A Thank You and our Quarterly Letter

A huge thank you to everyone who e-mailed or left a comment following my last blog post. More than 100 of you kindly took the time to provide your thoughts and insights. I am still catching up, so sorry if I have not responded just yet. Opinions varied, but the broad consensus is readers don’t want to see OTC Adventures content go behind a paywall or otherwise become less accessible. I am happy to oblige! At least for the foreseeable future, I am going to continue writing here but allow Seeking Alpha to publish my content when they see fit. I think this approach will best accomplish my twin goals of reaching a larger audience while maintaining control over my output and website.

I thought readers would enjoy Alluvial’s second quarter 2020 letter to partners. In it, I review our top holdings and provide some additional commentary. Please don’t hesitate to get in touch to discuss any stocks mentioned. (This is not a recommendation to buy or sell any of these stocks. Please conduct your own extensive due diligence before buying or selling any security.)

Alluvial Capital Management Q2 2020 Letter to Partners

The Future of OTC Adventures

OTC Adventures is eight and a half years old. In internet time, this site is practically an ancient relic. For roughly half of my post-college adult life, I have been sitting down every few weeks (OK, sometimes months) to hammer out a post on some little-known company. And it’s been wonderful! I owe so much to this blog and its readers. Through it I have come to know dozens of like-minded investors who have generously shared their own considerable wisdom and expertise. OTC Adventures is directly responsible for the existence of my life’s work, Alluvial Capital Management, LLC.

I’m proud of my output here. Most of my work holds up well. There are a few posts I look back on and cringe, having been way off with my projections and assumptions. But that’s life. I have yet to meet an infallible investor. I like to think there is some merit in making mistakes in a public setting and owning up to it. I have never deleted a post, even those that in hindsight fall short of my standards for quality and insight.

I have changed considerably since 2012, and so has OTC Adventures. When I started this blog, I wrote with the individual investor in mind. People who were happy to find opportunities to plunk down $5,000, $1,000, even $500. Because that’s who I was. My personal investment account didn’t reach five figures until I was nearly 30. I don’t come from money. I grew up in an isolated Pennsylvania timber town of 4,000 people, pre-internet. Nobody I knew had a stock portfolio or paid much attention to the faraway, ephemeral stock market.

Today my situation is different. Through Alluvial, I manage nearly $40 million in client capital. So my investment focus has shifted to securities and situations where I can invest at least $100,000. Buying $5,000 of some promising liquidation story simply doesn’t move the needle, no matter the potential return. So I spend a lot less time looking for that sort of opportunity, and that results in fewer OTC Adventures blog posts of that ilk. To be clear, I still focus on little-known, thinly-traded issues. That’s where I know how to find value. They’re just a little larger on average than they used to be. But blogging about those ideas while I am attempting to trade them could disadvantage my clients.

This is undoubtedly disappointing to some long time OTC Adventures readers. But just as my focus has changed, markets have changed, too. There simply are not as many micro-cap/unlisted deep value opportunities as there were eight years ago. The long bull market took care of many of these situations. A sizable proportion of “dark companies” were bought out or cashed out minority shareholders. The ranks of OTC-traded community banks continue to dwindle. The value ideas I find today rarely make for a brisk, 500-800 word blog post. I don’t have any interest in publishing comprehensive research reports here. I also don’t want to attempt to compress complicated ideas down to a few paragraphs by glossing over important details. I try to pay readers the same respect you have given me, and that includes making efforts not to bore you or insult your intelligence.

That brings me to the topic that has occupied my mind for several months: what do I do with OTC Adventures? How do I best position this blog to achieve my goals? The plain truth is OTC Adventures is a commercial blog. No, there are no ads here. Never will be. But my primary goal in writing here is to make people aware of my portfolio management services through Alluvial. My success on this front has been mixed. Yes, I do occasionally hear from somebody who likes an idea I have profiled and is interested in hiring me to find more of them. But more often, writing here feels a bit like shouting into the void.

OTC Adventures has never been terribly popular. Some of the reason for this is simply the subject matter. There is not a big appetite out there for blog posts about community banks in Wichita or Latvian chocolatiers. And some of the reason is, well, me. I could have kept to a more consistent posting schedule or made my writing snappier, clearer, more relevant. Finally, some of the reason is just the way that internet investment writing has developed. It’s tougher than ever for an independent website to compete for attention against portals and aggregators with marketing staff and content curators.

The low traffic in itself doesn’t bother me. I am grateful for the engagement I receive and the lively conversations that sometimes ensue. But I have to evaluate the return on my own effort that this blog provides. Every blog post represents hours and hours of time spent in research, writing, and editing. If the resulting post is viewed by only a few hundred blog visitors with only a handful of potential clients among them, I am not making the most of my limited time.

As I see it, there are four ways forward. I could:

  • Maintain the status quo. This is the easy approach, but obviously it does not address the issues I just made a wordy blog post discussing. A non-starter.
  • Cease writing on OTC Adventures and use the time I spend here for other projects. C’mon, not gonna happen. I enjoy this too much, even if the current format is sub-optimal. I need some kind of outlet to talk about the weird stuff I find in the markets, and nobody in my household is nearly as interested in this as I am!
  • Take OTC Adventures “private” and make it a paid service or a benefit for Alluvial clients and partners only. Interesting, but I am probably flattering myself to think there would be a market for my writing. And I cannot commit to writing with enough frequency to make it worthwhile for potential subscribers. As for offering content only to Alluvial clients and partners, this approach would fail to increase my reach and readership beyond those who already appreciate my investment style. There is no need to preach to the converted.
  • Move all or most of my future output to a larger platform, such as Seeking Alpha. Various investing sites have approached me over the years, asking to host my content. I have always declined, worried about giving up total ownership of and control over my intellectual property. I am becoming convinced this was short-sighted on my part. After all, what good is my intellectual property doing me if it reaches only a small audience? If the primary purpose of my writing about investments is making more potential clients aware of my services, shouldn’t I want as many readers as possible?

The last approach is the one I will likely take. I’m still thinking it over, but the ability to reach a large, untapped audience is attractive. If I do move platforms, future blog posts might amount to “Check out what I wrote on (______)!” OTC Adventures would undoubtedly lose subscribers from readers simply choosing to follow me solely on that platform, but the trade-off seems positive. (And if it isn’t, I can always revert to posting everything here.)

Before I make a definitive move, I want to invite readers to comment. I have benefitted substantially over the years from reader input. This blog is nothing without you, and I want to make accessing my content as easy as possible for the broadest possible audience. If you have any advice, please leave a comment or drop me a line. Thanks as always for reading. I’ll do my best to provide interesting, informative ideas and stock profiles until at least 2029.

Wheeler REIT – An Activism Story: WHLR, WHLRD, WHLRP

I wanted to bring some attention to an activist situation that has flown under the radar. There is something for everyone here: personal drama, a badly-underperforming company to make us all feel better about ourselves, and a potential investment angle.

Joseph Stilwell is an accomplished activist investor who has run dozens of successful activist campaigns, mostly targeting mis-managed or under-managed community banks. Stilwell is refreshingly direct, unafraid to call out laziness and greed wherever he sees it. There are many anecdotes concerning Stilwell, but my favorite comes from his proxy battle with Harvard Illinois Bancorp in which Stilwell took a picture of the bank’s chairman apparently sleeping during a shareholder meeting. Stilwell employed the picture to great effect, publishing it in an SEC filing and garnering national attention. At this point, any bank that catches Stilwell’s disapproving eye had better shape up quickly or risk embarrassment.

Most recently, Stilwell turned his attention away from small banks and toward Wheeler Real Estate Investment Trust, Inc., an atrociously under-performing retail-focused REIT. In a series of letters and presentations, Stilwell highlighted management’s incompetence and self-dealing, as well as the board’s absent oversight and minimal financial commitment. Perhaps most damningly, Stilwell pointed out the incredible losses suffered by Wheeler’s shareholders, down 96% since the IPO not even a decade earlier. Stilwell even placed a billboard near Wheeler headquarters with an image of the Grinch and a Wheeler stock chart. (The billboard mysteriously disappeared and was replaced.) Wheeler responded with no shortage of vitriol, accusing Stilwell of all manner of illegality and ill intent.

Despite Wheeler’s obvious issues, the Stilwell group was not successful in its first attempt at reconstituting the board. But Stilwell ultimately prevailed in December 2019, succeeding in electing three of its nominees to the board of directors. With the subsequent resignations of a legacy board member and the company’s CFO, the Stilwell Group effectively took control.

Stilwell’s plan for Wheeler was straightforward and sensible. The company would cut administrative costs and sell several of its properties, including its crown jewel shopping center. The company would use the proceeds to reduce debt and improve its balance sheet. Ultimately, the company would achieve a sustainable capital structure and would resume paying dividends on its common and preferred shares. Following the payoff of near-term debt maturities, Wheeler’s highest balance sheet priority would be addressing its Series D preferred shares. These shares were issued in 2016 during a dire period for the company and the terms reflect the circumstances. The company’s Series D preferreds carried a hefty 8.75% coupon at issuance. What’s more, the shares would be puttable by holders in September 2023, requiring the company to redeem shares at par value plus any accrued, unpaid dividends, in cash or in stock. Shares remaining outstanding past September 2023 would see their coupon increase by 200 basis points annually to a maximum of 14%. Obviously, the Series D preferreds represented a toxic liability for Wheeler. Depending on the company’s cash position, ability to access new capital, and common share price come September 2023, holders of Series D preferreds could wind up owning effectively all of Wheeler!

Stilwell’s plan to right the ship at Wheeler may have been intelligent and achievable, but it was certainly never a guarantee. Despite a number of obvious improvements the company could make to its operations and capital structure, Wheeler remained the over-leveraged owner of a challenging set of assets. The ongoing issues that many retailers face were no secret. Wheeler’s shopping centers were largely anchored by grocery stores, which helped. But the company’s ability to raise rents was limited at best, and occupancy trends were poor at many locations.

Enter COVID-19. The economic effects of the pandemic have further challenged Wheeler’s results with many tenants unable to pay contractual rents. Wheeler has been successful thus far in negotiating with its own creditors about loan extensions and forbearance, but the company will ultimately need to succeed in collecting the amounts it is owed in order to address its own liabilities. Furthermore, Wheeler will have to succeed in selling multiple properties in a difficult market for commercial real estate.

All of that said, if Wheeler succeeds in collecting the rents is it owed and if the company’s lenders remain cooperative and if the company manages to shrink to sustainability by selling off some key properties, the upside could be impressive. (This trio of ifs absolutely depends on factors outside the company’s control, so act accordingly.)

Wheeler Series D preferreds currently trade in the $12-13 range, or just over 40% of liquidation preference plus dividends in arrears. We are 38 months from the put date. Series B preferreds trade around $7, or 28% of liquidation preference. While both preferreds rank equally in the capital structure, the valuation difference is due to the Series D put feature and coupon step-up, plus the fact that Wheeler will engage in aggressive repurchases of Series D preferreds if it is able.

Wheeler common stock is priced like a call option, valued at less than 5% of the company’s enterprise value. Obviously, holders of the common stock could profit immensely if the Stilwell Group is able to turn the company around, but there is a high chance of a total wipeout for common share holders if the turnaround doesn’t materialize. At normal occupancy, operating efficiency, and cap rates for Wheeler’s properties, substantial equity value appears to exist for the preferreds and quite possibly, the common equity. Whether this value proves realizable will depend on the direction of the economy and on Stilwell’s ability to sell assets and satisfy liabilities. Historically, underestimating Stillwell has been a bad bet. Stilwell has done shareholders a lot of good over the years. I am rooting for him. Then again, these are unprecedented times.

For anyone interested in digging in, Wheeler provides a reasonable level of disclosure down to the property level including details on lease rates and terms, tenant composition, and its debt structure. Happy hunting!

Alluvial Capital Management, LLC does not hold Wheeler Real Estate Investment Trust, Inc. securities for clients. Alluvial Capital Management, LLC may hold any securities mentioned on this blog and may buy or sell these securities at any time. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.