Update on GYRO: Rights offering

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.