Understanding the Complexities of General Growth Properties

Took the evening to digest the General Growth Properties (GGP) news. Here is what I came up with for to affirm the investing thesis of the equity (stock).

First, here is the news.

So, why invest in the common stock? Does bankruptcy destroy it? Why aren't lenders forcing it? Will it be a Chapter 11 (reorganization) or Chapter 7 (liquidation)? The answers are all related so let's go through it:

If (when) there is a bankruptcy filing, why 11 and not 7? The simple answer is that having the second largest mall operator go into liquidation and throwing 200 million square feet of retail space up for sale would destroy the commercial real estate market. Why? The sudden supply of properties without bidders (loans still are very tough to get) would mean they would have to be placed on the market below "fire sale" prices to sell.

Because of that, all other operators' real estate values would fall dramatically, and in turn, causing debt covenants for them to be tripped. That would create a cascading effect on the whole industry. For those not sure, this would be a very, very bad thing. You think you have seen write-downs in home mortgage loans at banks? Force liquidation of GGP and as the saying goes "you ain't seen nothing yet".

It also means the banks holding the loans on the properties would then be forced to take pennies on the dollar, very bad for them. In a Chapter 7, shareholders, debt holders and the industry as a whole suffer. No one wins.

So, if we rule out liquidation. What happens in Chapter 11? Who wins there? Here is what Bill Ackman said Monday in the WSJ:

Some investors, however, consider a bankruptcy filing likely. Among them is activist investor Bill Ackman of Pershing Square Capital Management LLC, who bought 7.5% of General Growth's stock in recent months and put another 18% under swap contracts in a bet that the company's equity will survive a bankruptcy unscathed. Mr. Ackman also expects to soon get a seat on General Growth's board.

"We think the company will ultimately have to file for bankruptcy, but we think that it's a wholly solvent company with a liquidity problem," Mr. Ackman said in an interview Monday. "I don't think they'll need to dilute shareholders. All they need to do is extend the maturities [in bankruptcy court] and they can refinance those debts as they come due."

Now, one must realize that Ackman took his stake AFTER GGP's troubles were known. This is not a situation where we have an investor trying desperately to save a bad investment. He bought in knowing this scenario we now face was likely.

The typical bankruptcy is forced because the liabilities (debt) outsize the assets. In this case the common shareholders are wiped out. But, we know that the assets GGP has are in excess of the liabilities. In this case, even in a worse case Chapter 11, shareholders are not wiped out.

But, this goes even further. Again from Ackman “Most of the time, insolvent companies go bankrupt,” Ackman said. “It’s rare for a solvent company to go bankrupt. This is a solvent company with a liquidity problem.”

General Growth is not losing money. Rents are stable, occupancy rates are over 90% and FFO (funds from operations) remain healthy. What is the problem? Credit. GGP has loans due that they typically just rollover into longer maturities. With the current credit "lock down", the company cannot do that. That means bulk payments come due and the cash is not there. It should be noted that this is not an odd situation, this is what REITs typically do with their debt.

With a Chapter 11 debt holders are put in a room and told by a Judge, "we can pay you all 100% but we need to change and lengthen maturities OR we can liquidate and you can pick up scraps for pennies on the dollar". Here are the new terms. The choice is rather obvious.

The banks all recognize this too. This is the reason they have not been paid a dime since late last year and have not forced a Chapter 11 filing. They do not want to take the risk of writing down loan portfolios. Remember, our mark-to-market world means they just do not just write down GGP loans, they then have to write down ALL of them on their books. Again, this is very bad. So we get endless extensions to pay.

Why? The banks are riding this out. If we get MTM changes in Congress then we may see the log jam break. In that case a Chapter 11 would not have a cascading effect on their whole portfolio and restructuring the loans to again begin receiving payments makes perfect sense. They may be hoping for an economic turnaround late this year that enables GGP to sell some property to pay them off. They may all be playing a waiting game hoping someone restructures and sets the bar for the rest of them. That is better than a bankruptcy judge will do.

Who knows the exact reason why for each lender. We do know what they don't want right now, a Chapter 11 filing. If they wanted it they could force it easily.

Because of the financial situation of GGP, there is no need to convert debt to equity. Restructuring the loans would allow for payments to be made, equity holders would remain intact, the banks again have performing loans on their books and everyone is happy.....VERY happy.

I think the specter of Ackman going on the board must give the banks pause and perhaps want them to restructure sooner rather than later. Then, knowing he wants a Chapter 11, I am guessing, will bring people to the negotiating table a bit faster.

Disclosure: Long GGP

Comments

[throbulator:]

if the equity is such a great value, why are the bank debt and bonds trading around 30 cents on the dollar?

Mar 18 10:19 AM

[foolynaround:]

because people are scared and mostly don't understand commercial real estate financing. rolling over and continuing to carry debt, with interest only payments, is common in commercial real estate. the payoff comes when the property sells and these types of companies move assets in and out of their portfolio.

Mar 18 12:31 PM

[throbulator:]

hey i agree if it was strictly up to the mortgage lenders, they would roll their maturities into oblivion and some day in the distant future -- when the land of bees and honey goldilocks economy returns -- these properties will be valued at a level that justifies owning the stock.

the reality is that today, if these properties were to be put on the market, they would not recover value for the equity. that is what the trading levels of the bank debt and the bonds are implying.

the reality is that the banks, and especially the bondholders, have no incentive to wait around for the return of goldilocks. they are not being kept current on their interest, and by and large the original holders of this debt have sold their claims to new vulture investors. these vultures have a low cost basis, and dont need much upside to generate a nice return. they dont need to maximize the value of the estate over the long term. they simply need to demonstrate to the court that the value of their claim is impaired. that is the only test they need to pass in order to receive the bulk of the equity when this deal restructures in bankruptcy court. it is not a stretch to demonstrate that their claim is impaired given where the debt is trading.

you cant argue the value of the assets is rising given where the economy is heading, not to mention ongoing layoffs, consumer spending pullbacks, retailers posting alarmingly bad results....the bondholders are not patient capital. the worse this situation looks going in to bankruptcy, the stronger their argument to receive equity as compensation for the loss of value in their claim. their claim has priority over existing equity. so the existing equity gets nothing, and will be replaced by new equity that will be used to compensate debtholders.

Mar 18 02:05 PM

[Eric Boughton_:]

Todd, I appreciate your efforts in attempting to determine the value of GGP equity. However, the rationale behind your belief that assets exceed liabilities at GGP is highly flawed. Specifically, your argument rests on the extension of the price per square foot offered for a few higher-value properties to GGP's entire mall portfolio. It is unlikely that such an extension is in any sense reasonable.

The question of "ultimate value" of GGP's assets is an open one, of course. However, it would take a fairly low discount rate applied to expected rental cash flows on GGP's mall properties over the next, say, 5 years, to come up with a present value answer exceeding $30 billion. Such a low discount rate is not likely to be applied by any investor with actual cash to invest. You implicitly admit as much by saying

"The sudden supply of properties without bidders (loans still are very tough to get) would mean they would have to be placed on the market below "fire sale" prices"...

Think about what you are saying. You are saying that a LOAN would be required in order to get a bidder. But, in fact, there are many investors with "actual cash" to invest. Why aren't they offering $30 billion plus for GGP assets right now? Almost certainly because the present value of those future cash flows is, in their mind, lower than $30 billion.

Now, there may indeed be a rational investor who believes the present value of GGP property cash flows over the next TWENTY years exceeds $30 billion. Ackman may be one of them. But, consider that his ownership of GGP debt means that he can win (and win big) even in a Chapter 11 scenario which completely ELIMINATES the equity!

Ultimately, I agree with throbulator: The debtholders will own GGP in (essentially) its entirety within a year. The size of the bone they throw to current equity holders does not have to be large, and could be zero depending on the opinions of the bankruptcy judge. Debtholders who bought the bonds at $.25-.30 on the dollar will therefore experience a positive return IF the value of GGP mall properties turns out to be greater than $10 billion. I think that is a (relatively) safe bet, which is why I have made it.

Mar 18 03:05 PM

[foolynaround:]

if the feds actions yesterday do in fact free up some cash for commercial lending, or in fact, there is trickle down benefit to the commercial market, ggp may get its needed breathing room. re: ackman, he owns or controls 25% of the ggp equity. have to believe/hope that his read on ggp's liquidation value is correct. he is betting on a reorg as opposed to a liquidation and if he can convince either the banks or the courts he is correct, those who gambled/invested at the sub $1.00 range would be golden. can't believe that ackman is going to bale with a 3 or 5 bagger return. he holds or controls around 75 million shares. if he prevails, his return would be legendary.

Mar 19 05:10 AM

[DinNYC:]

I understand everyone's skepticism about GGP's future, but I was glad to see Todd lay out the very same argument/assumption I have had for upping my position in GGP. I think many of the posters have valid counter-arguments, but you are also assuming a sane and rational marketplace when making those arguments. Thats not what we have. We have a market driven by fear and paranoia, and serious attention needs to be paid to the idea that some debt holders of GGP may see it as "too big to fail". My suspicion is that some of the more savvy debtors (namely Goldman Sachs) may be calling around to other debtors to encourage restraint in calling in a debt, which would trigger a bankruptcy. I believe I read somewhere that it only takes one debtor to call in a payment to "trip the switch" on a bankruptcy filing. I don't think its a coincidence that none of GGP's debtors have done so. It is also fair to say that some may have faith in the new management of GGP.

Lets not forget that consumer spending has shown some surprise increases in 2009, which is not to imply that this mess is over. But it may signal the beginnings of a bottoming out and to take less-than-fire-sale prices on GGP debt when we may be at a bottom is just plain retarded. The only risk I see here is that REIT's like Simon Property are purposely avoiding buying up GGP property to force a GGP bankruptcy so they can buy up their assets at even further reduced prices. There is a lot of cash on the sidelines and if Todd's arguments about the value of GGP's property portfolio are true, I would think someone may see fit to buy a large stake in GGP equity. Assuming we believe the stimulus, fed and treasury actions are going to have a positive effect. Big Assumption these days in an Obamaconomy.

Mark-To-Market may be the "dark horse" GGP needs to get their properties moving. Why on earth wouldnt someone want to buy the South Street Seaport in NYC??? Eh, I am a biased NY'er.

Mar 19 06:57 PM

[User 259493:]

This is just plain ignorant


On Mar 18 12:31 PM foolynaround wrote:

> because people are scared and mostly don't understand commercial
> real estate financing. rolling over and continuing to carry debt,
> with interest only payments, is common in commercial real estate.
> the payoff comes when the property sells and these types of companies
> move assets in and out of their portfolio.

Mar 19 07:37 PM

[User 259493:]

The only person who gets it...


On Mar 18 03:05 PM Eric Boughton wrote:

> Todd, I appreciate your efforts in attempting to determine the value
> of GGP equity. However, the rationale behind your belief that assets
> exceed liabilities at GGP is highly flawed. Specifically, your argument
> rests on the extension of the price per square foot offered for a
> few higher-value properties to GGP's entire mall portfolio. It is
> unlikely that such an extension is in any sense reasonable.
>
> The question of "ultimate value" of GGP's assets is an open one,
> of course. However, it would take a fairly low discount rate applied
> to expected rental cash flows on GGP's mall properties over the next,
> say, 5 years, to come up with a present value answer exceeding $30
> billion. Such a low discount rate is not likely to be applied by
> any investor with actual cash to invest. You implicitly admit as
> much by saying
>
> "The sudden supply of properties without bidders (loans still are
> very tough to get) would mean they would have to be placed on the
> market below "fire sale" prices"...
>
> Think about what you are saying. You are saying that a LOAN would
> be required in order to get a bidder. But, in fact, there are many
> investors with "actual cash" to invest. Why aren't they offering
> $30 billion plus for GGP assets right now? Almost certainly because
> the present value of those future cash flows is, in their mind, lower
> than $30 billion.
>
> Now, there may indeed be a rational investor who believes the present
> value of GGP property cash flows over the next TWENTY years exceeds
> $30 billion. Ackman may be one of them. But, consider that his
> ownership of GGP debt means that he can win (and win big) even in
> a Chapter 11 scenario which completely ELIMINATES the equity!
>
> Ultimately, I agree with throbulator: The debtholders will own GGP
> in (essentially) its entirety within a year. The size of the bone
> they throw to current equity holders does not have to be large, and
> could be zero depending on the opinions of the bankruptcy judge.
> Debtholders who bought the bonds at $.25-.30 on the dollar will therefore
> experience a positive return IF the value of GGP mall properties
> turns out to be greater than $10 billion. I think that is a (relatively)
> safe bet, which is why I have made it.

Mar 19 07:40 PM