Reckson Realty: The Real Story

Shares of Reckson Associates Realty (RA) have lifted on news that a syndicate of Carl Icahn and Macklowe Properties plan to offer $49 in cash for RA shares compared to SL Green's (SLG) current offer of $31.68 in cash and 0.10387 of an SLG share. SLG's offer was worth $43.31 a share at the time, being a slight discount to Reckson's closing price of $43.95 at the time the deal was announced.

SL Green's plan for Reckson Associates was to keep Reckson's Manhattan portfolio while selling off the remainder of Reckson to a team lead by the former management of Reckson Associates.

Carl Icahn/Harry Macklowe are not stupid, and they understand what SL Green is doing. Assuming the Manhattan real estate markets stays strong, Reckson's assets have organic growth from rent roll-ups estimated at 5%-8% per year for the next seven years. If you net-out the cash received from the management buyout of residual properties against SL Green's cash payment for Reckson's shares, this deal is almost wholly financed with SL Green common stock at 2%.

The 2% Solution

The chance to acquire a big slug of trophy Manhattan properties, at below market prices, with long-term financing at 2%, is irresistible.

On the back of an envelope, 80.15 million Reckson Associates shares at $31.68 is 2.55 billion. Less $2.1 billion from the management buyout, this equals a total cash contribution of $455 million. The enterprise value of Reckson Associates is about $6 billion total. With today's low rates who needs a gun?

The total cash equity contribution is piddling, so SL Green doesn't need to be too picky about the sale of the other 75% of Reckson. It's better that SL Green leave something for Reckson Management -- so that they will be motivated to do the deal. The fight is for the crown jewels in Manhattan and the opportunity to raise rents on hundreds of thousands of square feet of prime office space in a supply constrained market.

Although Reckson claims that they shopped the non-SLG portfolio around, ran a competitive auction for the whole company, and so forth -- I don't really believe it. If Reckson management did what they said, an offer like Carl Icahn's would have been made and accepted. Had Reckson's management been serious about getting full value for the company they would have used more independent advisors with a better valuation process. That Citibank (C) is in discussion with Reckson MBO syndicate about post-deal financing is evidence an obvious conflict of interest while they are in charge of bidding process for the whole company.

I am not impressed with the fairness letter/board presentation from Goldman Sachs (GS) either. Firstly, Goldman Sachs is not a disinterested party, and never will be in anything they touch. Like all investment banks they will have their hands on both sides of the deal. There is financing to arrange, consulting services to offer, and IPO's to underwrite. All this business depends on staying friendly with everyone on Wall Street. Getting in the way of a deal by saying that it is bad for Reckson shareholders doesn't win friends with people who do business with Goldman Sachs.

The Manhattan Transfer

Goldman's analysis was based on MBA type discounted cash flows and multiples analysis based ofnReckson stock vs. other office REITs. It was not based on a serious analysis of the market value of Reckson's real estate portfolio. SLG surely did this analysis, but Goldman didn't.

RA is one of two public REITs with a New York City focus. Reckson owns one-of-a-kind NYC assets that are not comparable to assets of any other REITs besides SL Green. Note that SLG trades at serious premium to other office REITs which gives a hint of just how valuable pure NYC real estate is. A sum-of-the-parts analysis would have shown that Reckson Associates is worth more than SLG's $43 cash and stock bid. Icahn's bid of $49 in cash confirms it.

At a deep level, Goldman Sachs' analysis had no imagination about the real way to value a dead REIT. After you remove the management premium (discount!) the value of the REIT is its liquidation value at current market prices. This means doing a granular assessment of the entire portfolio on a property by property basis. After you figure out what a reasonable person would pay, you demand more. And if the buyer won't overpay, then you don't sell.

That an outsider is willing to pay 15% more than SLG before seeing confidential information suggests that the entire sales process was flawed. The right people weren't invited to bid, and a lowball offer from SL Green was accepted without reservation. Reckson Associates is still worth more than Icahn/Macklowe's $49 bid, but that is a good starting point.