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Even during TCI’s most heavily leveraged days, Malone was always careful to use as much non-recourse debt as possible, so if water flooded one “compartment” (i.e. an individual cable system could not service its debt) it would not threaten the entire ship (TCI and its shareholders as a whole) – Investor’s Consigliere Blog

At MidAmerican, we have substantial debt, but it is that company’s obligation only. Though it will appear on our consolidated balance sheet, Berkshire does not guarantee it. Even so, this debt is unquestionably secure because it is serviced by MidAmerican’s diversified stream of highly-stable utility earning – Warren Buffett

“In my 40 years in real estate, I’ve found there is only one metric that matters replacement cost– Sam Zell

If you want to invest in hard assets (real estate, utilities, gas pipelines, oil fields, shipping, etc), you need to know how to analyze debt quality. I am not fan of debt, but most of the companies in this arena use easy credit in boom times taking advantage of their tangible and tradable assets, or collateral-- as bankers call it. Collateral makes it so easy. So if you want to profit from busts in these cyclical industries, it is important to separate those that were prepared for the bust from those that were just trading stinky sardines.

To make things as easy and illustrative as possible, I am going to use as an example Maguire Properties (NYSE:MPG-OLD). What I like about this example is that it is a pure equity REIT that buys and develops properties with debt. No investment in CDOs, CMBSs or RMBSs like a mortgage or hybrid REIT. In summary, no weird instruments that could obscure the lessons of non-recourse debt, stable earnings and buying below replacement costs.

So we are clear, I own MPG stock but it is a small position. There are still some necessary steps in the turnaround and it is just beginning to solve its issues. MPG is unusual both because of the quality of its assets and scale of its debt. The company has assets of $4.2 billion and liabilities of $4.7 billion. So $500 million of negative equity? Yes, but please bear with me.

Robert Maguire is the 74 year old founder and former CEO, fitting so well the part of gutsy developer that it is almost tragic. He built several of the most prominent skyscrapers in downtown Los Angeles. The Downtown skyline is dominated by Maguire properties: Gas Company Tower, One California Plaza, US Bank Tower, Two California Plaza, and the Wells Fargo Tower.

MPG's problems can be traced back to the $3 billion purchase in 2007 of a section of Equity Office Properties from Blackstone Group (NYSE:BX) that they had just recently bought from Sam Zell in a legendary deal. These deals were made at the market’s top and included office buildings leased to brokers and financial institutions in Orange County that were at the epicenter of the mortgage bust (i.e. New Century).

Facing a stock price tailspin and concerns about MPG’s financial strength, Robert Maguire tried to raise money to take it private. Having failed, he stepped down as chief executive in May 2008. Those of you that have followed the Premier Exhibitions posts know how I consider waiting for change of management a critical first step before investing in a potential turnaround. And that is even truer when the CEO is a brilliant, gutsy and stubborn founder.

Well, it is more than a year since Robert Maguire’s departure and only recently good news is starting to surface.

  1. MPG announced in August that it was handing over the keys to seven of its office buildings in Orange County and Los Angeles to lenders.
  2. On December, MPG announced they sold one of its prized properties: the Lantana Media Entertainment Campus, home to several entertainment firms (i.e.: Larry David Productions of Seinfeld and Curb your Enthusiasm fame). The deal was valued at more than $200 million. Minus $175 million of debt, it should report a profit

How is it that abdicating properties or selling prized ones for a small profit improves the prospects of a company? That is the power of non recourse debt. But to understand what is going on, it is important to lay down the investment thesis that is the subject of part 2.

Disclosure: Long MPG

Source: Maguire Properties: A Tale of Two Cities, Part I