Variant Perceptions

Category: Tepper

MPG Office Trust: recap

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.

Long MPG

This article was published in CGI Value two weeks ago


David Tepper at Carnegie Mellon

And concluding the series on David Tepper, a small surprise: a 40 minutes presentation he did probably around November 2007 at Carnegie Mellon, more specifically at the Tepper School of Business [add favorite Argentinians joke here]. It shows another side of him instead of the loud and profane publicized by the media. Specially interesting are his lessons from

  • the Russian crisis, bomb threats included
  • politics at Goldman Sachs, and his love affair with Jon Corzine
  • the use of cash as a hedge, actually the best hedge.

And it is time to go back to company analysis…

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RR: The video was removed but here is a transcript thanks to Santangel’s Review

David Tepper on investing under uncertainty: practice

We discussed how David Tepper protects his positions. However, at the same time when have your heard a value investor saying anything remotely like this:

We’re not afraid to lose money. Hence the plaque. I should say, we’re not afraid to make money – David Tepper

The thing that comes to mind with him is not his defense. In complete contrast to Seth Klarman for example his record is consistently inconsistent … as he would be the first to recognize. He has several years of average or below average returns punctuated by home runs every five years or so. As Seth Klarman is the master of being fearful when others are greedy, you could say that David Tepper is the master of being greedy when others are fearful… an important ability to learn if you ask me.

All the points that we discussed on how he protects his downside came into fruition in his now famous March 2009 trade:

Tepper was sitting on a pile of cash, having sold out of most of his positions in the spring of 2008, and didn’t have any debt. So when the U.S. Treasury put out a white paper in February 2009 announcing its Financial Stability Plan, which included the Capital Assistance Program designed to shore up the capital of banks, he took his time and read the fine print.

The white paper and term sheet said the preferred stock the government was buying in the banks would be convertible to common shares at prices far above current trading levels at the time — which meant it was indeed a time to buy, buy, buy.

So he did. The fund began amassing sizable positions in bank-related securities: common and preferred shares, and junior-subordinated debt, to be exact. His targets, Bank of America and Citigroup in particular, as rumors circulating that the banking behemoths would be nationalized in early 2009 edged the stocks to near collapse.

Tepper was able to buy Bank of America preferred shares at just twelve cents on the dollar and Citigroup bonds at just nineteen cents. As those stocks rallied by the end of 2009, Appaloosa raked in the billions.

Appaloosa also was able to buy about a billion dollar’s worth of AIG’s commercial mortgage-backed securities at nine cents on the dollar. Currently trading at about ninety-three cents, the “AIG ace” was a major coup and contributor to the firm’s success in 2009.

“Most of the upside was on the preferred and debt side, “ he says. “That’s perhaps why so many people missed this trade. They just couldn’t see it.” – NetNet profile

Let me emphasize this last point: most of his bets on banks and AIG  were on the preferreds and debt side.

He also  bought substantial stakes in common and preferred equity in several zombie REITs (NCT, GKK, MPG). We discussed one of these REITs and I hope to have showed that it had a margin of safety.

This is a sample of other moments:

  • 1989 Junk Bonds Collapse: “After the market imploded in 1989, most banks dissolved their high-yield trading desks. But Goldman’s survived, in part because Tepper, who had worked his way to head trader, helped take the edge off with a canny move: purchasing underlying bonds in the financial institutions that had been crippled by the crash. When the banks emerged from bankruptcy and the market picked up again, the value of the bonds soared.”
  • 1998 Russia: “Tepper bought a bunch of Russian debt on the assumption that the Russian government wouldn’t default. When it did and the ruble collapsed, it cost his fund hundreds of millions of dollars. But even as the market tanked, Tepper kept buying the ever-cheaper bonds, and a few months later, his tenacity paid off: The fund went up 60 percent.”
  • 2002 Junk Bonds Collapse Again: “when the junk-bond market collapsed for a second time. Tepper lost 25 percent, but made up for it the following year, when bonds he’d purchased in bankrupt companies went up 150 percent, Tepper’s big score in 2003. Tepper had purchased the distressed debt of the three then-largest bankruptcies in corporate history: Enron, WorldCom, and insurance giant Conseco. When they emerged from bankruptcy and the debt appreciated, Appaloosa went up a whopping 148 percent.”
  • 2010 Quantitative Easing: “You talk about when you get moments, this might be one of those—kind of (…) Either the economy is going to get better by itself in the next three months…What assets are going to do well? Stocks are going to do well, bonds won’t do so well, gold won’t do as well. Or the economy is not going to pick up in the next three months and the Fed is going to come in with QE. (…) What, I’m going to say, ‘No Fed, I disagree with you, I don’t want to be long equities?’ Sometimes is that easy, not all investment decisions are difficult ones”


David Tepper on investing under uncertainty: theory

Much like Eddie Lampert was able to see value in Kmart when everyone else wrote the company off. Tepper is great at identifying the true value of a company when the company looks like it is worthless- David is able to extract value where others cannot see or understand. And the exit strategy is simple thereafter! – Frank DeRose, Ferrata Capital

David Tepper is not the investor most easy to understand: media shy and does not like to talk about specific positions. His is a bond shop so the 13Fs only show a small part of his portfolio. Incredibly, Appaloosa’s offices are in New Jersey overlooking a mall parking lot. Even in politics he keeps his cards close to the chest: tell me the rules, just make them stable and certain.

Nevertheless, I decided to dissect the few resources available and see if there was anything to learn from him. The reason? over the last two years it was very surprising to me how often sectors, companies and even specific ideas that got my interest were part of his portfolio. Only that his results, given the size of his portfolio, were nothing short of amazing and I usually was one step behind.

He was a boundary-pusher, loud and profane, and a know-it-all – NY Magazine Profile

Some of you may wonder on what could be the use of investigating the habits of a former trader? David Tepper’s education was trading at Goldman Sachs but I take issue on that he is just a trader. His public equity positions have been medium to long term -Bank of America and other banks securities were bought in March 2009 and  still has them- and  has been active in several situations looking to improve companies finances -ie: Delphi and General Motors-. And that combination makes him interesting and someone from whom to learn a couple of tricks.

Distressed debt is Tepper’s specialty. He has mentioned that distressed is very similar to risk arbitrage. Actually the much descredited but still interesting Robert Rubin, who was head of Goldman’s risk arbitrage some time ago, was somewhat of a mentor so why not pick Rubin’s book and see what he says of this discipline:

In arbitrage, as in philosophy, you analyze, look for holes in the analysis, and seek conclusions that hold together. However, while analytical rigor may be sufficient for philosophy, it’s not enough for arbitrage -as in policy making- you also have to be able to pull the trigger, even when your information is imperfect and your questions can’t all be answered. You have to make a decision: Should I make this investment or not? You begin with probing questions and end having to accept that some of them will be imperfectly answered -or not answered at all. And you have to have the stomach for risk. – In an Uncertain World, Robert Rubin

Some would say this is reckless, and profane Tepper would probably interject balls to the wall. However, if you look more deeply he protects the downside and lives to fight another day when he is wrong.

  • Bond shop: he looks to the whole capital structure for opportunities for the best risk/reward tradeoff. Bonds and preferreds provide better protection, and in times of panic their rewards can still be substantial.
  • Themes are macro but investments are micro: He has a view on the financial difficulties and perspectives of a country, but the quality of the specific ideas he finally invests in provides another layer of protection.
  • Do not fight the government: And that means not just the FED. In March 2009, he trusted a federal government document detailing the banks bailout. You wonder if this only works in the USA, I am sure I would not trust other countries governments not to brake the law.
  • Sell fast if you make a mistake: probably a heritage of his trader days, he is willing to recognize he is wrong fast and close his positions. This sometimes has put him in awkward situations like Delphi: “pushed, with the grace and diplomacy of a battering ram, to play a central role in the reorganization of the company, only to turn tail and manufacture an excuse once they lost interest.”
  • Do not use leverage: for Russia 1998 he had leverage, but it was low and he learned his lesson. If his recent results are any evidence, leverage is not needed for high returns.
  • Hedge: if there is a possibility to filter the thesis in a pure way, hedge. At the end, was not this what hedge funds were about?
  • Markets adapt, people adapt: And if all that does not work, markets tend to heal themselves

I got a headache because I was listening to one guy talking about how there’s gonna be hyperinflation. And then after him there was some guy telling me there’s going to be a depression and deflation. Neither—neither—is most likely going to happen. The point is, markets adapt, people adapt. Don’t listen to all the crap out there – Ira Sohn conference May 2010

But the one thing that I would like to emphasize, and this comes straight from Rubin’s book, is the importance of scenarios, probabilities and downside for distressed investing and we are going to look next some of his famous moments to see how this all works… do you think you can make decisions with trees?

David Tepper on investing under uncertainty

Comments coming later

Vodpod videos no longer available.

Be greedy when others fearful: David Tepper edition

Comments coming later

Vodpod videos no longer available.

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