The Moody Merger Hot Mess

I thought this blog was the place for sharp analysis in a snark covered wrapper regarding alternative investments.  It seems I have some competition from an old industry player.  Robert Stanger & Co. has published some brutal commentary on the American Financial Trust (AFIN) and Retail Centers of America merger, and Brookfield Strategic Real Estate Partners II's advantageous investment into ARC Hospitality.  Last week Stanger shredded the cockamamie proposed merger of Moody National REIT II's (Moody's II) proposal to merge with Moody National REIT I (Moody I).  Here is the link (via the DI Wire) to read the entire Stanger commentary on the Moody merger.

The merger was originally announced last September.  It makes no sense for me to resummairze the merger because Stanger's report is excellent. The following is Stanger's summary of the merger and the fees involved with it:

So now comes Moody II with an offer to merge with Moody I by issuing shares of Moody II or, subject to an aggregate limit of 50%, cash for each Moody I share. The stated range of nominal consideration to the Moody I shareholders is $10.25 to $11.00 per share, depending upon the level of transaction costs incurred in the deal. While the structure is unusual to say the least, the transaction cannibalizes the inherent value of Moody I investors’ shares by burdening that value with up to $21.8 million of transaction costs. We estimate these transaction costs represent 13.8% of the aggregate Moody I equity value.

To take another bite out of the Moody I investors, Moody II will be denominating the value of the shares of Moody II at $25.00 per share rather than the pro forma Combined Net Investment Amount of approximately $23.00. By our calculation, the aggregate cost and discount related to the fees and possibly overstated stock price ascribed to Moody II in the merger totals about $29.3 million, or about 19% of the pre-transaction equity value of Moody I.

Looked at from a different perspective, the investors in Moody I are incurring up to $21.8 mil- lion of transaction costs to merge with a portfolio comprised of two hotel properties and one note purchased at an aggregate cost of $113 million – a merger which at best will provide liquidity to half of the Moody I investors.

Stanger goes on to detail Moody's II's skirting of the intent of FINRA 15-02, the lack of disclosure to investors regarding financial details of the merger, lack of fee disclosure, and how Moody's is paying financial advisors to recommend clients select the non-cash merger option of taking shares in Moody's II rather than cashing out. 

Moody's II has raised $91.7 million of investor equity through February 2017.   It has been raising equity capital for two years and only owns two hotel properties and a note receivable.  Moody's I closed its offering in early 2015, raised $133 million, and owns twelve hotel properties.  

I will add two points that I did not read in the Stanger report.  First, by merging Moody's I into Moody's II, Moody's I investors now own shares in a non-traded REIT that is still raising money.  Moody's II can extend its offer period another three years.  This is not a liquidity event, but some kind of twisted non-traded REIT hell where investors in a closed REIT get stuck in a capital raising reset.  

Second, if half the Moody's I investors select the cash option, where will Moody's II come up with the cash?  At a $133 million equity raise for Moody's I, that is at least $66 million Moody's II has to find to cash out the 50% limit.  Add this to all the fees Moody's is paying itself, and it is likely Moody's II will have to borrow money to cash out investors and pay fees.  (Moody's II had about $12 million in cash at September 30, 2016, the date of its most recent financial statement.  It is raising about $7 million a month in new equity.)

I urge you to read the Stanger commentary.