More than a year ago, I wrote a thesis for the MPG preferred equity and left some open questions on the value of the common equity. A sharp price recovery discontinued that series; nobody likes much to write about stocks sold or priced too high.
Some recent events, specifically the resignation of the CEO Nelson Rising, prompted a selloff so it is a good time to continue the series and answer those open questions:
- “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?”
- Do we think that the common is not only undervalued, but has more upside than the opportunity cost: the potential 3x of the preferreds and its higher preference in the capital structure?
As we discussed at that time, Maguire is a highly indebted REIT that is barely cash flow breakeven. Since that write-up, the company has practically eliminated all recourse debt and corporate guarantees so MPG may loose some valuable properties in the process but each mortgage is independent so a cash flow positive core will always survive.
The continuing debt restructuring is not the only recent news. The company also has a new name, MPG Office Trust, consequence of the firing and disentanglement of most business relations with Mr. Maguire, and a new CEO David Weinstein consequence of the divergent capital structure views of Mr. Rising and the board.
Over the last year my main worry with MPG has been a potential dilutive capital injection. I am not opposed to it at a property level, with a couple of asset sells if necessary, but I do oppose a capital raise at the corporate level because at the current valuation defeats the purpose of the well conceived debt structure.
Well, this worry has been mitigated with the leaks following the CEO resignation. I think it is pretty clear that the board had the same worries and is defending shareholders.
But Mr. Rising believed the company also needed to sell equity to stabilize its balance sheet, people familiar with the situation said. Other REITs were doing this. But MPG shares were at such a low level, board members felt that it would be too dilutive, these people said. Mr. Rising also had discussions with possible suitors interested in buying the company. But the board felt the price would be too low because of the company’s high debt load, these people said. – Wall Street Journal
Some of you will challenge this view that the market may be missing something. After all, MPG is not your usual small cap. It is widely known in the competitive REIT sector so it should not lack suitors if it had substantial value left.
The thing is, there is a long line of suitors. For a start,
- Winthrop Realty Trust was a large holder of preferreds and showed interest on a more active role before selling.
- Brookfield Properties has been mentioned as interested in several articles, including the WSJ article on the resignation of the CEO. One of their analysts has been a staple in recent MPG’s conference calls.
- Appaloosa has a very large position, close to 10%, in the common and most probably in the preferreds too.
- Third Point had a large 10% position that was sold. Daniel Loeb in one of his tirades complained about the company rejection of a $20 buyout offer in June 2008.
- Baliasny Asset Management, besides being implicated in the recent insider trading scandal, bought a 5% position between Q4 2009 and Q1 2010
- Robert Maguire, founder and former CEO, increased his position to close to 10% (prices between $1.4 and $2.5) while firing a 13D between February and March this year.
Quite substantial blue blood interest, specially for a company valued at only $100 million. The question is what are they seeing here. If you go the traditional way of valuing a REIT by using a multiple of NOI (net operating income) you would be disappointed. There is not much NOI.
At the same time, that method misses that MPG was known for their subpar NOI generation compared to its NAV (net asset value). The reason is that downtown leases were not paying enough while absorbing for decades the CRE bubble from the 1980s. Though, on the positive side, there is no new supply expected for years and, in the meantime, the office vacancy is below 20% in downtown LA so it will be absorbed rapidly after the downturn ends.
No new supply and continued downtown growth. I wonder what will happen next.
Past history is the way I have seen people arguing on behalf of MPG. They extrapolate its share price before the Orange County acquisition and conclude that it is worth more than $40 per share. But that is not right either: the OC debacle cost MPG significantly since they had to refinance and extract equity from the core Los Angeles CBD to buy those properties … properties that are being hand over.
There is value, substantial value, but it is going to take a long analysis. Please bare with me and let’s hope that this time the price does not jump before we finish the series.
This article was published in CGI Value two weeks ago