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?