A High Yielder Gets a High Premium

One of the bittersweet aspects of being an income investor is that high-quality, dividend-paying stocks eventually attract the attention of acquirers.

True, a good deal means you get to collect a big, fat premium. But it also means that you’re losing a crucial income stream and must now sift through the market’s offerings to find another stock that offers an attractive payout.

Even so, we’re in a celebratory frame of mind: InnVest REIT (TSX: INN-U, OTC: IVRVF), which is among Canada’s largest hotel investors and one of this month’s Best Ideas for New Money, is being acquired by Hong Kong-based Bluesky Hotels & Resorts Inc. in an all-cash deal for C$7.25 per unit, a whopping 33% premium to the real estate investment trust’s (REIT) closing price prior to the announcement.

When we recommend a stock in our monthly Best Ideas for New Money feature, we’re not expecting an instant payoff. But in this case, we’ll take it!

Of course, Canadian Edge subscribers who bought InnVest back when we first recommended it last August are poised to book even bigger profits: a 42% gain, not including the reinvestment of the REIT’s monthly distributions. Not bad for nine months’ work.

While we scooped up InnVest when it was a relative bargain, Bluesky is paying a pretty nice premium: Not only is the offer well above where the REIT had been trading recently, it’s also nearly 15% above our assessment of fair value.

We first picked up InnVest nine months ago as a turnaround play. And as we fully acknowledged at the time, on its face InnVest didn’t quite have the right stuff to be a Dividend Champion.

As Canadian Edge’s Chief Investment Strategist Deon Vernooy wrote last August, “Let me get this off my chest right away: InnVest Real Estate Investment Trust is not a Dividend Champion. It has a poor dividend-payment record, too much debt and resembles a classic attempted turnaround, with all the business and investment risks that go with it.”

And with the unit price down 50% from its 2002 initial public offering, this REIT looked like it might be more trouble than it’s worth, possibly a classic value trap.

So what caught our attention aside from its deep value and then 8.1% yield?

When we look at a stock, we know that the data don’t always tell the whole story, especially for a turnaround.

And for value-oriented investors looking for high-quality stocks on the cheap, a big part of any bottom-up analysis should focus on management.

Thanks to activist investors, InnVest had recently undergone a change in management that more properly aligned its incentives with unitholders. Obvious conflicts of interest with its partner Westmont Hospitality Group had been eliminated, along with onerous fees that weren’t actually tied to operating results.

Equally important, not only did InnVest get a new, full-time CEO, the board also got a makeover, with a new chairman, and a slate of independent directors.

We also couldn’t ignore the promise of the REIT’s investment portfolio, which holds 109 properties, including historic hotels in tourist centers and business hubs. We saw that not only had InnVest made some quality acquisitions, but that it also stood to gain as renovations translate into greater revenues.

In addition to fundamental analysis, we take macroeconomic factors into consideration. The biggest one for Canadian hotel owners is the decline in the country’s exchange rate. With the Canadian dollar trading well below parity with the greenback, the country is an even more attractive destination for U.S. tourists.

Of course, at the time, we expected a successful turnaround would take at least a few years to unfold. But even with the attendant risks, we were content to collect InnVest’s high monthly distribution.

And we certainly weren’t expecting an imminent takeover. But naturally, the lower exchange rate has also attracted economic tourists, or M&A-minded corporate suitors.

In addition to the support and approval of InnVest’s board and management team, the deal also enjoys significant unitholder support, particularly the activist investors who helped engineer InnVest’s turnaround and own 29.1% of outstanding units.

The acquisition still needs to be put to a full unitholder vote at the annual meeting in late June, and it also needs to clear regulatory hurdles, particularly since the deal involves a foreign investor. Nevertheless, the transaction is expected to close in the third quarter.

So what’s next for InnVest unitholders who are ready to cash out? Well, we can’t promise that you’ll always be rewarded so quickly, but we have nearly 30 other Dividend Champions from which to choose.

Maybe check out some of our other Best Ideas for New Money. Hey, you never know.

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