City Lodge forces a shareholder check-in

• South Africa
• City Lodge, Rights Offer, Standard Bank
• August 6, 2020

City Lodge has had a shocking year, which came to a head this week amid a flurry of market activity and shareholder shock.

Lockdown has crushed the business. Forced to close for months on end, the hotel industry is reeling. Despite being a respected, JSE-listed company, City Lodge is on its knees.

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It’s a financial catastrophe

Everyone knew the rights issue was coming. The surprise was the level of dilution and perhaps the extent of City Lodge’s financial catastrophe.

City Lodge is busy finalising its latest financials and has noted KPMG’s view that there is significant doubt over the company’s ability to carry on as a going concern unless the rights offer is successful. In English, that means that the auditors think the company will be bankrupt unless shareholders come to the rescue and put R1.2bn in.

Standard Bank is acting as the underwriter to make sure that happens. This means they will make up the difference between R1.2bn and actual cash raised through the rights offer. If there is no difference, they simply take their fat underwriting fee and ride away into the sunset. It’s almost like an insurance policy for City Lodge.

The interesting thing is that the rights offer has been structured in such a way that Standard Bank probably won’t have to take up any of the shares. By issuing 13 shares for every share in issue, each shareholder is practically forced to act or face enormous dilution.

Whether they like it or not, most shareholders will have to check in at a City Lodge financial hotel and stay there for a long time to recover.

Shareholders can elect to sell their rights in the market, but that would be depend on demand from other potential investors to put money into City Lodge. Regardless of how you look at it, shareholders are taking serious pain here.

The share price dropped 77% on Wednesday when the full rights offer circular came out. It jumped 22% on Thursday as traders decided that the move on Wednesday was a little too drastic.

It’s been a rollercoaster week for shareholders as a company worth only R825m tries to raise R1.2bn to stay afloat.

The B-BBEE structure is a haunted hotel

A huge chunk of the proceeds will go to bailing out the B-BBEE deal that City Lodge is on the hook for. The B-BBEE structure owes R755m to…wait for it…Standard Bank.

The bank is earning eye-watering fees to ensure that it gets paid back on the debt it loaned to the B-BBEE participants, which in any event was guaranteed by City Lodge.

Before the share price collapse, the B-BBEE structure shares were only worth around R120m. That was based on R18 per share, not the current +-R4 per share. The shares are therefore now worth less than R30m, leaving a gigantic hole of over R720m to be filled by ordinary shareholders.

A bargain for the brave?

Assuming City Lodge survives this, the current share price is ridiculously low vs. the replacement cost of the hotels. The net asset value per share at 31 March was R20.7 and the replacement cost was R140.6 per share. The share price is R3.90 per share.

That’s a mega discount to what the underlying assets would be worth under remotely normal circumstances. However, there’s certainly a risk that the entire thing goes to zero.

 At least the advisors are enjoying their stay

Whenever you see a circular to shareholders over 200 pages long, you know the advisors have made good money here. Sure enough, a quick flip to page 138 reveals that whilst City Lodge shareholders are suffering, Standard Bank certainly isn’t.

A casual R34.2m in fees will find their way to the blue bank. Not bad considering they faced a potential nightmare of having to liquidate City Lodge to get back the value of the BEE funding. Instead, they raise the capital to pay themselves back and charge a fortune for the pleasure.

The lawyers on the deal will make around R8m. The auditors are making around R3.5m. Now you know why audit firms desperately try to earn revenue beyond the role as auditor, because auditing is far less lucrative than advisory services.

Having digested these fees and all the rats and mice that go with them, we get to a total cost of the rights offer of R47.7m. For the 9 months ended March 2020 (i.e. before lockdown), the group made an operating profit of R270m (before impairing its assets). This fee is enormous for a company of this size, but desperate times are what bankers thrive on.

As Standard Bank’s team pops the champagne that they hopefully remembered to buy before prohibition, City Lodge shareholders can only cry in their rooms. They are in this for the long haul.

The most interesting question is whether those who took a punt in the past day will be rewarded handsomely. It’s gambling, but it’s a gamble that may pay off for some.