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An easy-to-refuse offer

The opportunistic bid by Thalassa for Local Shopping REIT should be rejected by shareholders
February 11, 2019

I note that Thalassa (THAL:70p) has made an unattractive firm offer for Local Shopping REIT (LSR:27p), a small-cap property investment company that’s sold off almost all its properties, after it thwarted Local Shopping REIT’s plan to wind itself up through a voluntary liquidation and return its cash to shareholders at the end of last year. Thalassa used its 21m shareholding in Local Shopping REIT, representing 25.5 per cent of the issued share capital, to object to the voluntary liquidation (‘Thalassa stalls Local Shopping REITs cash return’, 18 December 2018). I have an interest here as I advised buying Local Shopping REIT's shares at 30.8p to play the end game of the liquidation process (Alpha company research, 5 March 2018).

Bearing this in mind, Local Shopping REIT’s annual results highlighted that it had net cash of £18.95m (22.9p a share) on its balance sheet as of Monday, 10 December 2018, and held 34 properties at various stages of sale as follows: 16 properties worth £4.4m were under contract for sale; seven properties were under offer for sale at an aggregate price of £1m; and 11 properties with a book value of £3.9m were being marketed for sale. The cash pile has since increased to £21.2m and will be swelled by net sale proceeds of £2.2m from contracted sales in the coming weeks, to give the company £23.4m of cash (28.3p a share). Of the 12 remaining properties worth £4m still to sell, six are under offer and the others are being marketed. If these 12 properties realise £3.6m net of all selling fees and discounts, then Local Shopping REIT will have net cash of £27m (32.7p a share), in line with the board’s previous guidance for a net cash realisable value to shareholders at the lower end of its 33p to 34.5p targeted range.

In stark contrast, Thalassa’s firm offer for each Local Shopping REIT share is a paltry 14.64p a share in cash and 0.26 new Thalassa shares which, based on that company’s current bid price of 67p, are worth 17.4p each to Local Shopping REIT’s shareholders. In effect, Thalassa would be returning only £9m of Local Shopping REIT cash to shareholders, and issuing 16m new shares to increase its own share capital (excluding Treasury shares) by almost 90 per cent. The obvious issue here being that it would be impossible for all of Local Shopping REIT’s shareholders to sell their Thalassa holdings at around the 67p level as they would hold a hefty 47 per cent of Thalassa’s enlarged share capital. Moreover, there are strong reasons why some Local Shopping REIT shareholders would not wish to hold Thalassa shares in the first place.

I have raised serious questions over the corporate governance of Thalassa in the past (‘A conundrum to solve’, 4 October 2014), so much so that I suggested selling the shares at 114p at the time of that article. Other investors clearly have issues, which is why Thalassa’s shares are trading on a 50 per cent discount to NAV of 134p a share even though net cash of 75p a share backs up all Thalassa’s share price.

In terms of the offer being tabled, it's disingenuous for Thalassa’s board to talk about how it has trebled its own NAV per share in sterling terms in the past decade. That's because the company raised £5.4m in a placing of 4.5m shares at 120p in April 2013, and another placing of 7.24m shares which raised £18.2m, at 250p, in November 2013 to boost the issued share capital to 25m shares. Short of ideas of how to deploy the capital, which is why the company decided to stray outside its oil services sector by taking a punt on the shares of Local Shopping REIT, Thalassa's board has been using its cash to buy back shares ever since. Indeed, excluding 7.7m shares held in Treasury, Thalassa now only has 17.85m ordinary shares in issue. Investors who backed both placings are well under water, hardly an endorsement of Thalassa’s claim of creating shareholder value. Furthermore, even investors who backed Thalassa’s £3.1m placing of shares at 50.1p each when it joined the Alternative Investment Market (Aim) in July 2008 are hardly in clover, with the share price rising by just 40 per cent in the past 10 and-a-half years.

As for its financial performance, Thalassa has reported a combined post-tax loss of $8.75m in the past two financial years, and its ill-timed investment in Local Shopping REIT can hardly be called a success as it underestimated the time it would take to sell off the company's properties, and overestimated the sale prices likely to be achieved.

I am also perturbed by Thalassa’s decision to issue preference shares that carry 10 votes per share last October, thus giving preference shareholders over 90 per cent of the voting rights. True, Thalassa will cancel these preference shares if the firm offer for Local Shopping REIT succeeds, but the fact that it issued them in the first place raises another red flag in my view. Thalassa chairman, founder and 20.3 per cent shareholder Duncan Soukup aside, there are only two non-executives on the board, hardly good practice in terms of corporate governance either.

Under the offer timetable, Thalassa is expected to post its offer document between 20 February and 6 March 2019. Local Shopping REIT has 14 days to post a response document after the offer document has been posted and strongly recommends that shareholders take no action at this time. However, I have already made my decision, and it's not a difficult one to make. Reject the offer.

Please note that this article was first published on Monday, 11 February and has been updated on Tuesday, 12 February to reflect the subsequent property sales update announcement from Local Shopping REIT.