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Update on GYRO: Rights offering

May 13, 2015

Gyrodyne Corporation of America (GYRO) is a company in liquidation, or rather, it wants to liquidate. I won’t go through the history of the company, you can read my earlier posts on the company here and here. Since I closed out my earlier investment in 2012 a number of things have happened. The Company paid a large dividend then entered into a plan of liquidation. However, the plan of liquidation, in order to minimize the tax impact, provided that the company be divided into two separate entities, an operating entity (listed) and an ownership entity (non-listed and non transferable), as well as for the issuance of a dividend in the form of non-transferable notes. Unfortunately, this strategy has caused an unforeseen problem as the liquidation plan requires the corporate ‘pieces’ be remerged before the liquidation can be completed.  This ‘remerger’ requires a 2/3 majority favorable shareholder vote which has yet to be achieved despite 3 scheduled shareholder meetings; each had to be cancelled due to insufficient shareholder participation. The lack of shareholder voting has been ascribed by the company to the makeup of the current shareholder base. So we come to the rights offering. It was first hinted at after the last scheduled-then-postponed shareholder vote in December 2014. An initial S-1 was filed March 6, 2015 and a revised S-1 filed April 10. On April 28 the company announced that the record date for receiving the subscription rights would be May 6 as well as publishing updated liquidation ownership percentages (GYRO, GSD and dividend notes) for the remerged entity. The purpose of the rights offering is to get shares of GYRO into ‘friendly’ shareholder hands that will participate in a shareholder vote and approve the liquidation. Remember, the clock is running on the liquidation. Management has 2 years from the liquidation announcement on September 13, 2013, (thus, September 13, 2015) to effect the liquidation, otherwise the plan will have to be adjusted. If this latter happens there could be adverse tax effects for current AND prior shareholders, I believe in the form of tax recategorization of prior distributions.

The mechanics of the rights offering are straightforward. For each share of Gyrodyne (GYRO) owned as of May 6 the shareholder will receive 1.5 rights allowing him/her to purchase 1.5 shares of GYRO for $2.75 per share (one right, one share). Thus the number of shares outstanding will increase from 1.483 million shares currently to 3.707 million if all the rights are exercised. The rights are non-transferable and there is a provision for oversubscription if all the rights are NOT exercised. This is the key. Presumably those shareholders who did not participate in the last 3 shareholder votes will not exercise their rights, allowing those who participate to oversubscribe, become larger owners of GYRO and, if all goes well, provide the necessary 2/3 favorable shareholder vote to remerge the entities and thus provide a path to liquidation within the stipulated timeframe.

Let’s look at the value proposition for an investor. In the revised plan of liquidation of December 19, 2013 the book value of GYRO (post dividends) was $5.70 per share. As of year-end 2014 the book value had declined to about $5.16 per share. Given that the company was officially in liquidation as of September 2013, these book values should equate to (conservatively) estimated liquidation value. But the liquidation payout of each security (the public company, GYRO, the ownership entity dividend, GSD, and the dividend notes and their PIK interest) is ultimately defined as a percentage of the recombined entity. Those percentages were originally set in December 2013 (GYRO – 15.2%, GSD 55.6% and the dividend notes 29.2%) THOUGH THEY CAN BE CHANGED AT THE DISCRETION OF THE GYRO entities’ boards. As the subscription rights plan provides for an injection of an additional $5.6 million into the GYRO (and thence the combined) entity it certainly wouldn’t be attractive for rightsholders to exercise unless the liquidation payout percentages were adjusted. And that’s what the April 27th press release addresses. The revised ownership percentages now are: GYRO shareholders, 22.6%, GSD shareholders, 47.4% and dividend note holders 30%. Assuming that the revised percentage ownership in the recombined entity post-rights exercise reflects relative liquidation values and using the 12/31/14 book values we can conclude that the recombined entity currently has a liquidation value of about $58.7 million vs the $55.3 estimated at 12/31/13. Taking into account the $5.6 million capital inflow from the rights offering this would mean the estimated liquidation value has decreased by $2.2 million over the past 18 months.  On a per-share basis, the estimated liquidation proceeds per GYRO share will be reduced from about $5.16 to $3.58 if all rights are exercised. For an individual obviously the more shares purchased at the rights exercise price, the lower the average cost and the greater the potential gain at liquidation. Based on my average cost of $4.18, if I exercise only my subscription rights, my new average cost would be $3.28, so my upside to liquidation value is only 8%! (vs. the 23% under a non-rights scenario).  Hardly a great investment or even very enticing. To say the least I find this subscription rights offering structure quite disappointing! Clearly I can increase my upside by purchasing additional shares under the oversubscription facility, if they are available; the more shares I can get my hands on at the $2.75 rights exercise price, the lower my average price will be. But as the number of oversubscription shares is not linked to current share ownership, and it is unclear that ANY shares will be available for those oversubscribing, this is of small consolation. Making the situation even less appealing, any upside, in the case of liquidation proceeds exceeding the company’s initial estimate (not uncommon) is limited by the ownership structure because of reverse leverage. Since the GYRO shareholders will receive only 22.6% of the liquidation proceeds, they will only share in the upside to this extent, with GSD and dividend note holders receiving the balance. So with limited potential upside and significant downside (if the remerging of the entities cannot be achieved), I will be holding my position and possibly even pruning it if Mr. Market becomes exuberant, rather than increasing my exposure, even though, at the current share price of $3.07, there is a 16% upside to the implied liquidation value.

  1. Why didn’t you sell after record date for higher price than today? I didn’t expect gyro to trade that high before the ex-date and sold too early.

  2. In retrospect I should have sold before the record date at $4.80 and repurchased now under $3.10. That would have given me a lower average cost. But then again, hindsight is 20/20… one can never predict exactly what’s going to happen. It now appears to me that the share price was pushed up by a number of people buying small positions before the record date so that they could participate in a large way in the oversubscription; that would have been perhaps the best strategy. We’ll see. It’s not clear to me how many shares will actually be available on an oversubscription basis. If the rights offer is withdrawn those buying now will get a windfall.

  3. 10q:”Assuming the merger is effected and completion of the liquidation of Gyrodyne, LLC’s assets took until December 31, 2016, and giving effect to its estimated cash flow from operation of its existing properties until their sale, the Company expects Gyrodyne, LLC would have a cash balance of approximately $43.6 million plus the net proceeds from the rights offering at the end of December 31, 2016. Such cash would equate to future post-merger liquidating distribution of $13.26 per share assuming the full exercise of the rights in the rights offering resulting in a total of 3,706,700 units outstanding. For a further discussion see the definitive proxy filed on July 1, 2014 including the section titled The Estimated Distribution to Shareholders (including Estimated Distribution to holders of Gyrodyne, LLC shares), which is located on pages 67 through 69 inclusive.”
    Shares are trading high, if I understand this correctly.

    Yes hindsight is 20/20.

    • Matt permalink

      I’m having a hard time understanding this. I compared the math that Martin did to get $3.00 per share liquidation value vs. $4.47 without the rights offering and using the previous allocation. The $4.47 number seems reasonable, but how can $3 be right? So the GYRO share from last month that traded for over $4 will only be worth $3 for a loss of over $1, but buying 1.5 new shares in the rights offering at $2.75 each will only produce $0.375 gain (and this all ignores time value). This would imply that no one should exercise their rights because we’d all be better off under the previous situation. This can’t be right, can it? What are we missing?

  4. OK, after getting it wrong the first time I think I have a better handle on what is happening. I think Martin’s math is right. And Matt would be right, too, except that we holders of GYRO common don’t have a say in whether the rights offering goes through or not. Yes, this is a cram down! We common shareholders really simply have to accept what the Board decides.

    After talking with a GYRO representative I think I have a better understanding of what’s going on. I had previously thought the Board’s strategy in implementing a subscription rights offer was to entice retail investors (who picked up shares after hedge funds dumped their GYRO common post the 2013 distributions) to exercise their rights and oversubscription privileges, thereby gaining enough votes to pass the merger proposal allowing liquidation. But now it appears to me that the Board’s thinking was much more Machiavellian; It seems to me that they believe they have greater leverage with the hedge funds (yes, those who dumped their common shares in 2013 but were unable to dispose of their GSD shares and Dividend Notes because these latter two are illiquid). As I see their strategy now, the Board is using two leverage points to force hedge funds to reenter the common and vote for the merger; those two points are, 1) the merger is the only way that they can realize value for their illiquid holdings of GSD and Dividend Notes and 2) unless the merger is completed prior to Sept. 12, 2015 the favorable tax treatment afforded the 2013 distributions will be retroactively cancelled!!! If we retail investors who purchased after the 2013 distributions have gotten caught in the crossfire, well, that’s just too bad!!

    What can I say? I think my initial analysis didn’t take into account all the different players and moving parts. Of course, nothing is set. The rights offer could be cancelled (especially if not enough rights holders exercise their rights). The announced distribution percentages could be adjusted, as I was reminded by the company representative, up until 10 days before the merger vote. But it is clear to me that the Board is most concerned with value for ‘long-term’ holders, however that might be defined.

    What to do for the rights offering? The temptation is to sell my existing GYRO shares now and use these funds, and others, to exercise all my subscription rights, minimizing my GYRO investment and taking the inevitable loss. However, if the offer is cancelled the price of common shares should bounce back and I would have sold at a disadvantageous price. So I’m left with substantially increasing my position in GYRO simply to protect my current investment (as much as possible, anyway). Oversubscription rights? Haven’t decided on that yet but tend to believe it’s not a great investment. We have a week or so left to make up our minds.

    Last thought. Will the share price tank after the shareholder vote? I think it might, especially if the merger is NOT approved!

    • Matt permalink

      I hadn’t thought about the angle of forcing the GSD holders back into a voting position (makes sense), but I’m not sure about everything you wrote. Bulldog had written in its closed-end fund letter a number of months back that it still saw value in GYRO shares and might want to “help” (themselves and GYRO, of course!). So I assumed that part of the reason for the rights offering was to get the “unlimited” oversubscription option so that someone like Bulldog could have a small current stake but potentially load up with discounted shares in an easy manner, swaying the votes in the process.

      I think it would be crazy to sell shares right now that you bought before the ex-rights date. If they pull this offering, you’re locking in one heck of a loss. Obviously, there is some trading of the shares so some investors have been taking this risk (knowingly or not!).

      My view on this is that, like those hedge fund investors, I’d like to get this thing wrapped up, too as I have GSD and dividend notes in limbo, as well. So I will exercise all of my basic subscription rights and might even throw a couple thousand dollars more into the oversubscription. That’s not so much about the great value I see, more about making sure the shareholder vote gets approved and we can get this liquidation done so the value in the existing shares don’t get taken down.

      If the shareholder vote goes through AND liquidity seeking investors dump shares, I’d be glad to buy some more. Buying the subscription right now at $2.75, we still face the risk of the vote not going through. If the vote has passed and it is still selling at $2.75, that’s a good deal, IMO.

      • Matt permalink

        P.S. On the flip side of selling shares today, those buying today are getting a nice call option on the rights offering falling through and still an okay price if it doesn’t. I’m not buying any more in the market as I’ll have more than enough with the rights exercise, but hadn’t really thought about that.

  5. Dan permalink

    I have also had my shares held in limbo.

    This has been one of my favorite investing situations that I’ve ever been involved in. I bought shares at $63 or $65 the day before the ex-dividend date on 30th or 31st of December 2013. I then sold the next day for $15. Which also created a taxable loss according to my broker.

    Would selling the stock and then exercising the rights a month later would qualify as a loss for tax purposes?

    Unfortunately (or maybe fortunately) I decided not to invest in the rights offering because I didn’t have too much cash in my account and the NAV/share after the rights offering was fairly low compared to the initial investment so I thought it would have been somewhat risky to bet on the over-subscription privilege. In hindsight I think that there’s going to be a massive ability to oversubscribe to the offering. I probably should have bought a token amount before the ex-date.

    Matt’s point on their possibly being a windfall to current buyers because the rights may be outright canceled or canceled and then reinstated is quite interesting.

  6. Any idea why the borrow on GYRO is roughly 5%/10%?

    • None! I’m interested more in seeing where the shares trade if the rights offer goes through. My guess is below $2.75.

  7. Matt permalink

    PR just hit. I was right – institutional buyers wanted in and the oversubcription rights were massively “bid” while a little less than half the normal subscription rights were exercised (hefty losses for those pour souls, can’t understand why you would own a stock like this and pay no attention to what’s going on).

    Jay’s previous view may be about to change as I think there will be a strong bid at $2.75+ going forward to soak up any sellers who come along after the vote.

    • Yes, I MAY have to eat my words. Let’s see what happens today. Share price has trended up over the last couple of days, but was this the effect of trying to buy the last few votes for the August 20 shareholder meeting and vote???? Could the share price now decline without this support? After all, if the estimated liquidation value of the common is now $3.00 with the rights offering pretty much secure, why would the shares trade much higher?

  8. Matt permalink

    Voting math: The record date for the merger vote is on Friday, so if we assume as a worst case all shares now owned by normal subscribers and oversubscription buyers vote YES, it should be 78%. With the hurdle at 66.7%, looks like we’ll finally be moving forward on this liquidation!

  9. Matt permalink

    First insider purchase filed. Salour Nader only had 194 shares previously, but purchased 7609 in the rights offering. And since the oversubscription was only about 20% accepted, he had presumably been willing to buy over 37,000 total shares. (I say presumably because maybe he expected a significant oversubscription and thus upped his amount knowing he wouldn’t get all of it). Nonetheless, if insiders and institutions loaded up at $2.75, I will hold onto what I’ve got.

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