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Someone who has proven his knowledge and proficiency in valuing GGP shared some viewpoints with me regarding the latest GGP conference call. I bounced my opinion back. This is the type of discourse to expect from the user groups of this blog, and I encourage individuals, institutional/professionals and press to join the appropriate group and add to the discussion. The follolwing is the "sanitized" version of our exchange:

As rightly mentioned above, on excluding lease termination fee income, the comp NOI growth works out to 3.8% versus 5.8% including the income. This reflects that the company has already started witnessing softness in its commercial space rentals amid weakening macro-economic fundamentals in the US. This also indicates a probable expansion of cap rates going forward particularly on properties bought after 2004 at a relatively higher premium.

No doubt it was talked about in the first quarter of 2006 when the rentals were witnessing an increasing trend (and benefits them) but the situation at present is entirely different. The rentals have already started to witness a sign of slowness and an increase in lease terminations imply lower rentals for the company going forward for the same property under a renewed lease agreement. We have thoroughly researched this with several independent sources. I have decided to release this for all to see what everybody else is getting in GGP's operating areas (see icon Commercial Leasing and Vacancy Rates in GGP's Operating Areas (854.45 kB) - you will have to zoom in with your Adobe viewer to see each page legibly). Unless GGP is defying gravity, they are probably seeing the same leasing results as the rest of the industry. Be prepared though, these numbers are not as rosy as they report!

In its 4Q07 conference call GGP is talking about termination fees and temporary rents as compensating for the loss of rentals on lease terminations - it must be mentioned that termination fees and temporary rents are by nature not regular income streams. Further, GGP’s termination fee increased 264.8% and 357.4% in 3Q2007 and 4Q2007, respectively, over the corresponding periods last year, indicating higher number of terminations and turnover amid possible increased exploration of alternate cheaper space by the company’s lessees. It is without a doubt that this turnover will result into leases rolled into lower revenue streams due to the weakening market. This was one of the first things we pointed out in the first GGP post.

 

That’s true. The company specifically showed increase in comp NOI excluding termination fee to reflect increased figure in 1Q2007. The practice certainly seems to be inconsistent. The end of 4Q 2006 marked the height of the commercial rent bubble (see graph above). What a coincidence...

 

 

2007

2006

2005

FCF ex-capex

188.3

224.8

308.1

 

 

 

 

Though we have computed GGP’s FCF using a slightly different approach in line with the company’s reporting methodology, the overall trend is same as observed by you. As per our computations (which includes the unconsolidated entities’ contributions on equity basis), GGP’s FCF (pre-capex) fell to $159 mn from $183 mn in 2006 and $217 mn in 2005. Including the maintenance capex (1.1 % of properties) of $312 mn in 2007, GGP’s FCF has turned a negative of $153 mn implying that GGP has almost no cash flows to finance its other development plans. Our estimated FCF (pre-capex) for 2008 is a ($581) mn owing to expected negative growth in NOI. Including the maintenance capex, this turns to ($902) mn. We believe that GGP would either have to cut down its dividend distribution or reduce its expansion plans. Please see the detailed table below.
image002.gif
 

Our explanation above explains this point.

 

Quite true. GGP has leverage of nearly 84.3% as on Dec 31, 2007 against 72.9% for SPG and 71.0% for MAC. Such high leverage makes GGP more vulnerable to impact from the current credit crisis, particularly since a significant portion of its total debt is due for repayment over the next two years. GGP’s interest cost as percent of revenues for 2007 is also significantly higher at 35.7% in comparison with 25.9% for SPG and 29.4% for MAC. All this considered together with its expected declining NOI indicates GGP is headed for difficult times ahead of its peers, SPG and MAC.

  

 

Debt / Rev

Debt / EBITDA

Debt / NOI

S&P Corp Rating

 

Fixed Debt, %

EIR

GGP

6.93

11.88

10.76

BBB-, outlook negative

87%

5.70%

SPG

4.75

7.30

7.29

A-

 

 

81%

5.70%

MAC

5.73

9.45

 

Unrated

 

 

85%

5.73%

Though GGP’s current EIR is nearly the same as for SPG or MAC, we believe that the company will witness an increase in its EIR in the coming quarters as a significant proportion of its debt becomes due for repayment. In our detailed analysis of GGP, we have assumed GGP’s financing costs at 6.14% (close to your assumption of 6.2%) under our base case assumptions. This is around 44 basis points higher than the company’s current EIR of 5.70%. In my opinion, the factors which would contribute to GGP’s higher EIR are 1) huge refinancing requirements under the current credit crunch conditions which shall entail financing at higher interest rates, 2) GGP’s unfavorable credit metrics together with lower credit ratings, and 3) lower LTV ratios (expected in the range 50-60%) when applied to falling property values would curtail finance availability forcing GGP to negotiate at higher interest rates.

 

 

Implied GGP Price

 

Implied Loss (Gain) on Short 

 

EV/Rev

EV/EBITDA

EV/NOI

 

EV/Rev

EV/EBITDA

EV/NOI

SPG

29.17

16.62

27.76

 

-20%

-54%

-24%

 

 

 

 

 

 

 

 

In comparison with SPG and MAC, we find GGP’s stock significantly overvalued, based on EV/ FFO and EV/EBTDA multiples. GGP’s EV/FFO and EV/ EBITDA for 2007 is 18.9x and 36.5x, respectively, while SPG’s corresponding multiples stand at 14.6x and 25.5x and MAC’s at 13.4x and 25.7x. Considering the current credit market scenario and the highly probable recessionary conditions in the US, such high valuation multiples seem unjustified for GGP implying further downside risk for the stock from current levels.

ggpvalue.gif

 

We covered a similar analysis under the “Sale of Properties” version of our GGP analysis where we have computed the funds deficiency the company may face even if it sells a few of its properties and curtails its capital improvements in view of the liquidity issues (pls see the table below).  In its latest 4Q07 conference call, GGP announced it is exploring the sale of properties as a feasible option to finance its debt maturities. In addition, the company is also postponing a number of redevelopment projects to cut down on its financing requirements.

Re-financing under conditions of sale

2008

2009

Re-financing required (base scenario)

$3,850

$5,000

Capital improvements (base scenario)

$1,582

$661

Financing re-quired (base scenario)

$5,432

$5,661

 

 

 

Financed through sale of assets

$1,209

$1,465

% of re-financing required

31%

29%

 

 

 

Capital improvements curtailed

$772

$466

 

 

 

Re-financing required

                        2,641

                3,535

Capital improvemnts

                   810

                   195

Financing required (revised scenario)

                3,450

                3,731

The above table shows how GGP’s total re-financing requirements of $5.4 bn and $5.6 bn in 2008 and 2009, respectively, may be cut down if the company sells a few of its properties and curtails it capital improvement expenses (which is precisely what GGP says it plans to do). However, even after that the company would be left over with nearly $3.4 bn and $3.7 bn of financing needs. We believe this deficiency will be raised at higher interest costs under the prevailing conditions. Please also note that in estimating the sale price of properties which may be sold, we have used our own estimates of property valuations which we done for each of the GGP’s nearly 270 properties.

For a senior executive to say "I don't know why you and others think that we are [in danger] is telling in and of itself. If he was doing his job, he would know why we felt he was in danger. If he was good at doing his job and we were wrong, he would cogently, concisely and precisely show us how and where we are mistaken. To date, I am not aware of such. I am a short seller of their stock. I am a short seller because I see them as underperforming and overvalued. My short position didn't come first, their underperformance and overvaluation did. I will be a long buyer of their stock if they got their act together and overperformed. No need to take it personal...
  • GGP again must be making their lenders uncomfortable by emphasizing the value of their non-recourse debt should they default. "But more importantly because it provide us with cheaper debt, that was I might add non-recourse, which is also something that many people seen lots of value, which confuses us a little bit. Because if you have bonds and you have a default, it's not possible to give the company back to the creditors and still keep the company and where we don't envision, emphasize as much as I can in 54 years, we've never had a default, we don't expect to but should condition turn into whatever horrible things, you would like to contemplate. Non-recourse debt at that time is better than recourse debt."

I know I sure as hell would be nervous to hear someone who owes me money bragging about how valuable it is that he can get away with stiffing me!

The wild cards in this situation are alternative sources of funding - pension funds (too risk averse after so many mortgage holders are getting burned), "certain banks" (yeah, right), insurance companies (likewise) and hedge and private funds (the most likely alternative source - guaranteed to offer one of those "deals you can't refuse" along the lines of pricing and terms). Securitzation is a bad word for right now - so we are now back to the old fashioned (you know, like 7 or 8 years ago) market for balance sheet based loans. It is my opinion that risk aversion remains high particular in real estate financing.

When the GGP 10K/Q is released, I will revisit this topic in more detail.