General Growth: An Attractive Arbitrage Trade

Includes: BPR, SPG
by: Green Griffin Analyst

General Growth Properties (NYSE: GGP) has had quite an extraordinary few years. A little less than a year ago, it became one of the largest victims of the financial crisis, filing for chapter 11 bankruptcy protection. Being the second largest U.S. mall operator in the country, right behind mall giant Simon Property Group (NYSE: SPG), its demise brought further panic and uncertainty into the real-estate market.

For General Growth shareholders, it was total defeat. The company’s stock had sunk to below $1 in anticipation of the filing, from its heyday highs of more than $50, and didn’t budge much after the filing was announced. For the founding family of General Growth - the Bucksbaums - it was a sad day in the company’s storied history, going all the way back to 1957 when two brothers, Martin and Matthew Bucksbaum, decided to expand their family’s grocery business and build a shopping center in Cedar Rapids, Iowa. The Bucksbaums owned (and still own) around 25% of the outstanding shares.

Along with the Bucksbaums, there was another very large shareholder: William Ackman of Pershing Square. Mr. Ackman also owned around 25% of the outstanding shares, and was instrumental in pressuring General Growth to file for bankruptcy. At the time, shareholders likely resented Mr. Ackman for the filing, but in hindsight, Mr. Ackman turned out to be one of the best things that could have happened to the company. Why? Because not only is General Growth preparing to exit bankruptcy, shareholder value appears to be fully intact, which is extremely rare for companies exiting bankruptcy.

How did this happen?

While I am not a bankruptcy lawyer, nor do I have special training in bankruptcy proceedings, I do know that when companies file for bankruptcy, they are typically insolvent. That is, their assets do not exceed their liabilities. When your assets do not exceed your liabilities, shareholders are typically the first group to get wiped out. Bondholders and other creditors are paid out first. Let me provide an example:

Let’s say you own a bicycle worth $100 (your assets) that you bought for $150 (your liabilities) a year ago with money borrowed from two sources: a bank (loaned $100) and your friend (loaned $50). You don’t have a job, and can’t pay anyone back with cash. Luckily you have the bike which is worth $100. In this example, legally the bank is at a higher tier than your friend, and must be paid back first. You are insolvent, the bank takes your bike, is made whole, and your friend loses his entire investment of $50.

Consider the above scenario, only that the bank is comprised of bond and other secure and unsecured debt holders, and your friend represents the shareholders as a whole. A typical bankruptcy is just like this. Shareholders almost always get wiped out.

But in this case, shareholders are not getting wiped out. Why? Because General Growth is not insolvent. Their assets exceed their liabilities. Due to the extraordinary disruption in the credit markets, General Growth had to file for bankruptcy because they were illiquid, not insolvent. Let’s take the above example again, but with you being illiquid rather than insolvent.

Let’s say you own a bicycle worth $200 (your assets) that you bought for $150 (your liabilities) a year ago with money borrowed from two sources: a bank (loaned $100) and your friend (loaned $50). You owe the bank $10 per month, and your friend $5 per month. Normally, you’d borrow this money from your parents, but they recently cut you off. So now you can’t make the payments on time. Rather than defaulting on your loan and having your $200 bike taken away, you file for bankruptcy to stop the bank (and your friend) from harassing you while you figure out a way to make the payments. You go into bankruptcy, develop a plan to pay back the money you borrowed (perhaps you renegotiate with your bank to pay $5 per month, and with your friend to pay $2.50 per month). When the plan is agreed upon, you emerge from bankruptcy and everyone will still get their money. Best of all you, get to keep your assets (the bike). Granted, the bank and your friend might get their money back later than anticipated, but they’re still getting it back, which they’re happy about.

This is exactly the situation that General Growth was in. The only wild card was whether all the parties involved would accept a deal so that General Growth could emerge.

Now that General Growth was in bankruptcy, they re-structured many of their debts and the stock climbed out of the doldrums and into the upper-single digits in late 2009. By this time, shareholders seemed to be voting with their wallets that General Growth would emerge from bankruptcy without wiping them out.

Then came Simon

In February 2010, Simon Properties Group came out with an un-solicited bid to buy General Growth for $10 billion, which equated to around $9 per share for all General Growth shareholders. To the shareholders, this was outstanding news, and confirmed that General Growth did indeed have substantial value. Anyone who bought shares of General Growth below $1 were sitting very pretty now with a floor of $9 per share. General Growth laughed the bid off, rejecting it almost immediately. At this point, the shares were trading around $13. I purchased shares of General Growth for both myself and my clients, figuring the floor is roughly $9, and the ceiling was anywhere from $15-$50. I came to this conclusion by taking into account Simon’s notoriously conservative bidding practices, General Growth’s prompt dismissal of the bid, Mr. Ackman’s own valuations that put the stock between $15 and $30, and my own valuations that, when discounted to today from 10 years out, General Growth could be worth as much as $50 (including all future dividends that must, by law, be paid out to shareholders). That is, of course, assuming that no dilution will take place upon exiting bankruptcy. That’s quite an un-realistic assumption, so I pegged the range to be between $15 and $25. At $13, with a floor of $9 and a ceiling of $15-$25, the risk-to-reward was too good to pass up.

Then came Brookfield

After the Simon bid of $9 per share, a new bid quickly circulated in the rumor mill. This rumor bid, which was later confirmed to be true, was presented as a stalking horse bid. A stalking horse bid is a bid which defines a minimum bid from which all future bidders must bid higher. Mr. Ackman partnered up with Brookfield Asset Management (NYSE: BAM) to put together a counter-bid to Simon’s paltry $9. The Brookfield deal was valued at roughly $15 per share of General Growth. To my and my client’s delight, a new floor of $15 had been set.

And so here we are

Since the Brookfield stalking horse bid (which has yet to be approved by U.S. Bankruptcy Judge Allan Gropper), there have been rumors swirling around, focused specifically on Simon raising its’ bid to counter the Brookfield stalking horse bid. From my view, Simon has everything to gain and very little to lose by even paying $25 for General Growth. I’m not even sure shareholders would accept that bid, figuring that General Growth would be worth far more as a stand-alone, dividend paying REIT.

As General Growth edges closer and closer towards emerging from bankruptcy, I believe the risk-to-reward is still too good to pass up. Especially at today’s price of $16 and change. With a floor set at $15, and a company worth potentially $25 (or more as a stand-alone), I’m adding to my positions. In addition, there’s a relatively short time-line to wait for this arbitrage to play out: the stalking horse bid is set for approval by April 19th, and bidders will want to get their bids in before that to reduce the cost of the warrants associated with the bid.

I encourage you to perform your own due diligence of General Growth as an arbitrage play. If that doesn’t work out, and it emerges as a stand-alone, the arbitrage play of $25 may seem like a pittance. Either way, and as always, do your own research and do not take my position as a recommendation to buy, sell, or do anything else.

Disclosure: Author holds a position in General Growth Properties, as do his clients.