (part of the reason to create and show it), namely
Net Book Assets = Book Real Estate Assets + Cash and Liquid Assets – Total Liabilities, simplified to
Net Book Assets = Book Real Estate Assets – Liabilities Net of Cash, or just Net Liabilities,
Market Value = Market Value Real Estate – Net Liabilities
and Market Recovery would equal: MV/Current market prices
This is really the information that we would like to have to answer the question about potential recoveries. We don’t know the aggregate value for the market value of the individual properties, but we can stipulate a range and look to see how the recovery changes as market values change to provide significant information about the respective securities, so
Market Value = (Ratio of Market/Book Value)*(Book Real Estate Assets) – Net Liabilities, with the boundaries established as 0-30% discounts to Book Real Estate Assets, simplified to
Market Value = (Market Discount)*Net Book Assets – Net Liabilities &
Market Recovery % = 100%*(Market Value/Current Purchase Price).
Market Discount becomes the “x”, independent variable, varied to produce the Market Recovery or “y”, dependent result.
1) the recovery for the Unsecured Noteholders, assuming a purchase price of about 37.5% of face value of any of the Unsecured Notes ($516M), receiving $50M in cash, $500M in secured debt (with constant value of $500M assumed for this chart) and 90% of the $1.2B in Net Book assets distributed,
2) the recovery for the Preferred Shareholders, assuming a purchase price of $0.71/share (near closing prices of both the D and E Shares on August 21st per Yahoo Finance, or $17,750K if total position purchased) if 5% of the total equity is distributed to Preferred Holders, and
3) the recovery for the Preferred Shareholders, assuming a purchase price of $0.71/share (near closing prices of both the D and E Shares on August 21st per Yahoo Finance, or $17,750K) if 10% of the total equity is distributed to Preferred Holders.
and varying the market discount to yield the following market recoveries by security/scenario:
So one can see the relative recovery for the Unsecured Noteholders (in blue) versus the recovery for the Preferred Shareholders at 5% and 10% equity distribution (light and dark orange) to provide a range of possible outcomes as market discount on book value increases from 0% to 30% (again, at which point equity is exhausted). What is clear is that the Preferred Shareholder option creates greater leverage to this variability than the Bonds. The bonds may be safer, illustrated here, but the Preferred Option more levered to a good outcome by a substantial margin.
Here is my core assumption upon my view of what a “reasonable distribution” of equity to the Preferred Shareholders would be (90% of the remaining 10%, or 9% of New Equity issued to the Preferred Holders, given their senior claims relative to the common holder):
If market discounts to book value remain above 20%, the Preferred option delivers better results; whereas, if the market discount to book value drops below 20%, the Bond option appears preferable. Of course, as market discounts begin to move below 30%, the core secured bond holding which secures the value of the Noteholders recover begins to become impaired pro-rata with the other debt holdings. Of course, the Preferred Holder is zero out below 30% market discount.
1) This is not referring to the market discount immediately in the short term. One can infer that the Board is setting up a longer-term initiative, since the $500M Secured Debt instrument won’t mature until 2028. This market discount, while perhaps very significant in the short run, really represents what the company can achieve over that longer period of time. The market discount over the long run should regress back towards Book Value.
2) While it is common to see substantial deviations from Book Value for individual properties or small collections of properties, this would be the market discount to book value for the entire portfolio (and over a longer period of time). So while there will be properties that fall far short of Book Value, there will be other properties worth near their Book Value or, dare I even suggest, more than their Book Value. In the view of this analyst, the market discount for an entire portfolio of properties is more likely to show less variation from Book Value than smaller groups of properties.
So, the Unsecured Notes show a flatter response to varying market values and demonstrate better recovery at bigger market discounts. That is the good news for those securities and represents lower risk on that basis. However, the Preferred Option shows much higher leverage to good outcomes than does the Unsecured Note option. One can secure a much less expensive leverage to the upside for CBL with the Preferred option than can one using with the Unsecured Note option.
What Does This Author Conclude?
Purchase of CBL Preferred Shares near current market prices represents a very inexpensive call option with a strike price of $0 and no expiration on the ability of CBL to restructure and rebuild their core business to a degree that CBL to become a sustainable, viable enterprise (or generates terminal value by liquidating the portfolio or a combination of both).
On a reward-risk basis, buying the Preferred Shares offers a superior reward-risk balance as compared to buying the Notes. Obviously, the Notes are safer. There is not, nor has there ever been, any question about that for this author in his publications. This position of relative safety is pointed out here and has been pointed out in earlier articles by this author in this series on this company for CBL. This is hardly surprising since the Unsecured Debt is almost universally senior to the Preferred Tier in the capital structure.
However, the view of this analyst has been and remains that the Preferred option provides a much greater increase in reward potential than increase the risk, thus having a better reward-risk balance and represents the preferred route for exposure to potential upside in CBL.
If one believes, as does this author, that CBL has good odds of coming back after the restructuring, then the security to use to express this sentiment is the Preferred Shares, not the debt.
If one believes that this is not true, and that the future for CBL is bleak, then this author would not be buying the Unsecured Notes. Why would one do that? Move on to better opportunities that will do better because there is less upside for these securities and the debt begins to become impaired below 30% market discount.
If an investor absolutely had to own the new secured debt instrument being created, wait until after the Plan is approved and executed, then buy those instruments being dumped by those attempting to monetize their recovery.
Indeed, this author is holding back some potential investment in CBL to buy, directly, the New Equity if the price swoons after the Plan is approved and executed. This could happen as those receiving shares attempt to monetize their recovery through the sale of shares received. I will be securing some New CBL through owning the Preferred, but would consider buying additional at the right prices if the New Equity swoons after issue. If not and it shoots higher, then my core position will be making me significant money to console me for not being able to buy more.
How is The Owl Positioned in CBL Preferred Shares?
As some readers know, this author has held the “E” Series Preferred Shares for an extended time, so I own some legacy shares at prices much higher than current market prices. Starting on July 24th and extending through mid-August, I began buying CBL Preferred Shares again at prices at or below $0.50/share, essentially tripling my previous legacy position. On August 24th, I added another 50% to that larger, tripled position, now more than four times my position in Q1’2020 as well as when I last reported on CBL.
My new basis going into the anticipated Bankruptcy Process for CBL is $1.82/share, so my recovery profile for varying market values for CBL looks like this:
Alas, the earlier legacy purchases of the Preferred Shares are burdening the ability to make money on this position relative to current purchases. The ability to make money (or recover losses) will also depend upon how much equity is offered to the Preferred and common shareholders as this chart assumes the 9% position, which may or may not come to pass.
There will be more to come on the development of the restructuring plan for CBL. Now that it is clear what the Unsecured Noteholders will be offered in the restructuring plan, even absent certainty about the offer to the Preferred Holders, the Preferred Option looks to this investor as a much superior approach to playing a potential recovery in CBL as it is much more levered to a positive outcome than are the Unsecured Notes.
More than just writing or talking about it, I am putting my money where my published sentiments are.
All tables and graphs have been produced by the author using source data from the CBL & Associates Properties Trust IR Website, from which information from the CBL SEC Filings were obtained, or from the Yahoo Finance Website.
Disclosure: I am/we are long CBL.PE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Disclaimer: No guarantees or representations are made. The Owl is not a registered investment adviser and does not provide specific investment advice. The article is for informational purposes only. You should always consult an investment adviser.