The Logic Behind Bill Ackman's Purchase of General Growth Properties

Found this story via Marketfolly, via Todd Sullivan's Value Plays, via Reuters... whew!

Bill Ackman (previous post) at Pershing Capital is a noted hedge fund manager who is generally well respected; he has been purchasing bushels of General Growth Properties (GGP) a mall based REIT we've pointed out in the past with ire. The stock is now down to $1.50ish and seems to be flat lining. So why the purchases that on the surface seem to make no sense? Ackman actually wants the company to go bankrupt. This is generally a terrible thing for common shareholders as they are last in line to get proceeds from a bankruptcy. But maybe not in this case...

• Hedge fund Pershing Square Capital Management, one of General Growth Properties Inc's GGP.N biggest shareholders, is betting the No. 2 U.S. mall owner will file for bankruptcy -- and equity investors will end up big winners, a person familiar with the firm's thinking said.
• Bankruptcy usually leaves stock investors with plenty of nothing, but General Growth is an unusual case. It has almost $30 billion of assets on its books, and just about $27 billion of debt. But most of the company's real estate assets are recorded on its books at their historical value, and many were bought years ago, meaning their value now is likely substantially higher. The company's problems are not with its assets, but with refinancing maturing debt in frozen markets.
• Historically, companies whose assets are worth much more than their liabilities have gone through bankruptcy in a way that leaves shareholders intact, which is what Pershing Square is banking on, the person familiar with the firm's thinking said.
• Pershing Square owns or has exposure to more than a quarter of General Growth's shares.
• In real estate circles, Chicago-based General Growth is admired for its ability to manage its properties well, boosting their value in the process. But the credit crisis has hit the company hard, sending its stock price down more than 97 percent, and leading to the firing of its chief financial officer. The company is trying to raise cash by selling off some malls but has yet to do so.
• In Pershing Square's estimation, General Growth's real problem is its maturing debt, in particular two loans totaling $900 million. Those loans were set to mature at the beginning of December. Lenders extended that deadline to February, adding to the $2.49 billion of other debt due next year.

There is precedent for a "winning" outcome in a bankruptcy for shareholders....

• General Growth is not the first company to find itself in this bind. Amerco Inc (UHAL.O), parent of moving truck rental company U-Haul International Inc, filed for bankruptcy in 2003 after a dispute with its former auditor and multiple accounting restatements left it unable to refinance debt.
• The company listed $1.04 billion of assets and $884 million of liabilities in its bankruptcy filing, and had considerably more assets off its balance sheet as well. Its shares tripled during bankruptcy, and rose more than fourfold after it emerged from bankruptcy in 2004.
• Pershing Square sees parallels between Amerco and General Growth. The founding families of both companies own substantial blocks of stock, giving them a real incentive to refrain from diluting shareholders' stakes during bankruptcy.
• And General Growth is still generating more than enough cash flow to service its debt and meet other day-to-day obligations, just as Amerco was. In other words, General Growth has problems with liquidity rather than solvency, the person added.
• Pershing either bought or gained exposure to the shares at prices ranging from 35 cents to $1.58 per share,

So if Ackman is right, this is exactly why he is smarter than the average bear... or blogger.

Meanwhile a reader pointed out a similar name to GGP in terms of a mall based REIT - Developers Diversified Realty (DDR).

Developers Diversified Realty Corporation (DDR) operates as a real estate investment trust (REIT) in the United States. The company engages in acquiring, developing, redeveloping, owning, leasing, and managing shopping centers, mini-malls, and lifestyle centers. As of February 5, 2007, it owned or managed approximately 461 shopping centers and 7 business centers, as well as 1,170 acres of undeveloped land.

There is about $6 Billion in debt - the company claims they can service it.

• Developers Diversified Realty Corp, which owns and builds shopping centers, is ending the year with enough liquidity from property sales and financings to meet its near-term debt obligations, the real estate investment trust said on Wednesday.
• The company, whose shopping centers are usually anchored by big-box stores, said that in 2008 it raised $1.2 billion from new mortgage financing, generated $136 million in proceeds from asset sales, and netted $43 million from stock sales to reduce its debt.
• In the 2008 fourth quarter, it bought at a discount $71 million of its outstanding senior notes. The outstanding principal balance of its Jan. 30, 2009, senior notes is $227 million.
• To shore up its balance sheet, the Ohio-based REIT earlier this year canceled new U.S. development projects and expansion plans in Russia and slashed its dividend. It suffered a setback earlier this month when a deal to sell 13 assets failed to close.

This is where an analyst who specializes in REITs would be helpful - I'd love to see a list of REITs with the most debt needing to be rolled over in 2009 as a % of total debt.

The danger in this arena is the government interference (see previous blog entry), bailouts (aka lack of free markets), and the fact some of these stocks now whip around like penny stocks (or like our biggest banks): +/- 15 to 20% a day. But it does look like a promising short idea as it's hitting resistance...


No positions

Comments

[F. Brian O'...:]

Interesting comparison with Uhaul, but there is one major problem with Ackman's thesis - commercial real estate values are falling, fast, and it will be difficult to receive anything close to fair value for a portfolio the size of GGP's. If BK drags out and it is forced to accept lowball bids for the assets, the equity will certainly get nothing. Ackman is simply just taking a huge risk - with other people's money.

Jan 14 09:12 AM

[User 337106:]

Debt needing to be rolled over in 2009 as a % of total debt is irrelevant. The commercial RE debt crisis is a matter of capacity. The CMBS market, which permitted the creation of this level of debt, is now nonexistent. Alternative sources--life insurance companies and banks--cannot make up for it. Deal in the sub-$100 million range can still be done with these alternative sources. Deals over that amount are unlikely to get done. So if a REIT has an amount that begins with, say, a "B" that is maturing in 2009, it is in trouble, regardless what percentage of total debt this represents.

Jan 14 09:44 AM

[bungaloo:]

Sullivan also suspects GGP may be a vehicle for Ackman to realize his Target REIT proposal using GGP to manage the assets freeing up Target management from doing so.

Jan 14 09:56 AM

[jzkl1234:]

I don't see the logic of buying equity in a company you think is going bankrupt. If Ackman thinks GGP has positive NPV, why wouldn't Ackman buy the bonds which are trading at a steep discount? Owning the bonds would give Ackman more contraol in bk and would be a much much better risk -reward position.....no?

Jan 14 10:55 AM

[ChrisWebPub:]

See CBL, they're like GGP but without the same degree of debt problems (ie a smaller load and thus-far financing success). They're also still paying their dividend (albeit at a reduced rate, still the yield is above 20% right now).

As for GGP, the key thing as I see it is the positive cash flow. I cannot see commercial real estate values falling that much, because they tend to be based on rents, and rents are still there. Unlike residential real estate which is valued based on some esoteric need to live in a certain place with certain amenities, commercial real estate is valued based on how much money it brings in on a monthly basis.

Even with added mall vacancies, the cash flow puts a floor on the property value, like a dividend does with an equity.

GGP's business model is in fine condition, they can afford to service a normal monthly payment on their debt, and have cash left over to pay a dividend. The only thing they can't afford is a one time balloon payment at the end of a short term loan. So because they can't refinance commercial real estate values are going to plummet and no one is going to want properties that bring in hundreds of millions of dollars in rent? I find that reasoning suspect.

Jan 14 02:47 PM

[User 305589:]

ackman seems a bit obsessed lately with property plays. he quit shld tries - unsuccessful so far - at borders and target and now ggp? . and i have the same question as jzkl1234: why not the bonds, preferably those that mature at the earliest because then you can force concessions from mgmt - much like citi did when they allowed ggp an extension on the deember 2008 debt. now they secured a sweeter spot for themselves. risk to all equityholders here is, that other bondholders will do the same. in fact bondholders could end up over-collateralized.
ackman probably just took a cheap short to play a temporary rebound. given the porices he bought at, he could easily exit/have exited already with a 50-100% gain.
buyers beware. ggp will set in motion a chain reaction in the sector. and no, the rents provide little cushion these days. look how the ep and pipeline mlps got killed - even though their distributions are much safer than those from commercial property REITs. go figure.

Jan 15 09:24 AM

[Kafkaesque:]

Retail Property REITS are going to see their tenants (i.e. their property's Retailers) "absolutely hammer" their FFO (revenue) streams and there is little that they can do about it. Retailers of every type (Nationals, Regionals & Locals) are going to reduce their operating costs with renegotiations of base rent or close. This is happening in mass already. Couple this event with a complete drying up of percentage rent as a result of the tenant's severely reduced gross sales and one has a real problem. The BK's of the retail industry will allow many of these retailers to carte blanche renegotiate their economic occupancy cost line items or leave their spaces vacant. The GGP's, DDR's, CBL's of the world have very little leverage in this equation and little can be done at this stage to stop the train from running off of the cliff.
Office REITs and Industrial REITs have a very similar storm coming that they, too, will have to weather. Beware of the REIT game today; despite what you think the hidden value of the assets are because they were booked years ago........ be very cautious.

Jan 15 04:06 PM

[Urbane Gori...:]

I agree with Kafkaesque. As vacancies occur, pressure will be placed on the mall owners to reduce rents in an attempt to keep the malls full. They'll next attempt to fill the vacancies any way they can.. Nothing like finding a mall with a 'Tattoo Parlor', an 'off-brand Church' and a 'Used Hubcap Outlet' filling in the gaps. Now there are some real customer draws!

Whether or not a REIT has good cash flow, they still need to refi their loans. Clearly lenders down;t want to own a mall, apartment complex or office block. But they won't be eager to throw good money into an operation that will be unable to meet its future obligations. If i were a commercial lender right now, I'd be ordering family sized bottles of Valium and Maalox.

I'd like to point out that Apartment REITS are already feeling downward pressure on their rents as well. Shippers are under the gun due to the collapsed rates and Energy REITS are under pressure due to the low price of Natgas and Oil. No dividend paying stock is safe at the moment. Any time a lender forces a Mall REIT or Shipper to cut its dividend, the price of the stock will drop.

Rots-o-Ruck! jegan

Jan 15 05:26 PM

[JAMMAR2:]

Why doesnt Sears,Dillards,Macys,J... Pennys,and many other retailers work with General Growth,s lenders to hammer out a resolution acceptable too all parties...?They have a viable intrest also, Everyone loses if the mall dies including surrounding communities residents and the like...

Jan 29 12:35 PM

[User 324565:]

Ackman's would've won the game if GGP's file for protection back in December '08. I would've have won too if bankruptcy gone though. I bought 5k shares earlier in December and decided to dumped that stocks at the end of '08 when GGP got loans extension. Reason Ackman's might have problem and it's shown with current share price is that the longer he wait the more assets would depreciated due to vacancy rate. I'm not surprise if their assets value is now much less than liabilities by now and it will get much worst as time goes by. I still like to put GGP under my radar but that get rich quick scheme is just too little and too late.

Feb 04 04:41 PM