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General Growth: Rebutting Shorts thesis - Part 2

|Includes: GGP, Inc. (GGP)
 
GGP shorts have recently put out a presentation defending their thesis. A large part of the thesis relies on valuation. I would like to weigh in with my analysis of how things may pan out here.

On NOI
There has been a lot of talk on NOI. I believe lot of the talk on NOI decline is exaggerated. Simon as recently as Aug 2009 has given guidance of flat NOI growth for 2010(slide 20-Pershing presentation). I also believe NOI number to be used in Valuation will be more closer to the LTM NOI (this is actual for Last twelve months) number used in Pershing presentation. The US retail sales in Q4 have improved year-on-year.
 
So what is the right Valuation methodology for GGP ??
To answer this, the most important thing to ask is: who are the market participants in the market General Growth intends to raise capital or be sold off ?
 
Here are some of the possibilities. I would like to point out these are REAL possibilities and most of the transactions have a reasonably good demand factor from the buyers in the market TODAY.
 
1. GGP does public secondary offering in the capital market.
Who are the Buyers: Institutional players like REIT Mutual funds, Pension Funds, etc
 
   Who is the Buyer: Simon
 
3. GGP raises non-controlling equity capital from BAM, Westfield or others
   Who are the Buyers: Simon, BAM, Westfield
 
In Scenario 1) GGP is looking to raise equity capital in the capital market.
If Equity capital of comparable(in business/operational cash flow risk and financial/leverage risk*) company is trading at a certain market multiple(cap rate), and if the market participants are the same, why wouldn't the market price valuation of such an offering be closer to market price valuation of comparable company's ?
 
Let's assume if the company did not care about existing shareholders (this is not the case here - Bucksbaum Family trust owns >20%, Pershing has stake of 25% and the CEO has handful of stock options) and priced the offering at huge discount to comparable company's market price.
 
Wouldn't the price in secondary offering in, let’s say Dutch auction process, be bid up by the participating institutions or arbitrage funds to its comparable peer's market value price ?
 
When Pershing put out its Dec presentation valuing GGP at around 32$ per share (6.71 cap rate) analyst James Sullivan from a REIT research firm, Greenstreet Capital said "Some of his assumptions are at an aggressive end of a reasonable range -- more aggressive than I would use, but still within a reasonable range,” (http://www.businessweek.com/news/2009-12-23/ackman-says-general-growth-shares-are-undervalued-update4-.html). This is important because this is coming in from a independent and pre-eminent research firm in the REIT area; REIT research or valuation is what people at GreenStreet Capital do for a living.
 
In Scenario 2) as pointed out by Pershing, there is going to be an additional price premium associated with selling a "controlling" stake. An all-out acquisition from Simon would enable it to be the nation's BEST mall operator, improve efficiencies and cut costs, and arguably give Simon much better leverage over rental negotiations with tenants.
 
Here is a transaction to prove pricing point from another angle:
Let's say Simon were to value GGP at the low end of Pershing’s valuation (7.21 cap rate- 23.74) and offer to pay off GGP bonds by issuing new bonds and then issue new Simon's stock for GGP's stock with the exchange valuing GGP at 23$ per share..
Such an acquisition would be accretive for Simon’s old shareholders as entity being acquired at a discount to parent company’s market value.
 
Wouldn't Simon Share price increase to the extent it gets valued where it was pre-acquisition (implied cap rate of 6.71%)?
 
Why are the shorts wrong on Valuation methodology?
 
Hovde in its most recent presentation says:
Based on Observed Transactional Data We Believe Current Cap Rates Are Higher 
Than Pershing Square Argues
.The acquisition of Prime Outlets by Simon Property 
Group (NYSE:SPG), announced on December 8th, was estimated to be priced at 
an 8.0%
‐8.4% cap rate on in‐place NOI based on some Wall Street estimates.(1)
 
Hovde is comparing outlet malls to high quality regional malls. This is not apples to apples comparison. Many longs have already explained this ad infinitum.
 
Hovde’s other comparison was of sale of JV interest in individual property in August. This is again not apple to apple comparison on several basis: interest (this is JV sale), scale(this is one property) and time(in Aug simon was trading at 55$ per share..now it is at 80$ per share) basis
 
Boombust Blog says
“The valuation of mall on the basis of trading multiples in the stock market (highly volatile and largely influenced by overall market sentiment not to mention the proclivity for short term manipulation by momentum traders) does not give the realizable value of the portfolio on liquidation under the existing market conditions, not to mention distressed market conditions - nor does even come close to doing so.”
 
I agree. But why would the company sell or liquidate individual properties under current conditions? Isn’t that why the company filed for Bankruptcy to get extensions on the loans without liquidating ??
 
BoomBust Blog appears to live in pre-2009 world and apparently does not recognize some of the 2009 events that I have pointed below. It is fixated with its liquidation value analysis (which is used by creditors) which was largely relevant a year back with lot of CRE coming due, a frozen CMBS market and with no precedent of CMBS loan modification. Back then, for GGP and other CRE players, there was a lot of refinancing risk and uncertainty of how the secured loans would be dealt with and liquidation was a real possibility. A commercial real estate Armageddon was everyday news on the WallStreet Journal. That was 2008.
 
But fast forward to year-end 2009, the company's risk of refinancing and hence risk of liquidation is gone. Landmark decisions by Bankruptcy Judge Gropper, Treasury relaxing tax rules on loan-workouts for CMBS and Fed Reserve's tacit guidelines on mark-to-market rules have all been to thwart mass liquidation in CRE sector and favor consensual loan extensions. 
 I would like to highlight a few of those precedents below:
 
1 Bankruptcy court says "Bankruptcy remoteness of SPE does not mean it is bankruptcy proof"
GGP the parent company dragged a number of so called Special Purpose Entities/those were the collateral behind the CMBS securities (even those where loans were not due for number of years and where they had not defaulted). The SPE subsidiaries were set up expressly to protect the collateral of investors of mortgage backed securities from any bankruptcy event at the parent.
 
2 Treasury eases restructuring of CMBS or Loan modification of CMBS securities -  Removal of tax implication for CMBS work outs
 “The Treasury, responding to the growing pain in the commercial real-estate industry, released new tax rules that make it easier for distressed property owners to restructure loans that were packaged by Wall Street firms and sold as securities.”
 
3 Federal Reserve says - Secured loans don't need to be written down solely based on decline in collateral value, if the borrowers can meet mortgage payments.
It incentivized banks to modify loans with borrowers instead of trying take possession of properties and having to deal with writing down that asset.
 
All the above paved the way for consensual loan modifications in lieu of piece meal liquidation of properties.
 
Consequently, I think, the capital market has "priced away" the refinancing/liquidation risk in the REIT stocks. The credit market too has seen some new CMBS offerings.
 
There is other relevant anecdotal evidence worth taking note off:
 
a. The REIT stocks which were beaten down heavily in 2008, are up >50% YTD in 2009.
b. IPO market has improved significantly since Sept 2009 (www.businessweek.com/news/2009-12-29/gol...)
c. On Dec 16th, Citi came up with largest public stock offering ($17 billion) in the entire US history.
d. "So far this year, REITs have raised more than $35 billion by selling shares and bonds, outshining most private companies and funds which have been struggling to raise capital from institutional investors, lenders and other sources." - WSJ
http://online.wsj.com/article/BT-CO-20091208-712552.html
 
All this highlights the current bullish sentiment in the capital market and how a potential secondary offering from GGP would be received
 
The world that BoomBust Blog paints seems more like the 2008 world before any of the above events happened. Also, the blog completely ignores the real possibilities of M&A transaction as highlighted above.
 
Implied Cap Rate of Comparable peer is the most relevant market price for the capital being raised:
A valuation methodology of looking at precedent transaction of individual property sales and applying that CAP rate is more apt in a distressed scenario of property-by-property liquidation; It doesn't make an iota of sense, when you have REAL capital market participants willing to own capital asset of whole company at market prices (implied cap rate) or multiple strategic players willing to bid on company to acquire a majority controlling stake, all for the long run. In such a scenario, market valuation based on implied cap rate of comparable capital asset would be the most appropriate.
 
What is Current Market Rate (Implied CAP Rate)
Pershing has pointed out in page 23 that the implied CAP rate of two of its most comparable peers, Simon and Westfield are 6.71% and 6.5% respectively (source: Green Street Advisors Weekly Pricing Update - Dec 16th 2009)
 
Simon’s Asset Quality, Operational Risk and Leverage risk makes it the most comparable peer to GGP (post conversion of unsecured debt)
Simon’s asset quality is comparable to Simon (Source: Greenstreet capital..See Pershing’s slide 24)
Debt/LTM Cash NOI of around 8 which is slightly above Simon ratio of around 7.8. This assumes GGP unsecured debt converts to some sort of equity capital (See Pershing’s slide 25)
 
If a CAP rate of 6.71% is used with LTM NOI of 2.478 Bil, the equity value in GGP would be around 32$ per share. (See page 26 – Pershing presentation). I do believe secondary offering would be priced at a discount to market price
 
Appendix:
Pershing presentation-> https://seekingalpha.com/article/179435-bill-ackman-rebuts-hovde-s-short-thesis-for-general-growth-properties?source=yahoo

Disclosure: Long GGP equity