Brian McMorris'  Instablog

It has been a few weeks since I have posted anything on General Growth for the readers of this blog. As those who have been reading know, GGP (now going by ticker GGWPQ) is a favorite speculation of mine. This is both for personal reasons (Midwest based and founded company; relationship with family member of founders) and for financial reasons (great speculative opportunity when digging beneath the surface). It is also a very interesting and likely historic situation. So, it is fun to be associated with GGP from an educational standpoint.

Other news on GGP the past four weeks: as reported on June 8 on Reuters: Bill Ackman and his hedge fund, Pershing Square LLC, were awarded a seat on the General Growth board of directors.  This is in stark contrast to Target which fought Ackman tooth and nail to keep him off.   Ackman's presence is important because he has a 25% stake (including swaps and call options) in GGP.

 The other big news  the past week was the decision of Judge Gropper, who is overseeing the bankruptcy proceedings, to make a decision by the end of June or thereabouts regarding whether or not General Growth is even entitled to a bankruptcy that includes its malls.   

In the most interesting turn of this situation, the parent brought a number of mall partnerships (SPEs) that were financed by securitized debt, under the corporate umbrella.  The debt holders cried foul because they thought they were immune to the parent's bankruptcy.  Most of the debt holders had refused to negotiate to extend loans with GGP.  My thinking is they were trying to take advantage of the credit crisis and had plans to strip away the assets without compensating General Growth.  The mortgages were bound to default if GGP could not refinance maturing loans during the financial crisis.

Today, I responded to a question poised to Todd Sullivan, a frequent commentor on GGP who posts on Seeking Alpha blog. The questioner was wondering about the future value of GGP and whether it was too late to get in. Here is my response:

Regarding the future value of General Growth and the appropriateness of buying more shares now, as you say, this is a pure speculation. There is no way to know the value of General Growth today. It is in bankruptcy proceedings and the value will be determined by the bankruptcy judge. So, to talk about today's economy and industry fundamentals is really missing the point of investing in General Growth.

It is much better to look at the range of possibilities and then decide how much you want to put down at the table. This is very much like gambling, though I think the odds are much better than any Vegas roulette wheel (which is about the only place you can get 13:1 odds in a gamble, other than the sports book).

The worst case is the stock is worth zero. That is certainly a realistic possibility. The judge can easily declare all common stock worthless. But given all the details of the situation, I think that is a low probability. As numerous reports indicate, and repeated here by Todd and on my website, General Growth remains cash flow positive. It is doing a great job of day to day operations management. It is highly unusual for shareholders to be wiped out under this circumstance.

A more likely resolution is for the debt holders as a class, to be awarded some amount of equity in return for reducing the debt outstanding. We just saw this in the GM and Chrysler bankruptcies. And in those cases, the companies were bleeding badly. General Growth is in much better shape, and is almost as strategically important in the American economy (in terms of size and setting a precedent for the resolution of securitized commercial debt).

 

So, the speculation here really comes down to the amount of equity the debt holders are awarded by the court in return for reducing debt, and the resulting dilution of the current equity holders. I am willing to speculate that the debt holders may be awarded an amount of stock in an amount no more than twice that which is outstanding (313M shares).

Why this amount?.... Why not? It seems that the judge may decide the debtholders, who inherently have a senior position to common equity, should end up with more than half the company. This solution would award them 2/3 the company, a solid majority.

The next question to answer, is what is General Growth worth in a normal economy if its debt is cut in half (from $28B to $14B) allowing GGP to operate in a normal fashion (service its debt)? GGP had cash flow of $1.44 oer share in 2007 prior to the Rouse acquistion and $2.11 per share in 2008 including the properties of the Rouse acquisition. 2007 and 2008 especially, were not good years for retail. It is possible normalized cash flow is $2.50 to $3.00 per share going forward in a typical economy. Let's say it is at the upper end of that range with less debt to service after the bankruptcy settlement.

What is the proper multiple on cash flow in retail real estate? Let's try eight. That works for a lot of businesses. It is equal to an unlevered 12.5% return on invested capital. The shares outstanding will become 1B (rounding up) if my projection of a 2:1 dilution (new shares to old) comes to pass. So, doing the simple math: 8 times $3 = $24 per share / 3 for dilution = $8 per share.

I consider that to be the mid-range scenario. There are rosier $13 / share scenarios, and more negative $2 / share scenarios. As I said before, I consider $0 to be a very low probability event.

All that said, at the current price of $2 per share, GGWPQ should still be a buy, though not nearly as good a one as two months ago at $0.60 / share.

Disclosure: No Positions