A Model Valuation of GGP

We have looked at General Growth Properties' (GGP) plan for raising non-debt capital through private participation. This model was actually completed right before GGP announced its equity offering, so the number of shares are off, but the logic remains the same.

Our model (based on 3Q2007 results) assumed that the company would be able to raise the required finance in 2008 and 2009 through additional debt (and we didn’t specifically provide for equity participation). The ‘liquidity-trapped’ capital and financial markets have been making it increasingly difficult for the borrowers to raise additional money, and GGP might find it easier to dilute its equity and raise additional finance under the current conditions of financial turbulence.

During 1Q2008, GGP was able to finance $1.3 billion of loans against six mortgage properties. The existing loan on these properties was $550 million. Consequently, GGP was able to realize additional proceeds of $750 million, which was partly used to purchase The Shoppes at Palazzo at Las Vegas.

GGP is currently in discussion with various mortgage lenders to raise $2.5 billion of loans on both encumbered as well as unencumbered properties. In addition to property specific mortgages, GGP is also considering various forms of non-debt capital through private participation which could result in equity dilution. Overall GGP expects to raise $1.75 billion of additional capital through private participation of which $1.5 billion is expected to close by 2Q08.

$m	2008
Loan outstanding at beg. of year	24,282
Additional loan for capital improvements and redevelopments	1,582
Principal repayment as per schedule	(2,643)
Loan repayment (additional loan on refinancing and capital improvements)	(861)
Loan outstanding at end of year (before refinancing)	22,360
Refinancing	3,850
Loan outstanding at end of year	26,210

In our financial model we expected GGP to require re-financing of $3.9 billion in 2008, of which GGP has already refinanced $1.3 billion in 1Q08. The company is raising additional $1.75 billion from non-debt financing through private participation.

Valuation

Based on GGP’s portfolio of properties as of September 30, 2007, we expected GGP’s valuation at approximately $6.9 billion or $28.4 per share implying a downward potential of 30.7% from the current share price of $41.

However if we expect GGP to raise additional capital of $1.75 billion through private placement, GGP’s valuation increases to around $7.7 billion due to savings in interest expenses. However as a result of the dilutive effect (due to the increase in shares outstanding) GGP’s per share valuation declines to $26.5 (under our base case assumption), implying a further downward potential of 35.3%. It should be noted that the base case is no longer the "base case" since I consider us to be undeniably in a recessionary period, which would indicate $23.9, or -41.7% as of the close yesterday. Now, these numbers are off because we actually assumed that they were going to raise more money than they did, but if anything, they are optimistic.

click to enlarge

If you are new to the site, let me assure you that we have a decent amount of talent and knowledge represented by our regular members and subscribers. We share a lot of ideas and knowledge behind closed doors and on occasion I publish some of the discussion and debate. Here is a contribution from a CRE specialist, with my additional comments in italics.

Conclusions

• My estimate of the market value LTV for GGP as a whole is 72%.
• The current market is reluctantly accepting 60-65% LTV according to Reggie.
• If they raise all properties less than 60% to 60%, or all less than 65% to 65%, they can raise $3.1 billion - $4 billion of new cash. This would leave the company fully levered on a property-by-property basis. It would have an average LTV of 85%, burning cash from core operations north of $400 million per year, and would still have $4.4 billion-5.3 billion of debt that it would need to refinance assuming it keeps all its development plans in place. Even if it stops all development capex, it would have $2.1 billion-3 billion that it would have to refinance. And note, all of these properties would then have LTV's equal to or greater than 60-65%!

This all implies GGP won't be able to make it through the end of 2009 without having to sell assets or do a very dilutive transaction. [This was written right before it announced its very dilutive transaction yesterday]. After going through all this in detail, still looks great to me. I get a fair value of 20, but should go lower as they dig themselves into a hole.

GGP

My basic view of the latest development is that GGP is simply trying to show progress on the refinancing end so that they can get their rating back from S&P. The timing was too perfect. They are pursuing a strategy of levering their un-levered properties to squeeze as much cash as they can out of their existing portfolio. This delays a process that cannot be delayed for too much longer. I believe this for 2 reasons:

1. The core operations are losing money when dividends are factored in, and the new debt will only make future core operational cash flow worse. I estimate $150 million and $250 million of core operational cash outflows after dividends without any debt problems in 2008 and 2009, and $430 million and $530 million, respectively, inclusive of a full wringing of their existing portfolio.
2. Wringing their existing portfolio dry will only last them through 2008, but will leave them requiring cash in 2009. Even after doing all the money raising that is possible, they will have $5.3 billion and $2.8 billion due in 2008+2009 if they spend the expected development capex and if they don't, respectively. Moreover, its LTV will rise from 72% to 85%, by my estimation, when 60% is a fair estimate for the LTV it will be required to have on these properties.

Bank Risk? Seems overblown.
Assuming this to be true, the only thing that GGP can hope for is to get debt forgiveness or a lower interest rate by strong-arming the banks it's dealing with. Perhaps they could say to their banks that they know it isn't possible for the banks to foreclose, and the debt is non-recourse, so it's best for everyone if the banks were to cut GGP some slack. This logic is a little tenuous. Regional banks are the guys who are expected to experience a rapid rise in bankruptcies due to their C&D exposure, prompting the FDIC to beef up their staff for the expected wave. They might not exactly have the ability to let things slide when they are cash strapped themselves and may slide into bankruptcy! "The agency, which insures accounts at more than 8,000 financial institutions, is also seeking to hire an outside firm that would help manage mortgages and other assets at insolvent banks, according to a newspaper advertisement."

This is my view of GGP's cash situation at this time in dirty detail:

• Current debt and cash flow: GGP had $5.6 billion of consolidated debt due in 2008+2009, and $6.4 billion when you include the JV's at the end of 2007, before these financings. 2007 core cash flow was $0 after normalizing and assuming maintenance capex equal to 1.1% of their assets.
• Development capex: Development capex in 2008 and 2009 of $1.3 billion and $1 billion, respectively. Total = $2.3 billion.
• Expected future cash burn: Core cash burn (EBITDA minus maintenance capex and other non-growth cash costs minus dividends) of $150 million in 2008 and $250 million in 2009. Total = $400 million.
  • This probably merits additional comments, but suffice it to say that from multiple angles, it seems fair to say that the retail environment is truly terrible. BGP is selling itself, SHRP has gone bust, ANN and Talbot's are closing a bunch of stores, Domain Home has gone bust, Foot Locker is shutting down 80 stores, ... and even JCG, which is expanding, is doing so in stores that are 30% smaller than their average store in 2005. All of this does not bode well for occupancy and/or rates.
• Excess money raised: Total stated new loans worth $1.3 billion versus existing debt of $550 million. But, the Palazzo is also an asset that has debt capacity when purchased, and LVS says the initial payment all-in is $500 million. My hunch is GGP neglected to mention this and drew down on Palazzo for $250-300 million, independent of the debt coming due.
• Summary of cash needs: So after all this, they will have the following payments to deal with:

$5.4B of total debt (consolidated and unconsolidated) due in total in 2008 and 2009 that will still have to be refinanced;
$400M of core cash burn on their core operations;
$2.3B of development capex;
$200-250M to pay off the equity piece of the Shoppes at Palazzo;
Total cash needs of $8.4B in 2008 + 2009 -- and $6.1B without any growth capex

• Encumbering the unencumbered properties: This is one key element that requires some thought.
  • Getting a feel for the distribution: From what I can see, around 3% of their property assets are unencumbered and perhaps 20% have LTV's less than 40%. Your blog was stating 40% as unencumbered! I am fairly certain that you were simply doing a count of properties and not weighing by asset value. Is this true? Yes, I was doing a count of properties, and not a weighted asset value.
  • Estimating total asset base: My estimate of the market value of the assets of the company is $33 billion -- Reggie believes $29 billion. I put a lot of time and resources into getting an accurate valuation estimate. I stand firmly behind the $29 billion number. Go back and look at the GGP valuation methodology used. We valued each of 260 properties independently using local data from local brokers in very robust models, then through common sense adjustments that skewed to the conservative side when there was a doubt. I have 2 GB of GGP valuation data on my servers right now. See the Commercial Real Estate section of my blog for the series of GGP analyses and the final valuation and fire sale analysis in particular for details.
  • LTV of the company: GGP has $24 billion in total debt, implying an effective "loan to value" that I can see of 72% fairly conservatively for the whole company.
  • Allowable LTV in this market: According to one of Reggie's posts, even 60-65% LTV was having a difficult time getting through as of January 2008. Contacts in the mall biz tell me banks right now want loan to values of between 60-70%, and that at 70%, they will bring up leverage being on the high side. He said that 2 years ago people were getting away with 80%+. The prior calculations assumed 2 LTV's, 60% and 65%, which are within this range. With the additional encumbrances that GGP is incurring, they are way north of all of these numbers anyway.
    • Upside should commercial banks experience financing problems Through contacts in the industry, it appears as if banks haven't really written down their commercial loans yet at all. The market would really tighten up if we did see people start to take a bath on their commercial debt. The FDIC is bulking up for commercial bank failures due to high exposure to commercial C&D loans (construction and development). There is a lot of other data that commercial banks will probably take a bath sometime soon. This post offers some good data -- commercial bank loans to real estate are at all times high *by far* as a % of GDP ; delinquency rates are near all time lows ; 76 commercial banks are now on the "problem list" for the FDIC ; charge-offs are at all time lows. Putting it all together, I think the funding environment for CRE will get worse. The local and regional banks and savings and loans have very high concentrations of construction and development loans that are time bombs waiting to explode. The condo development loan exposure alone is scary, since many of these won't even get the chance to be flipped over to permanent financing. (Many C&D loans are libor based credit lines that were planned to be refinanced into permanent loans as the condo was sold out. Guess what? The condo market is glutted out in many areas, with Miami and Vegas not anywhere telling the whole story.) I know from personal experience that this will at least rival the public home builder experience.
    • LTV and Financing Conclusion
    • Summing up, looks like the market range right now is around 65% with downside as we move forward into 2009. This compares unfavorably to the 73% - 80% LTV that GGP is operating at, driving home the view that squeezing the portfolio will only extend their life to mid-2009, at which point they will be forced to do a value destroying transaction of some sort.
  • Calculation of available cash: Let's assume 60% allowable LTV for starters. Theoretically then, GGP could encumber all of its properties that have less than 60% up to 60%. This can give us a view as to how much this factors, when keeping in mind that GGP has already used up $658 million of this as per their press release. By my estimate, this can get them a grand total of $3.75 billion in additional cash in total, and $3.1 billion net of the excess they have raised already. This would increase their effective LTV from 72% to 85%, which is almost ludicrous. At a 7.5% interest rate, they would pay an extra $280 million in interest per year.
  • Resulting cash flow situation: GGP's total cash needs in 2008 and 2009 were $8.4 billion with development capex and $6.1 billion without after the latest refinancing. Netting out $3.1 billion of excess proceeds from fully leveraging its portfolio, its net cash needs drop to $5.3 billion and $2.8 billion, respectively, for a business with no additional ability to squeeze assets for cash, core cash burn from its operations, a portfolio average LTV of 85% and assets whose LTV is north of 60% which will need additional equity.
  • Sensitivity to specific figures not too large. Even assuming a 65% LTV, net excess cash raised goes up from $3.1 billion to around $4 billion. This still leaves them without cash some time in 2009, while the economy is still in dire straits, and presumably the credit markets are still junked up.

"Private transaction" -- no magic bullet
They can attempt to raise additional capital through a private transaction, but my view is they will have to do so at a high cost. There is no one who has a strong incentive to subsidize a sunk loss. Equity holders are all on the small side (well smaller than $1.75 billion), and debt holders are all non-recourse! As a result, anyone who does do a transaction with them would be looking at this purely from an independent risk adjusted return on capital standpoint. Centro is having difficulty finding buyers for itself, and I don't think GGP will be able to raise any more convertible debt at any sort of a reasonable cost.
Discussions on $2.5B of other mortgage debt
This statement seemed meaningless. Of course they are in discussions with their mortgage debt lenders. They have a lot more debt that they need to refinance! Duhhh!!!
Conclusions
The only options that are left then involve diluting the current equity holders heavily, or selling prime assets into a bad market to sell assets. Both options destroy shareholder value per share. And both are what they are doing, in addition to getting a much higher market price per share from this trading rally. Hence, less per share value and higher per share price. If we connect the dots...
Other ways of looking at the thesis

• GGP is extremely levered relative to its peers.
  • GGP, MAC, SPG and TCO have consolidated interest / revenues of 36%, 29%, 26% and 20%, respectively. Hypothetically, debt paydown of $15.8 billion would be necessary to normalize the capital structure to a more reasonable level.
  • GGP's debt / (market value of assets) is 72%, versus a peer median level of 58%. MAC, SPG and TCO's are 58.2%, 55% and 55.2%, respectively. Again, GGP's is well higher than that of its peers.
• Using a normalized FFO valuation, GGP should be worth around 22. I have done out the calculations below.

FFO-based Valuation

FFO Defined: FFO is basically Earnings before D&A, adjusted to remove some extraordinary items, available to everyone (stockholders and operating partnership units) from everyone (consolidated properties, unconsolidated properties). My valuation method takes FFO from the core mall properties and adds to it the net market value of the residential assets, after which the shareholders get their pro rata piece of the pie. I add the residential assets b/c recurring cash flow isn't how the business is run; they sell assets, so a cash flow-based valuation method is inappropriate. This forms the valuation basis for how GGP can think through its options.
Normalized FFO in 2007: FFO from the mall operations, or "Core" FFO, was $880.93 million in 2007. Adjusting for one-time litigation costs, Core FFO was actually $912 million.
After tax cash flow to shareholder calculation: FFO does not subtract maintenance capex, yet the ongoing business must spend that cash simply to maintain itself. I knock off maintenance capex of $352 million. This might seem like a lot, but one should keep in mind they have 55.5 million square feet of property to maintain, so this implies around $6.3 of maintenance capex per square foot of property they own per year, which seems extremely fair. I then make an adjustment for the expected future interest rate on GGP's debt (6.3%, versus the present 5.7%), as well as the expected decrease in Core FFO in 2009 versus today (5% drop). Both are also subtracted. Shareholders receive their 82.4% share of the residual cash flows (operating partnership unitholders receive the rest), or $291 million. I take this after tax cash flow figure and slap a multiple on it (17x) to get the value associated with the mall operations.
Net Market Value of MPC Assets in 2007: Net book value provided by an "expert" was $1.64 billion. I then took the Price / BV of 12 of the largest homebuilders, and pulled the median P/BV of the bunch -- 0.87x. I used this to get a reasonable estimate of the real market value of those assets of $1.42 billion. Again, could be optimistic, but is a good place to start. I again adjust this down to the share available to the stockholders.
Adjustment for haircut on forced asset sales: Prior estimate of need to sell assets to raise cash was around $2 billion. Assuming this to be true, we'll also need to deduct the % of fair value of these properties GGP will lose b/c it is in a stressed sale condition, in an unfavorable selling environment. I assume a 20% haircut, or $400 million. This is probably pretty fair. The Bear Stearns to JP Morgan office building option valued that distressed transaction at about a 30% haircut. That was very distressed, although it was also ultra prime office space. GGP features mostly retail mall and some residential properties. I believe these properties will be hit sooner and harder than the office space in this current recessionary environment. So long story short, 20% seems feasible.

Putting it all together we have the following then:

• After tax cash flow to shareholders: $291M
• Multiple on after tax CF to shareholders: 17x
• Value of mall business: $4.95B

• MPC Value to stockholders: $1.17B

• Total value, mall business + MPC = $6.13B

• Subtract haircut from forced asset sales: $400M

• True Value of GGP's Equity: $5.73B.
• Shares outstanding: 244M
• Expected stock price: 23.5. I'm going to take the liberty of diluting this figure for my guest contributor here since this was penned before the announcement of the stock offering. GGP offered about 22 million shares, to total about 266 million shares outstanding which would lead this valuation to approximately $21.54 per share.

The valuation method is pretty robust. It is mathematically difficult for GGP's EIR to ratchet up much more than this b/c most of the debt is fixed, and only that which comes due will be eligible for a rate hike. And, we're assuming $2 billion of asset sales.

Other Factor #1: Dividend Cut
GGP paid shareholders $450 million in dividends in 2007. This is clearly in excess of the normalized cash flow to shareholders from the mall business of $291 million. And $2 billion of cash from asset sales implies $2.4 billion of book value assets sold, while MPC only has $1.42 billion available from above, so there will be nothing left coming from this asset, in addition to the $1 billion of core mall assets that will need to be sold (which brings us to Other Factor #2). For those who are not REIT investors: REIT investors are highly reliant on income and a dividend cut would be highly detrimental to GGPs share price due to devaluation in the market place.
Assuming they reduce the dividend to an amount they can actually pay sustainably, they will have to cut the dividend by 35%.

Other Factor #2: Sale of Mall Assets on Core Profitability
One needs to factor into the 2009 projected FFO the fact that GGP will have to sell $1 billion of its $24 billion of mall assets. Right off the bat, this lowers FFO by 4%. My projection simply assumes a 1% drop in FFO from here, which could be optimistic if things get bad. If things get really bad, with FFO down 10%, fair value drops to 20.9. If FFO goes down 14%, fair value drops to 18.8.
Conclusion
In sum, assuming we see a small amount of core operational weakness, GGP will have to cut its dividend 35% and will have a fair value of 23.5, implying downside of 34% from here. If things get really bad on the retail side, GGP will probably have to sell more assets at more stressed prices just to stay above water, will have to cut its dividend further and imply a fair value closer to 19.

This is from an additional communication...

From the point of view of being thorough and accurate, I've got some updated figures. The conclusions are similar, but this takes into account the fact that the real LTV is the total secured debt divided by the total market value of GGP's properties. I am not confident on the covenant-related cap on debt issuance, but would strongly recommend looking into that, as I will. The ability to screw the unsecured debtholders may provide them some wiggle room, but it won't last them through 2009 in any case, and will only further destroy value.

• The numbers strongly point to not having enough cash by mid-2009 even if they could lever up as much as they wanted to. GGP would need $2.8 billion of additional cash from rights offerings, asset sales, or something else like that.
• Debt covenants seem to imply GGP can only re-encumber unencumbered properties by an additional $1 billion before negative covenants trip on unsecured debt. Even though I have had my team go through the fine print, I can't recall detailing the debt covenants. It is quite likely this was not fully factored into the analysis, but I would have to go back to check. In any event, net worth triggers are standard fare for unsecured debt covenants and one should expect them to be there unless GGP somehow negotiated one hell of a sweetheart deal several times over, which is unlikely.
• GGP's 2009 financials, normalized for the additional debt, imply cash outflow of $470 million per year. 2009 EBITDA minus all core operational cash costs is $291. Additional interest expense amounts to $211 million. Dividends at that time will be $550 million. To plug this gap down to -$100 million and cure the cumulative cash shortfall in 2008+2009, GGP would need to raise $9.5 billion, which would double the equity value of the company. I believe this would be highly dilutive.

And a last word from me...

I have diverted resources to the consumer finance and investment banking (again, I think I may have found something more) arena, so will not be digging any deeper into GGP for now. I wish to state, again, that no one should be taking my opinions (or statements or research or anything else), nor any opinion on this blog, as investment advice. I am not allowed to, do not intend to, and do not wish to dispense investment advice to the public. I am a very aggressive, high risk/high reward, contrarian, fundamental investor that often hurls himself against the crowd - which is very dangerous - even with the risk management procedures that I put into place. I also do not share my trading activities nor all of my research on the blog. There are plenty of people and entities who freely and legally offer investment advice such as James Cramer and the sell side investment banks. I, personally, do not have much faith in their track record of making people money, but the point is that advising is what they do - and not what I do. I am not allowed to do it. What I am doing on the blog is discussing my market and corporate opinions, viewpoints and experiences.

With that being said, I do not believe this recent bear market rally is supported by the macro economic environment nor the fundamentals. In fact in flies in the face of them. Hence, I have been steadily adding to my CRE and investment banking short positions in the recent rally.

Comments

[granger:]

Amazing analysis. Thank you. I have long steered clear of GGP. Not exact matches, but I have leaned towards MPW, FSP and DDR, with a sprinkiling of IGR instead for my real estate exposure.

2008 Mar 26 05:37 AM

[User 17009:]

In looking at your "analysis" the projected impact of the equity offering assumes that they gave stock away, the proceeds increase equity by $.8 B. This would bring your $23.5 figure up to $24.6. Missing this fundamental brings to question the accuracy of your analysis.

2008 Mar 26 08:15 AM

[Reggie Midd...:]

The writings in "my" analysis states clearly:

"However if we expect GGP to raise additional capital of $1.75 billion through private placement, GGP’s valuation increases to around $7.7 billion due to savings in interest expenses. However as a result of the dilutive effect (due to the increase in shares outstanding) GGP’s per share valuation declines to $26.5 (under our base case assumption), implying a further downward potential of 35.3%."

Thus, not only did we take into consideration the equity captial infusion, we took it at 2x what actually occured. These numbers are very conservative. I hope you would read a little more carefully before being so critical.

I diluted the guest commentators numbers to reflect the equity dilution and you are right in that I didn't include the funds from the offering explicitly - which is why the they are "comments" in italics and the original commentary and numbers are there for all to see and agree or disagree with as all deem fit.

I very rarely get around to commenting on Seeking Alpha, so anyone who has questions or comments that they actually wish to be addressed should direct them to my blog, boombustblog.com. I will be glad to engage you there where I appear on a regular basis.

2008 Mar 26 08:55 AM