Tuesday, March 21, 2017

Dark Corners

There are some strange stories on financial websites and message boards.  I found an odd post on a bizarre transaction on the Seeking Alpha website.  It discusses a transaction between Presidential REIT and First Capital Real Estate Trust, Inc., where First Capital entered into an "interest contribution agreement" with Presidential on a 23-acre development site in Sacramento.  First Capital is contributing a 66% interest in its 92% ownership interest in the development project in exchange for 37,281,000 convertible Operating Partnership units.   The author of the Seeking Alpha article somehow thought this transaction added value to Presidential, and allowed investors to buy Presidential's stock at a 39% discount.

A non-cash transaction involving a development property and operating partnership units in a REIT with a market capitalization of $4 million is suspect.  The story then goes from suspect to downright dodgy.  The Seeking Alpha article makes no mention that as part of the "interest contribution agreement" Presidential is assuming 66% of First Capital's liabilities on the project, and that the project with the supposed hidden value is in default on its mortgage.  The Sacramento property is subject to a mortgage with a $20 million principal, but the mortgage is in default due to First Capital's inability make principal and accrued interest payments, and First Capital now owes $42 million on the mortgage.  First Capital has received a "Notice of Default and Election to Sell under Deed of Trust" from its lender.  

(Think about it, the original mortgage value of $20 million requires a $42 million payment, or more than double the principal outstanding.  This is due to accrued interest that gets paid at loan maturity along with principal, and not in regular interest payments.  To accrue this much interest, even at an assumed high interest rate, would require years of accrual.  This loan had to have been extended repeatedly, which shows the poor management at First Capital.  This is staggering.)

If the astute Seeking Alpha analyst/author determined its supposed $23 million net value for the development project with the outstanding $20 million principal, the addition of $22 million eliminates all value.  The analyst should have read First Capital's filings.  This whole transaction is nuts.  It is as if both sides are trying to take advantage of one another - Presidential trying to buy assets with worthless operating partnership units as currency, and First Capital passing off a near underwater property with a defaulted mortgage to a dupe.  And even if the analyst incorporated the $42 million mortgage into his valuation, how is Presidential, with a market cap of less than $5 million, going to repay this mortgage? 

I wrote about First Capital last fall.  It has not filed financial statements since the second quarter of 2015.   It is a public company; it has to file financial statements.  Its reverse merger with Presidential, although announced in July 2016, has not happened, and instead it is entering into non-cash deals with Presidential and others.  This company is toxic.  Oh, and it is still trying to raise money from investors in private placements.

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