January 9, 2013 Comments

Today would have been a mildly negative day for our stock picks except for one stock.

Several alert subscri9bers emailed me this afternoon to report that Melcor shares were up sharply (almost 20%) this afternoon (closed at $20.37) after announcing that it would look into the idea of spinning off its commercial rental income properties into a Real Estate Investment Trust that it would retain significant ownership of. This sounds similar to a plan that Loblaw recently announced.

There are several points to consider here:

1. This is not a done deal. Then again there is little reason to think it can’t or won’t be done.

2. These properties represent about 43% of Melcor’s assets, the raw land and developed land is not included here.

3. We can’t be too sure where the share price ought to settle out on this news. Melcor is a quite thinly traded, most days less than 10,00 shares trade, some days there are no trades. Only 93,000 sga=hares traded today. Many Melcor investors were likely unaware of this news. The share price could easily slip back as people take profits in the coming days. Or maybe it will rise.

4. I certainly have no idea where the price should be in terms of fundamentals. The REIT structure saves income taxes and that alone does add some real value (even considering REIT distributions will be not qualify for the dividend tax credit).

5. Fundamentally the value of Melcor should in theory not be changed by this excect for the income tax savings. But practically speaking it’s value is increased in the market.

6. Melcor was under valued before this announcement.

7. Having bought Melcor at an attractive price it is not surprising that an event has happened to release value. In some ways the REIT does not so much create value as release value that was already there.

8. I had not thought of Melcor doing this, but now that it is announced it seems almost obvious that this is something that they might have looked at.

9. I don’t think there is much reason to think that this in isolation would increase Melcor’s dividend much. The partially spun off REIT will trade independently and will have a high yield. But Melcor itself will not see its cashflow per share rise much from this. Melcor would get a cash infusion from the partial spin-off but may use that for new investment or debt repayment rather than dividend increases.

10. It’s really anyone’s guess whether an investor should take profit at this time either fully or partially. I am inclined to sell half or so especially if the price stays over $20. I doubt that we have to worry about it falling back to say $17 anytime soon.

11. I am not sure why they don’t consider selling off the entirety of this into a REIT and not retaining any. After all if the market offers really high (stupid high?) prices for real estate why not sell? And it if makes sense to sell some, why not all? Perhaps the market would not take up all the shares if all were offered. If they sold all they could do a special dividend. But companies are usually reluctant to do things that materially reduce their asset base since that diminishes the domain of mangement.

By the way ,I emailed Canadian Tire several times over the past months suggesting they do something like this. I wonder though if the moment has passed for Canadian Tire given it seems so many others are doing this. Loblaw and I believe the Bay might be doing this as well. I can’t recall them all but I believe there has been a relative flurry of this type of announcement just in the past month or so.