The long thesis on MPG Office Trust (MPG) (either its common or preferred MPG.PA) rests largely upon the structure of its debt obligations. Over a tumultuous couple of years (where the stock collapsed during the credit crisis), the company has taken a number of very prudent steps to accept losses and virtually eliminate all material debt recourse obligations back to the company. As such, it can now be reasonably analyzed on a property-by-property basis to estimate the ultimate recovery value for preferred and common holders.
Non-recourse debt matters
Forgive me if this is pedantic, but for less sophisticated investors I want to provide a simple, non-technical illustration of this concept and why it matters. The table below compares two companies that own the exact same assets (Subsidiaries Alpha and Beta) and have identical debt loads. However, Company A is financed with debt that is fully recourse to the parent rather than having each subsidiaries’ debt limited to that entity (or you could say the debt is “cross-collateralized”, which would be equivalent in this case). At Company B, the debt is not guaranteed by Company B, but instead is down at the subsidiary level. Company B could “flush” Alpha and still retain the positive equity value of Beta.
With the exception of $15 million in unsecured debt at the corporate level, the debt capital structure at MPG is analogous to “Company B” above. If certain properties are underwater, their drag on value stops at zero – the positive equity value of one property won’t be used to make a lender whole on another property that is underwater.
MPG “burndown” analysis
With that said, let’s move on to a conservative calculation of what MPG might really be worth. Based on the balance sheet framework I laid out in my earlier post, let’s assume the following:
- All of the properties that are currently in default are gone – zero recovery.
- Only $300 psf can ever be realized on the key LA properties – no recovery on the gas company, Wells Fargo (WFC) or KPMG Towers, ever.
- The Tri-Cities portfolio is worthless except for Plaza Las Fuentes (100% leased at over $27 psf and the Westin which generates NOI of $5.7 million).
- Orange Country portfolio is worthless.
- JV stake is worth its current book value, and apply a 40% discount to the stated book value of the development land.
Based on this fairly conservative set of assumptions, I get the following (click to enlarge):
As shown above, assuming that only three properties in the wholly owned portfolio have positive value, based on fairly conservative assumptions, results in 1.15x coverage of the full preferred stock value plus accrued dividend (currently at $28.81). I believe the market price of ~$14 offers a reasonable margin of safety based on this framework, and the potential for an attractive return.
Note that the analysis above gave basically zero credit to management’s ability to salvage value on any of the highly-levered trophy properties. In addition, no value was given for the ~$5 per preferred share in unrestricted cash currently on the balance sheet, or the other excess of non-property assets over non-mortgage liabilities.
The common stock at $2.80 is obviously much more speculative, but could have substantial upside based on some of the factors that were fully discounted in the analysis above. I think of the preferred stock here as a fulcrum subordinated debt security, and you can analyze the common stock as warrants to capture any upside above the base return (if limited to a small portion of your overall position).