Ed note: Last week we published Bill Ackman’s bull case for the mall REIT General Growth Properties. This morning we posted a rebuttal by Hovde Capital. Below is Whitney Tilson’s rebuttal to the rebuttal.
General Growth Properties (GGP) is one of our biggest winners in 2009, having risen from $1.29 on January 1 to a high of $12 a few days ago. It has sold off over the last two days to a low of $7.00 earlier today, most likely due to a widely circulated bearish presentation by Hovde Capital Advisors (posted here), which is short the stock. Hovde directly challenges Pershing Square’s analysis, which Bill Ackman presented at the Ira Sohn conference on May 27 (posted here; Pershing Square also discusses GGP in its Q3 investor letter and shares its bullish views of malls and retailers in this Dec. 7 presentation to the ICSC).
We don’t normally let the stock of a company in bankruptcy grow to be one of our largest positions, but have done so with GGP based on our belief that the company is very likely in the near future to either exit bankruptcy or be acquired – in either case, the stock should be north of $20. That said, GGP is no fortress like Berkshire Hathaway (also one of our largest positions), so such a large position makes us nervous and we’d welcome a rationale to trim it. We also always look for disconfirming evidence in all our investments, so we reviewed Hovde’s presentation with great interest. Alas, we found it unconvincing and full of valuation inconsistencies – but are grateful for the drop in the stock, which we’ve been using to aggressively add to our position this morning.
Valuing REITs is not that hard. The most widely used measure of financial performance is Net Operating Income (“NOI”), which is simply the income generated by the underlying properties. Enterprise value is computed by dividing NOI by the appropriate capitalisation rate (think of this as an annual hurdle rate; the lower the cap rate, the higher the resulting enterprise value).
Hovde’s bearish case paints an inaccurate picture of rapidly declining financial performance, then misstates NOI, and then applies an inappropriate capitalisation rate – a rare trifecta of poor analysis. Here’s a summary of the most important mistakes Hovde makes:
1) Hovde arrives at its NOI estimate for GGP by annualizing Q3’s NOI, which is invalid because of seasonality. Here’s an excerpt on this in GGP’s filings:
Although we have a year-long temporary leasing program, occupancies for short-term tenants and, therefore, rental income recognised, are higher during the second half of the year. In addition, the majority of our tenants have December or January lease years for purposes of calculating annual overage rent amounts. Accordingly, overage rent thresholds are most commonly achieved in the fourth quarter. As a result, revenue production is generally highest in the fourth quarter of each year.
2) Hovde compares GGP’s valuation to other REITs, but isn’t consistent in how it does so. Hovde takes GGP’s future NOI (which it projects will decline, as does Pershing Square, incidentally – see page 36 of its May presentation) and compares it to peer companies’ trailing NOI.
3) Hovde is also inconsistent in how it calculates NOIs – it haircuts GGP’s NOI with certain “unusual items” but fails to do so for peer companies’ NOIs.
4) Hovde only analyses GGP’s core REIT business, ignoring GGP’s valuable management and Master Planned Communities businesses, which are worth at least $1 per share (and could be worth as much as $8/share; see pages 5 and 59-66 of Pershing Square’s May presentation).
5) Hovde uses high cap rates that are outdated and based on invalid comps. With the market moving so rapidly, even transactions from a few months ago are of questionable value. This slide from Pershing’s ICSC presentation (page 19) shows how quickly mall REIT cap rates have fallen in recent months (and how they are likely to fall further):
In addition, take a look at the stock charts of Macerich (MAC), Simon Properties (SPG) and Boston Properties (BXP) since the Pershing Square presentation on May 27. In light of how much the market has moved, Hovde’s belief that the cap rates Pershing Square used in May are too aggressive in today’s market is absurd:
6) Hovde completely ignores GGP’s value as a strategic asset to an acquirer, which is not a theoretical idea but a concrete reality as both Simon and Brookfield are circling right now. For Simon, there would be big cost savings and, more importantly, revenue benefits: according to the WSJ article below, “Buying General Growth would make it by far the dominant player in the U.S. mall industry with more than 500 properties, giving it enormous clout over retailers in lease negotiations.” As for Brookfield, it raised a $5 billion fund in the past year to make acquisitions and GGP represents its last opportunity to break into the U.S. market in a big way. These are two very motivated potential acquirers.
Here’s an excerpt from an 11/18 WSJ article:
Mall giant Simon Property Group Inc. has hired investment adviser Lazard Ltd. and law firm Wachtell, Lipton, Rosen & Katz to help it formulate a strategy for possibly bidding for all or part of rival General Growth Properties Inc., which is operating under Chapter 11 protection.
The moves set the stage for what could be a takeover struggle as General Growth readies a plan to reorganize and exit from bankruptcy…
…The manoeuvring comes as mall owners are getting pummelled by the weak economy, which has hammered rents and occupancy as consumers have reined in spending. Nevertheless, a prize like General Growth, which owns 200 malls, may be too juicy for others to resist. The opportunity “is a potentially transformational event that doesn’t come along very often,” says Steve Sakwa, an analyst with International Strategy and Investment Group Inc.
And here’s an excerpt from a 12/4 WSJ article:
One of Canada’s largest property owners may be about to face off against the largest mall owner in the U.S. over General Growth Properties Inc., according to people familiar with the matter.
Brookfield Asset Management Inc. (BAM, of Toronto, which manages some $40 billion of commercial property world-wide, has purchased close to $1 billion of General Growth’s unsecured debt to position itself to make a bid on the company or some of its malls, people said. General Growth, known as GGP, is the country’s second-largest mall owner with 200 properties. It collapsed under billions of dollars in debt at the height of the credit crisis and has been operating under bankruptcy protection since April.
Brookfield faces competition, though, from Indianapolis-based Simon Property Group Inc., which owns 323 U.S. malls and has been hiring advisers and buying General Growth unsecured debt in preparation for making a bid, people said. Simon wants to acquire all of General Growth not individual assets, a separate person familiar with the matter said.
“This is a once-in-a-generation opportunity to buy a large, high-quality mall portfolio in the U.S.,” said Jim Sullivan, an analyst with Green Street Advisors Inc…
…Both Brookfield and Simon have strong balance sheets and are highly motivated. Simon has raised $4 billion this year by selling stock and bonds and has more than $3 billion in undrawn money in its credit lines. Buying General Growth would make it by far the dominant player in the U.S. mall industry with more than 500 properties, giving it enormous clout over retailers in lease negotiations.
Brookfield, whose most prominent properties include World Financial centre in downtown Manhattan and Brookfield Place office complex in Toronto, has been trying to break into U.S. retail for years. It attempted in 2007 to buy Mills Corp. and its 37 discount malls, but Mills ultimately was bought by Simon and Farallon Capital Management LLC.
More recently, Brookfield was part of a bid led by Goldman Sachs Group Inc. to provide debtor-in-possession financing for General Growth in bankruptcy, but a rival bid led by Farallon ultimately prevailed. Brookfield in the past year has raised $5 billion, mostly from institutional real-estate investors contributing to its newly created fund for making acquisitions.
Our Valuation Methodology
Reasonable people could argue endlessly about what the appropriate cap rate is, so we believe it is useful to value GGP another way: based on cash flows. Our simple (and we believe conservative) valuation of GGP’s REIT business is:
NOI $2.4 billion
Minus senior debt service* $1.1 billion
Minus cap ex $0.3 billion
Equals cash flow of $1.0 billion
Simon Properties trades at 14x this number. If we apply this multiple to GGP, the unsecured debt plus the equity is worth roughly $14 billion. Netting out the unsecured debt leaves approximately $7 billion for the equity, equal to more than $22 per share.
* Assumes the remaining senior debt gets renegotiated on similar terms; see this morning’s press release here.
We’ll let Todd Sullivan, who raises some additional questions about Hovde’s analysis here, have the last word:
I will not make any accusations. BUT, whenever I see anything that uses changing metrics (sales per sq. ft. to NOI margin), data a year old in a rapidly changing industry, omitting some data and comps that are questionable at best due to the deal structure, in virtually every instance it is done so to make the data fit the preconceived outcome, not deriving an outcome based on the data…
The true irony of this short thesis is that they accuse current GGP investors of using the Pershing presentation from May of this year claiming its data is “outdated”. They say that, and then go on the use even older sales per sq. ft. data from December 2008 for their comps.
What did the pot say to the kettle?
Disclosure: Author’s fund is long GGP.