Munger on valuation

Organized common (or uncommon) sense  is an enormously powerful tool. There are huge dangers with computers. People calculate too much and think too little

Charting Banking III: funding

A bank’s liabilities are its assets, and its assets are its liabilities – David Merkel’s clever old boss

I am a sucker for paradoxes because they stretch our linear thinking. Before any accountant starts complaining that I should get back to school, let’s give David Merkel the opportunity to explain what that means

Banks that focus on their deposit franchises have something of real value — that is hard to replicate. But any bank can invest their funds aggressively, which will lead to defaults with higher frequency. It is true of insurers as well, most financials die from bad investing policies, and short-term liabilities that require complacent funding markets – David Merkel

Deposits are a sticky funding source and is critical for banks; institutions that for the most part are lending long term with short term borrowings. Deposits in a sense have become long term borrowing and in time of crisis they can make a difference. That was not always the case but FDIC insurance, consequence of the Great Depression, changed the rules of the game. So most modern run on the banks are consequence of the drying up of wholesale funding sources like the Northern Rock case.

So here is a chart from a Citizens Republic Bancorp presentation, a bank that I do own, that tackles this risk of funding sources. Some would argue that instead of equity you should use tangible equity and that instead of total assets you should use tangible assets; you might want to do those adjustments.

Long CRBC

The art of profitability

I am a better investor because I am a businessman, and a better businessman because I am an investor – Warren Buffett

This book review is a lot about me, and at the end you will find a book and how it inspired me. I will not try to sell you that nonsense that my story can help others. I just felt that my journey overlaps with the story, and since I know myself pretty well and want to know myself better, I thought it was a good complement. So please, if you do not like too many I’s and me’s just skip them and go directly to the book review.

Some of us have followed the roundabout way to become an investor. After three years in the investment department of a small insurance company (two people, the CIO and myself) I decided that it was more fun to learn about good businesses and not only to invest in them. Had enough of dealing with brokers and their nonsense pitches, fund managers high on themselves while copying each other, and internal politics with a focus on outcomes rather than processes. In summary, I was not learning much.

So enough! Time to know about good businesses and how to run them. So I cashed my investment profits and moved to the US to study an MBA. Some of you will laugh at that thought but it sure started a fun journey.

If I ran a business school there would be only two courses: how to value a business and how to think about markets. No modern portfolio theory, no beta, etc. – Warren Buffett

Warren Buffett is clearly thinking on chapters eight (Mr. Market) and twenty (Margin of Safety) of the Intelligent Investor. It is also clear that he made that comment for effect: his target was the foundations of modern finance.

Having had the fortune and misfortune of also completing an MBA, I think the quote focused so much in a very deserving target that missed the mark on other aspects of an MBA and of being an investor. First of all, even for an investor I would add at least three themes to that curriculum

1. How to find good, cheap and safe ideas? (Greenblatt and K. Fisher, also competing for worst book title ever)
2. How do I manage a portfolio of ideas across the credit cycle? (Lynch and Klarman)
3. What can we learn from history? (Kindleberger and Livermore)

Because for an investor reaching a certain size or managing other people’s money, net-nets will not suffice. The framework stands but he should also become a good sociologist, risk manager and historian.

But even more, the output of business schools is not supposed to be investors but businessmen (not that they are doing it). These are some of the things a businessman should know

1. What is a good business?
2. How good businesses are born, grow and decline?
3. How do you renovate a business?
4. What is good management?
5. How do you manage a portfolio of good businesses?

And of course, negotiation, motivation, networking, all that soft stuff …

This is a different journey, from economist, passing through historian, entrepreneur, sociologist, and finally becoming … an investor. This knowledge can be highly complementary to an investor arsenal, as referenced by Buffett with the initial quote, and is usually learned over time. Others, like me, decided to learn it at the beginning and realized at the end that there was more about investing that you thought.

So being a sui generis investor let me suggest a book from this other path. A book that I am almost sure you have never heard before. A book that tries to answer that first question: what is a good business?

The Art of Profitability was written by Adrian Slywotzky a management consultant VP of Mercer (firm that I think changed its name to Oliver Wyman after the merger). Maybe for these reasons, the book carries the consultant sins of trying to put new names to known things, being a self promotional and somewhat condescending in parts. But if you look beyond those flaws, you will find an honest and inspirational effort on teaching how to learn about profits and good businesses. And if you can believe this former management consultant, Slywotzky is very good.

• Its focus, while teaching all these business models, is in the process of learning and how to inspire a newcomer
• It is not your usual dry checklist of what a good business is, like Porter’s Competitive Advantage, but a list that can be added, combined and transformed.
• Provides a fantastic list of business cases and books on a wide range of subjects to explore the limits on how to create profits. And I assure you, no matter how experienced you are, you will learn a trick or two
• Inspires not only to read a second time Sam Walton’s Made in America, but also a third and a fourth
• Made me realize that I may have known pretty well Berkshire Hathaway as a business but that I had missed Warren Buffett the investor. Believe it or not
• It emphasizes the importance of measuring things while avoiding being more precise than necessary (Cuánto!)
• Can be a good reference book to be reminded of the simple but not simpler in business, side by side to Updegraff’s Obvious Adams
• It asks more good dumb questions than it answers

In short, it is the sort of book that ignites a new learning journey. Go and read those first six pages of the prologue in Amazon. If you get hook, let me tell you that the rest of the book is much better. And by the way, the first time I heard about Graham and Dodd was in the The Art of Profitability

You must think independently and you must think correctly – Graham and Dodd

Maguire Properties, Liabilities (Part II)

Good liabilities are an asset – Bill Ackman

Note: this article was written for the Complete Growth Investor a couple of weeks ago. The preferreds and common had a fantastic ride since it was written. So I would recommend some caution with the margin of safety of both the common and the preferreds and please adjust the reference prices and target returns. Note also the intro written two weeks ago.

The thesis has two parts. First, to prove that MPG has a margin of safety and its liability structure will protect it from Chapter 11. If that is true, it will come perfectly clear that the unencumbered and non recourse properties should provide plenty of assets and cash flow to pay the cumulative preferreds in a year or two.

The preferreds have accumulated already $1.9 per share and will keep accumulating $1.9 per year. And there are only 10 million preferred shares with a $25 liquidation preference trading at $9 per share. I think it is safe to say we are looking to a potential 3x in two years with a clear catalyst (dividend reestablishment) and downside protection (properties with non recourse mortgages and unencumbered assets). And every quarter we wait at least we are accruing more dividends.

The second part is trickier because it is no only about showing that the common is undervalued. But more important, that it has more upside than our opportunity cost: the potential 3x of the preferreds and its higher preference in the capital structure. And there is a real possibility that I may fail to convince you given that an important part of the value in the equity is intangible optionality.

So let’s start. “Good liabilities are an asset” is a very counterintuitive thought. However, when credit is limited long term maturities and non recourse gives management options in his negotiation with lenders:

The post is dry, so I hope this chart will make things easier. The top right quadrant (Type 1) is the type of debt that you want to have, the type of debt that gives you options. In particular, if you have to refinance an unprofitable mortgage it will be in your terms because you have time (LT maturities) and you carry a stick (non recourse). It is much more difficult if you are in the bottom left corner (Type 4). The obligatory maturity payment gives the lender the upper hand. Even a profitable property in this situation, like Lantana, could be a problem. And that is the reason that its sale for a profit is such good news.

For the most part, MPG has good liabilities (Type 1 in green). However, even some of these good mortgages, the ones highlighted in red, have some recourse obligations. One is Lantana that was sold in November last year, so problem solved, and the other one is Griffin Towers recently mentioned in a WSJ article, with a $23 million recourse repo facility.

Also from the good mortgages (type 1) you have probably noticed that several are in default. Those are the ones jingled mailed (OC strategy) that I mentioned in Part 1 of the series:

I’d like to begin my comments this morning with a brief background on the assets involved in our plan announced today. All seven of these assets were acquired by the company after the initial public offering of Maguire in June 2003.Four were part of the acquisition of 24 EOP/Blackstone assets in April 2007. One was part of the acquisition of the common wealth portfolio in March of 2005 and Park Place I and Park Place II were acquired in 2004. The borrower for each of these loans secured by these assets is a special purpose entity formed for the purpose of owning and operating and individual property. Prior short falls in monthly debt service and leasing costs have been mostly satisfied through property level reserves. These reserves were funded at acquisitions with mortgage proceeds. As these reserves are exhausted, capital of contributions to these special purpose entities will be required.

Six of these assets included in the plan are encumbered by CMBS mortgage loans. The master servicers of the mortgage loans in cumber in these properties have been advised that the future operating and debt service requirements for the property will rely only on property generated revenues and as a result, the borrower expects an imminent default under the loan. (CC Q3 2009)

And what is the beauty of this? Well all these properties have a combination of large vacancies, high interest rate, or both. In other words, they were burning needed cash.

Projected cash flow savings for the next 18 months from the disposition of these seven assets are anticipated to be approximately $30 million. Then in addition for this group of asset, the cash burn associated with this group of assets during the quarter was approximately $6 million so as you can see once these assets are dispose we’re still slightly negative primarily due to capital expenditure but again we are still utilizing restricted cash on our balance to fund the majority of our leasing cost, those are funds that will be defeated overtime and need to replace but from a near term liquidity perspective , that’s a major source of cash that we have to lease of our portfolio. (CC Q3 2009)

Cash Flow Savings = $30 million / 18 * 12 = $20 million per year

Reduced Cash Burn = $6 million * 4 = $24 million per year

Increased Cash Flow = $44 million per year

For MPG, that has only recently achieved cash flow breakeven, this is nothing to sneeze about and should help the company navigate the recourse debt left. And also, it could easily sustain the dividends for the preferreds if the core Los Angeles CBD properties do not deteriorate.

But that is not the end of the story, since they are carrying a big stick and there is no incentive for the lenders to foreclose. I do not want push this point too far given that to renegotiate commercial mortgage-backed securities (CMBS) is difficult given the fragmented nature of its ownership (ie: Stuveysant). But, if MPG, that does this for a living, is not able to lease these properties up to profitable levels, who else?

Regarding the recourse short maturity portfolio (type 4), most of it is related to constructions loans

Each of our construction loans is subject to a partial or total guarantee by our Operating Partnership. The amounts guaranteed at any point in time are based on the stage of the development cycle that the project is in and are subject to reduction if and when certain financial ratios have been met. These repayment guarantees expire if and when the underlying loans have been fully repaid.

The terms of our Lantana Media Campus construction loan and Plaza Las Fuentes mortgage require our Operating Partnership to comply with financial ratios relating to minimum amounts of tangible net worth, interest coverage, fixed charge coverage and liquidity. Certain of our other construction loans require our Operating Partnership to comply with minimum amounts of tangible net worth and liquidity. We were in compliance with such covenants as of September 30, 2009.

So selling Lantana, that was a $176 million combined debt, solved a large part of the remaining recourse issues. The rest are substantially smaller and the way they are dealing with it is through a lease up strategy to eliminate some of the recourse obligations:

If you were to look at the portfolio, basically in Orange Country, probably an asset that has got the largest cash burn would be an asset called Griffin towers. It also has associated with it a repurchase facility that is recourse to the company. So there’s a $23.2 million, I believe recourse facility. Though upon Karman Campus, which is 151,000 square foot building in Irvine, it’s a building that we constructed that’s currently empty, that’s obviously has cash burn from interest expense. Again it has a recourse obligation associated with it approximately $7 million.

Then in Central Orange, we also having that, it’s called 3800 Chapman. It’s about 63% vacant, so it is not covering debt service. However, it has a debt service guarantee until maturity for 100% of the debt service. So, our focus there is to lease-up that asset if we can achieve a one-one debt service coverage ratio for two consecutive quarters we can eliminate the recourse and that has been our strategy for that assets.

Then in San Diego, we have an asset called 2385 Northside, which was a construction asset, was 52% leased. That tenant will start paying rent later on in the year. So, it’ll make a debt into the short fall. Currently, we have no rent coming in and we are very close to signing another lease that will take that asset to 72% occupied. Our strategy there has been to focus on leasing because again, that asset has a repayment guarantee that can be eliminated, as you achieve certain debt service coverage ratio. (CC Q3 2009)

If the lease up does not work, plan B is to sell the property and pay the difference. A strategy similar to the sale of 3161 Michelson in the second quarter of 2009.

Gordon Watson – Ore Hill Partners On the construction loans you’re selling, are you anticipating at this time making any payments from unrestricted cash to get rid of those construction loans?

Nelson Rising It’s conceivable there will be some, but it’s our hope that it will be minimal. The Northside property is on the market. It’s 75% leased. It’s a good property that’s part of a four-building complex, and we are marketing all four buildings and just the newly constructed building separately if someone wants that.

And so I think that will be successful in not having any payment. The offer that we have in bottom of that for in common stock will require some payment to bring that loan to the balance. The purchase price is being offered to us under a letter of intent, not a binding agreement yet, on the 207 Goode would be the loan balance number. These are all transactions in the works. Nothing is closed, and I just don’t have an answer as to the amount that we would be forced to pay. Those loans do have guarantees.

In the case of the Glendale property we have just received a Certificate of Occupancy and as is the case of most construction loans, until you have Certificate of Occupancy 100% of the loan is guaranteed. Once the lender approves the Certificate of Occupancy, the Glendale number will be $9 million. Von Karman is about $7 million, and Northside is about $4 million. But it’s our hope that our sales prices will come close to giving us break even on this.(CC Q3 2009)

So $20 million from the construction projects plus $23 million for Griffin Towers in recourse obligations should not be the end of the world. And there are no really big short term non-recourse issues (Type 3). KPMG Tower comes due only in 2012 and it is 93% leased so it should not have a problem to renegotiate or sell. The only other issue could be Brea Corporate Place that is only 56.3% leased.

So lets consider that are some assets besides the profitable LA CBD core: cash, unencumbered land, a 20% participation in a profitable JV and a net operating loss carry forward. First cash:

$62 million in unrestricted cash and it seems that items 2, 3 and 4 are just conservative accounting. And when properties are sold some of these reserves will be released. Regarding land, I went through the 10K (Note 22), $151.6M in the books is unencumbered (Note 4 in the 10Q)

We also own undeveloped land that we believe can support up to approximately 4 million square feet of office and mixed-use development and approximately 5 million square feet of structured parking, excluding development sites that are encumbered by the mortgage loans on our Stadium Towers Plaza, 2600 Michelson and Pacific Arts Plaza properties, which are in default.

Note 4—Land Held for Development and Construction in Progress

Land held for development and construction in progress includes the following (in thousands):

MPG also owns a 20% interest and is responsible for day-to-day operations of the properties of a joint venture withan Australian firm, Macquarie Office Trust (do not confuse them). Given that they use the equity method the cash flow statement only records distributions, undervaluing the earnings power of the JV. It also receives fees for asset management, property management, leasing, construction management, acquisitions, dispositions and financing. In this JV, Quintana defaulted but all the other properties are very profitable. One California Plaza is in a bind given its short term maturity. But its equity is substantial and generates good cash flow so it is in a good position for a sell

With respect to One Cal Plaza, that’s a process that is being basically driven by Macquire. There has been a significant interest in the asset. Again, it’s under contract, and the person who has it under contract with the entity is in the process of raising, trying to put together a final financing on that property. (CC Q3 2009)

And finally, As of December 31, 2008, MPG had a net operating loss carry forward of approximately $270 million that should shield the profits when the recovery comes.

So the equation is easy: not much in recourse obligations left, the OC strategy should restart cash flow generation, and there is cash, unencumbered land, a 20% participation in a profitable JV and large NOLs to carry them through the turnaround. The preferreds must be an easy kill, is there more value left for the common?

Long MPG

Charting Banking II: net interest margin

Net Interest Margin (NIM) = (Interest Income – Interest Expense) / Earning Assets

In simple terms, what a bank does? It borrows money to lend it. That has been historically its main income source until recently, when fees became important. The net interest margin therefore is a very important metric, equivalent to the cost of production of a commodity producer. You will see in the chart several banks that Buffet has had for a long time with very high NIMs, starting with Wells Fargo of course.

With the interest spread becoming more favorable the net interest margin of several institutions has been expanding. For several of the represented banks the NIM is higher than 3% close to the times where they could borrow at 3% lend at 6% and be in the golf course by 3. The old 363 rule, from the times when there was no significant fee income.

Not all bank institutions (Banco Popular BPOP) are in that expanding NIM sweetspot yet since their non accrual assets, very closely related to non performing assets NPAs, can be a drag in the interest income. But NPAs do not even need to improve to start having a positive effect in NIMs, they just need to stabilize.

No Position

Charting Banking I: interest spread

Let’s start with the most important story in banking today, and it is not commercial real estate. It is the significant improvement of the interest spread of new loans versus deposit costs.

This spread reflects both the marginal profitability of generating new loans and resetting those deposits to new lower interest rates. In time, this spread is driving the significant improvement in net interest margin (NIM) of most banks as soon their non performing assets (NPAs), that are not accruing interest, start to stabilize. Some call it the big bailout, but historically this has been the way that lower interest rates has stimulated the economy. As soon, as banks strengthen their balance sheets and competition for loans restart, new loans interest rates should also fall down.

The following is a chart from the recent Zions Bancorporation (ZION) investors day. This bank is still is shaky and has not been as aggressive as others in recognizing NPAs but the information disclosed was excellent. And this graph tells the tale.

No Position

Charting Banking Series Intro

“We worry top-down, but we invest bottom-up” – Seth Klarman

Despite its name, this is not a series on Technical Analysis. I think it is time to share some nice graphical data, result from a lot of time spent recently analyzing banks, that tell some underappreciated, misrepresented, or difficult important facts on the strength of the industry. Most of these graphs are from companies that I do not have and even some of them will be from companies that could be good shorts. So just the facts.

The streetcapitalist has a great interview with a bank analyst that raises some very good points on the suitability of this industry for value investing. The black box nature, leverage, and thin margins can look more suitable for speculative plays:

In Margin of Safety, Seth Klarman says that value investors don’t invest in banks often because their asset books are too opaque. How, when you’re analyzing a bank, do you make sure the assets have a credible margin of safety?

It depends on a lot of factors. 1. The types of loans and geography 2. How loans are performing. 3. Management’s track record in originating loans and honesty. 4. How the macro is performing and 5. How aggressive/conservative management is in working through problem loans.

So dealing with the transparency, that’s a good question. Investing in financials is more of a gamble than any other category. You will simply not have the transparency you have at other simpler businesses. In other sectors management on conference calls can give you line item guidance that you can just plug in your models to come out with next quarter EPS within a small range of error. How many financial management teams got it wrong or thought they wouldn’t be the last one’s holding the bag during the crisis? I remember hearing Ken Lewis (CEO of Bank of America) talking about how the recession will end in 2Q08. And this guy basically gets a real time update on the economy on a daily basis.

So you want a wider margin of safety. If you would buy a company at 6x P/E, you might want to aim for 4x P/E.

Financials are truly a different animal in my opinion. There is no advantage in investing in financials (meaning you are not getting superior moats or higher ROE businesses compared to other sectors) If you thought the market was dead cheap in march for example, there were plenty of businesses in plain vanilla sectors (retail) that had rises greater than or similar to financials and were much easier to understand. Assuming these stocks were undervalued and haven’t gone up for speculative purposes, you can see that car rental company Avis Budget Group (NYSE: CAR) is up 11 fold since its low compared to Bank of America which is up 6x. I would say Avis is a lot easier to understand than BoA.

So why did value investors get it wrong?

As a value investor, investing in a financial requires really getting comfortable with the macro-economic situation. So unless you’re doing some kind of arbitrage (market-neutral) play, you will have to look at the macro. If you want to ignore the macro because Warren Buffett says it is useless then you want to stay away, especially if you’re not benchmarked or don’t have a mandate to invest in financials.

The thing is that now banking microeconomics has become the developed world main risk. With banks and shadow banks being the main channel of credit, and with a government every day more limited in its options, it is clear we need a healthy banking system… and I worry.

And since the sector interconnectedness and fragility is the main driver of the credit cycle, this is a critical issue to follow in a top down risk analysis. I would argue that to understand the risks and the probabilities of a revisit of the March 2009 lows, a rapid recovery, or a range bound market it is important to understand the health of this industry and have a view on it. And if these analysis bring some collateral bottom up opportunities even better.

Meruelo Maddux Properties, a cautionary tale

Tariq, from the excellent StreetCapitalist, asked my thoughts on why Third Point sold his Maguire Properties (MPG) position last year. Dan Loeb did not disclose his reasons, it could be part that he did not see use for his activist role in the current turnaround situation or that we wanted to leave a bad chapter behind. And to tell you the truth, I did not look much into it given that others are buying.

However, Tariq’s question reminded me of a third possibility: that he was surprised that MPG’s inherited problems were worse than expected. Third Point probably started buying at the beginning of 2008 before Robert Maguire’s resignation. You can retrace most of the history through Market Folly’s posts. Robert Maguire at that time rejected a couple of offers in the $20+ range, and the company was subject to pressure from other activist investors. To give you an idea of their thesis at the time here is a report on JMB Capital Partners efforts:

However, from those reports you do not get a feelling of the cash flow and recourse obligation problems. Even Robert Maguire in October 2008, well after his resignation, fired an open letter and a 13D complaining that it was all the market’s fault, that it was under appreciating his baby, without himself giving proper balance to the not easily available recourse problems.

I write these words as I watch like a nervous father from the sidelines while a company I founded, nurtured and once ran as CEO, Maguire Properties Group, struggles each day with a Wall Street that seems to have lost its confidence in the resilience of the American economy and its workers, and is seemingly oblivious to the significant progress that I believe has been made to right the Maguire Properties ship.

A good cautionary tale on recourse debt surprises is Meruelo Maddux Properties (MMPI), a case brought to my attention by good friend Valuestocks. MMPI is another dominant Angelino developer and the largest residential landlord in downtown LA. To give you a taste of the quality of its properties here is a map from their 2007 IPO prospectus.

So let’s move forward in time to the August 2008 earnings call

Jack Ripstein – Potrero Capital Research Hi. Good morning. Thanks for taking my call. Question on the debt side, are there any properties or any changes in the debt associated with the new financing that are recoursed back to the company? Or is it all still projects and – either projects or land specific?

Andrew Murray All our debt is non-recourse.

Jack Ripstein – Potrero Capital Research Okay. So each piece that we can go through, the supplemental is attached to the actual project proposal next to it and nothing else?

Andrew Murray As you know, our construction loan is recourse, but that’s normal with a construction loan. But all the loans that we refinanced are secured by first trustees. We have one of our acquisition loans that we’re going to be doing with Overland terminal is a recourse loan, but that’s primarily because it’s a bridge loan.

Jack Ripstein – Potrero Capital Research Okay. You would replace that when possible?

Andrew Murray Yes.

Jack Ripstein – Potrero Capital Research Okay. Great.

Andrew Murray Generally speaking, we’re still in a non-recourse marketplace.

Jack Ripstein – Potrero Capital Research And that hasn’t started to change with some of the changing landscape out there?

Andrew Murray No.

Jack Ripstein – Potrero Capital Research Okay. Great. Appreciate it. Thank you.

So what would be your thoughts after that performance? Probably that even if the market was deteriorating there was still downside protection. Only those nasty construction loans could be some of a problem but if things got to the worse you could start handing back the keys of not performing properties.

Just six months later, March 2009 earnings call, we get the following Chapter 11 surprise:

Analyst for Jordan Sadler – Keybanc Capital Markets I just want to try to better understand your process and strategy and so what exactly would be the benefit in declaring Chapter 11? I see several properties that are 100% occupied or about six or seven that are over 90% occupied and so I guess first, what loans exactly are recourse to the company? And then second, why wouldn’t you essentially hand the keys back to the lender on the vacant buildings or underperforming assets, reduce your expense load and just continue operating the remaining assets?

Richard Meruelo The great majority of our loans are either directly or indirectly recourse to the operating partnership or the company and so handing back keys is not enough of a solution.

Analyst for Jordan Sadler – Keybanc Capital Markets So most of the loans are recourse in some form or another? Were they non-recourse and now because of non-payment or a trigger of some sort of default they are recourse?

Richard Meruelo No but, many of them from the beginning had some form of recourse and as they’ve been modified over the last year it’s continued to increase the level of recourse. We’ve been modifying these loans now for over a year in short term extensions and recourse issue has become most prevalent in all of our loans except in just a few.

Analyst for Jordan Sadler – Keybanc Capital Markets On the non-recourse loans, when you say a few, can you just give a better sense of maybe what the NOI on those are which ones?

Richard Meruelo We have amount of non-recourse debt is how much Andrew?

Andrew Murray $74 million.

Richard Meruelo $74 million of our debt is non-recourse.

Andrew Murray We haven’t calculated the NOI on those properties but our overall strategy though is to continue to work with four of our lenders again, as we mentioned in our press release and in our comments to come up with an agreement with these four lenders that should deal with our cash flow matter, the cash flow issues we have in the company. We’re in advanced discussions with these four lenders. We’ve been having conversations with them daily now for several weeks and we continue to work towards a solution with them. That’s our primary focus right now.

Analyst for Jordan Sadler – Keybanc Capital Markets So the properties that are 100% occupied or in the 90% range, those are likely recourse or have some form of recourse to the company?

Andrew Murray If we have a performing property and it has recourse we want the relationship with that particular lender on that property to be in good standing.

From MMPI to MMPIQ in two years is almost a dotcom performance. From the beginning many of the properties had some form of recourse obligation. And some developers have this habit of shooting for all or nothing, so they compromise other properties in the refinancing. So be careful with developers with large pipelines and potential undisclosed recent obligations. I speculate that this may have been part of the issues with MPG for some value investors last year.

NOTE: If there is any lawyer or investor interested in bankruptcy plays with access to Pacer I would very much appreciate his help to get to the bottom of Meruelo Maddux Properties (MMPI) given my interest in Maguire Properties (MPG). variant dot perceptions at gmail dot com

Long MPG, and I hope not to get an angry activist letter on why all these speculations are bullocks

Maguire Properties, a tale of two cities (Part I)

Even during TCI’s most heavily leveraged days, Malone was always careful to use as much non-recourse debt as possible, so if water flooded one “compartment” (i.e. an individual cable system could not service its debt) it would not threaten the entire ship (TCI and its shareholders as a whole) – Investor’s Consigliere Blog

At MidAmerican, we have substantial debt, but it is that company’s obligation only. Though it will appear on our consolidated balance sheet, Berkshire does not guarantee it. Even so, this debt is unquestionably secure because it is serviced by MidAmerican’s diversified stream of highly-stable utility earning – Warren Buffett

“In my 40 years in real estate, I’ve found there is only one metric that matters – replacement cost” – Sam Zell

If you want to invest in hard assets (real estate, utilities, gas pipelines, oil fields, shipping, etc), you need to know how to analyze debt quality. I am not fan of debt, but most of the companies in this arena use easy credit in boom times taking advantage of their tangible and tradable assets, or collateral as bankers call it. Collateral makes it so much easy. So if you want to profit from busts in these cyclical industries it is important to separate those that were prepared for the bust from those that were just trading stinky sardines.

To make things as easy and illustrative as possible, I am going to use as an example Maguire Properties (MPG). What I like about this example is that it is a pure equity REIT buying and developing properties with debt. No investment in CDOs, CMBSs or RMBSs like a mortgage or hybrid REIT. In summary, no weird instruments that could obscure the lessons of non-recourse debt, stable earnings and buying below replacement costs.

So we are clear, I own MPG stock but it is a small position. There are still some necessary steps in the turnaround and it is just beginning to solve its issues. MPG is unusual both because of the quality of its assets and scale of its debt. The company has assets of $4.2 billion and liabilities of $4.7 billion. So $500 million of negative equity? Yes, but please bear with me.

Robert Maguire is the 74 years old founder and former CEO, fitting so well the part of gutsy developer that it is almost tragic. He built several of the most prominent skyscrapers in downtown Los Angeles. The Downtown skyline is dominated by Maguire properties: Gas Company Tower, One California Plaza, US Bank Tower, Two California Plaza, and the Wells Fargo Tower.

MPG problems can be traced back to the $3 billion purchase in 2007 of a section of Equity Office Properties from Blackstone Group that they had just recently bought from Sam Zell in a legendary deal. These deals were made at the market’s top and included office buildings leased to brokers and financial institutions in Orange County that were at the epicenter of the mortgage bust (i.e. New Century).

Facing a stock price tailspin and concerns about MPG’s financial strength Robert Maguire tried to raise money to take it private. Having failed, he stepped down as chief executive in May 2008. Those of you that have followed the Premier Exhibitions posts know how I consider waiting for change of management a critical first step before investing in a potential turnaround. And that is even truer when the CEO is a brilliant, gutsy and stubborn founder.

Well, it is more than a  year since Robert Maguire’s departure and only recently good news are starting to surface.

1. MPG announced in August that it was handing over the keys to seven of its office buildings in Orange County and Los Angeles to lenders.
2. On December, MPG announced they sold one of its prized properties: the Lantana Media Entertainment Campus, home to several entertainment firms (i.e.: Larry David Productions of Seinfeld and Curb your Enthusiasm fame). The deal was valued at more than $200 million. Minus $175 million of debt it should report a profit

How is it that abdicating properties or selling prized ones for a small profit improves the prospects of a company? That is the power of non recourse debt. But to understand what is going on, it is important to lay down the investment thesis that is the subject of part 2.

Long MPG