Pershing Square Bill Ackman’s presentation about General Growth Properties (GGWPQ.PK) at the Ira Sohn Investment Research conference has us wondering what he is up to. The tone of the presentation clearly targets an audience that is not familiar with bankruptcy investing. At the same time, his financial projections for GGP are overly optimistic and do not square (no pun intended) with current results. We believe that some of his analysis is very misleading.
As anyone who followed the saga knows, General Growth filed for bankruptcy not only because of poor operating performance, but primarily because of the credit crunch that made it impossible for the company to refinance its debt. Repayment also was not an option because it holds only a few hundred million dollars of cash. So the bankruptcy filing was triggered by a liquidity problem and not by losses. In fact, General Growth even made a small $3 million profit last year and has book value of $1.7 billion. But with $3.5 bn of debt coming due this year and another $7 bn next year, there was little the company could do when it did not gain an amicable settlement with creditors. Most of the debt are CMBS secured by properties, but some debt is unsecured corporate bonds. The unsecured bonds are a result of GGP’s acquisition of Rouse Co in 2004, and are still listed under Rouse’s name.
Ackman made headlines in May when his firm failed to become debtor in possession [DIP] lender to bankrupt General Growth Properties. Pershing’s Libor+1200 loan proposal was trumped by a slightly cheaper DIP financing from a group including Farallon, Elliott Associates and others. Pershing’s DIP loan had a 3% Libor floor, whereas Farallon’s has only a 1.5% floor and provides slightly more funds. Had Ackman been successful, he would have been both a 25% equity holder (including total return swaps) and a debtor, which would have given him a strong position to wrestle concessions from the creditors in order to maximize the return on his equity holdings.
Ackman’s presentation at the conference attempts to value General Growth’s equity. The key point is that GGP’s assets are worth more than the liabilities, and therefore the equity should have value upon emergence from bankruptcy. We do not question this thesis, but we doubt that the numbers underlying the valuation are correct. For a start, Ackman’s topline assumption is not accurate. He assumes a 2.4% drop in NOI for 2009, excluding the Master Planned Communities segment. However, annualized Q1 performance suggests a 4.4% drop. Minimum rents in Q1 even declined by 4.9% from the prior year’s Q1. So GGP will have to reduce its vacancy aggressively to get to Ackman’s projection.
In a difficult retail environment it is unlikely that a mall operator that is in Chapter 11 will find many new renters. We would think that throughout the year some leases will not be renewed, and the tenants on others will end up in Chapter 11 themselves. So the full year NOI may well deteriorate further from the 4.4% drop in Q1. Pershing’s presentation quotes YTD sales growth at GGP’s malls as minus 6.7%, so the outlook for leasing activity clearly is bleak.
Like most valuations, Pershing Square lives and dies with its cap rate assumption. Ackman contends that GGP should trade at a 7.5% cap rate, 100 bps better than Simon Property Group (SPG). 7.5% cap rates are not what malls trade at these days, if they trade at all. SPG itself trades at an implied 8.5% cap rate, and Pershing Square thinks that this cap rate discounts the risk of bankruptcy of SPG. Therefore, reasons Pershing Square, GGP should trade at a lower cap rate, resulting in a higher valuation.
The problem with this argument is that it can be applied to GGP as well: if the maturity of the debt is extended by 7 years as proposed, the market will discount a potential liquidity squeeze at the new maturity date of the debt. In addition, we believe that an 8.5% cap rate for SPG only shows that SPG is overvalued. If we apply a more realistic cap rate (9%, in our humble opinion) to GGP, then the upside for the equity looks much less appealing. And we haven’t even mentioned dilution yet, which we will address in a moment. After dilution, the equity looks pretty close to fair value to us.
Ackman uses more than 10 slides to explain Bankruptcy 101: how equity holders can retain value in a bankruptcy. He seeks to overcome the perception that equity holders will always be wiped out. Clearly, this part of the presentation is geared to investors who have no knowledge or experience of distressed debt investing or corporate bankruptcies. We are not sure whether he is trying to make investors in his fund feel comfortable, or whether he is trying to entice other investors to jump on his bandwagon. In any case, it is rather odd that he would include such a lecture in a presentation held at a conference full of financial professionals.
Pershing Square offers several solutions to GGP’s exit from bankruptcy. The first involves a simple extension of the debt by seven years. Somehow, Pershing Square assumes that debt holders will grant such an extension without asking for anything in return. The presentation states literally that Pershing Square wantsAll Debt maturities extended seven years at current interest rates
A free lunch for shareholders? We would think that such an extension would at a minimum be accompanied by warrants, and more likely by actual equity. We have seen cases where simple consents in connection with minor technical defaults were accompanied by 25bp consent payments. It is highly unlikely that bondholders will simply extend maturities without asking for compensation. And (secured) CMBS holders have even less incentive to extend debt maturities. Since cash consent payments are out of the question, dilution of the existing equity is the only form of payment available. We are at a loss to explain why Ackman simply ignores this pretty fundamental problem in his analysis. We believe that this omission is highly misleading.
Ackman’s other idea for the exit, a “cram down” on debt holders, is completely unrealistic. It would include a cram down on all CMBS debt. We can picture the turmoil in the CMBS market that such a judgment would make. Investors receiving currently ~6.5% suddenly would find themselves getting 4% (prime + 75 bps). This might wipe out some CMBS tranches. We would see years of litigation before a cram down could even occur. Therefore, we believe that the cram down proposal is just a scare tactic to pressure debt holders, albeit not a very credible one.
Finally, Ackman closes his presentation by stating thatThe nuisance value of the equity is meaningfully greater than zero
If your equity has real value then you don’t need to rely on its nuisance value. The point of the entire presentation is to underline that the equity will have significant upside in the current bankruptcy proceedings, so if he concludes with the nuisance value, it shows that the remainder of the valuation analysis cannot be taken too seriously.
We do agree with Pershing Square that the equity will not be wiped out completely. However, we do believe that it will be diluted and will not be worth as much as in his optimistic projections. We are surprised that Pershing Square seems to address an audience that is not familiar with bankruptcy investing with flawed analysis. We are not quite sure what the goal of that strategy is, but we fear that some people who believe any spreadsheet or powerpoint may end up investing solely based on trust in Ackman’s public persona without realizing how misleading the presentation really is.
At this point, the bankruptcy has become a fight over valuation. Pershing Square will not help its cause by throwing out overly optimistic numbers that are easy to dismiss. We do favor the bonds over the equity and anticipate that equity holders will be appeased through the issuance of warrants with high strike prices between $10-$15. In that case, Ackman will be correct that “inflation is your friend.” We believe that the equity will be worth somewhere in the mid-single digits upon emergence. The shares have rallied to $2.60, so that we do not believe that it is worth assuming the risk of further store closings by cost-cutting retailers in addition to GGP’s bankruptcy risk.
Disclosure: Thomas Kirchner manages the Pennsylvania Avenue Event-Driven Fund (PAEDX), which holds securities of General Growth and/or Rouse.