Innovative Industrial Preferred: A Case Study In Stock Market Inefficiency (NYSE: IIPR)
In the stock market it is dangerous to use the word “guarantee” because the financial system is sufficiently complex that no amount of due diligence can fully grasp the spectrum of potential events. That said, IIPR Preferred A is the closest thing to a guaranteed loss I have ever seen.
- If IIPR does well as a company, holders of IIPR A will lose money
- If IIPR does poorly, holders of IIPR A will lose money
The only potential scenario in which the preferred comes out ahead is IIPR doing poorly yet staying solvent for an extended period of time such that they do not have the financial power to redeem, but still have the financial power to pay the dividend. That is a narrow window and quite a long shot.
The Sell Thesis
IIPR-A has a negative 22% yield to call. In just eight and a half months, holders are likely to lose 15.7% from today’s price. The math on this is summarized in the table below and will be explained in the following paragraphs.
IIPR-A is redeemable at the company’s option starting on 10/19/22 as seen below.
The liquidation preference of the preferred is $ 25 per share. Since redemption would include the partial period dividend, the number of quarterly dividends remaining to be paid is about 3.5 which sums to about $ 1.97 per share. This includes the partial already accrued since the 12/30/21 Ex-date through 10/19/22.
In receiving the $ 1.97 dividends plus the $ 25 liquidation preference, holders of IIPR are set to get a total value of $ 26.97. Based on the $ 31.98 pricing at the time of this writing, that is a loss of 15.7% and based on the 8.5 month duration that is a yield to call of -22%.
The irrelevant growth
Since IIPR-A was issued, the underlying company has done remarkably well with fairly explosive FFO / share growth.
That growth is anticipated to continue with analysts calling for FFO / share to rise to $ 12.67 by 2025.
Great for the common, not all that meaningful for the preferred. IIPR’s fundamental success to date merely serves to reduce the chance of defaulting on the preferred. Much like debt securities, preferreds do not get to participate in upside. The best case scenario is usually just getting paid the coupon and eventually the liquidation preference. In that scenario you get your coupon and your principal back making it a successful fixed income investment.
However, given where the preferred is priced so remarkably far above liquidation preference, the scenario which is usually the “success” case is actually a negative yield to call of 22% starting today.
Why IIPR will redeem the preferred
The 9% coupon is a massive cost of capital in this environment. At the time this preferred was issued, Innovative Industrial was a tiny company and the borderline legality of the growing facility REIT created sufficient uncertainty that it was difficult to source capital. As such, the 9% coupon was appropriate.
Today, IIPR has grown into a $ 4.8 billion REIT and the legal environment around marijuana has relaxed significantly. It now has access to large amounts of capital at much cheaper rates. Further, the $ 15 million total size of the Preferred A is just a drop in the bucket such that they could even redeem it with cashflows.
I can not think of any reason IIPR would not redeem it as soon as the option is available. The 10-K makes it crystal clear that they can call it on October 19th.
“On or after October 19, 2022, the Company may, at its option, redeem the Series A Preferred Stock, in whole or in part, at any time or from time to time, for cash at a redemption price of $ 25.00 per share, plus all accrued and unpaid dividends on such Series A Preferred Stock up to, but excluding the redemption date. ”
A good time to get out
So far, IIPR-A has been a highly profitable security for the holders. In addition to the high coupon dividend, they have enjoyed significant share price appreciation. Congrats! Now might be time to protect that gain by getting out. Going forward all that share appreciation will disappear as it gets called back at the $ 25 liquidation preference. Now is the time to find the greater fool and pass off your shares to anyone willing to buy this thing at a negative yield to call.
Amazingly, there are still people pouring into this security every day with a volume that, while not high, is sufficient to exit a position over a period of time.
Actionability for non-current holders
It might be possible to short IIPR-A at some custodians in which case there is nice upside, but I think the shares will be fairly hard to source. Otherwise, I find it just generally enlightening as a perpetual student of the market.
Even today, the academic debate of whether or not the market is efficient continues to rage on. I have always been on the side arguing that the market is not just inefficient, but wildly inefficient. There is mispricing and opportunity across the investment universe that is available to anyone willing to do the work of finding it.
IIPR-A is merely an additional arrow in my quiver of evidence that the market is inefficient. I can not imagine that an efficient market would trade the preferred of a risky equity at a 22% negative yield to call.