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We have looked at GGP’s plan for raising non-debt capital through private participation. This  model was actually completed right before  GGP announced their equity offering, so the number of shares are off, but the logic remains the same.

Our model (based on 3Q2007 results) assumed that the company would be able to raise the required finance in 2008 and 2009 through additional debt (and we didn’t specifically provide for equity participation). The ‘liquidity-trapped’ capital and financial markets have been making it increasingly difficult for the borrowers to raise additional money, and GGP might find it easier to dilute its equity and raise additional finance under the current conditions of financial turbulence.

During 1Q2008, GGP was able to finance $1.3 bn of loans against six mortgage properties. The existing loan on these properties was $550 mn. Consequently, GGP was able to realize additional proceeds of $750 mn, which was partly used to purchase The Shoppes at Palazzo at Las Vegas. 

GGP is currently in discussion with various mortgage lenders to raise $2.5 bn of loan on both encumbered as well as unencumbered properties. In addition to property specific mortgage, GGP is also considering various forms of non-debt capital through private participation which could result in equity dilution. Overall GGP expects to raise $1.75 bn of additional capital through private participation of which $1.5 bn is expected to close by 2Q08.

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In our financial model we expected GGP to require re-financing of $3.9 bn in 2008, of which GGP has already refinanced $1.3 bn in 1Q08. The company is raising additional $1.75 bn from non-debt financing through private participation.

Valuation

Based on GGP’s portfolio of properties as of September 30, 2007, we expected GGP’s valuation at approximately $6.9 bn or $28.4 per share implying a downward potential of 30.7% from the current share price of $41.

However if we expect GGP to raise additional capital of $1.75 bn through private placement, GGP’s valuation increases to around $7.7 bn due to savings in interest expense. However as a result of dilutive effect (due to increase in shares outstanding) GGP’s per share valuation declines to $26.5 (under our base case assumption), implying a further downward potential of 35.3%. It should be noted that the base case is no longer the "base case" since I consider us to be undeniably in a recessionary period, which would indicate a $23.9 per share valuation, or -41.7% change as of the close yesterday. Now, these numbers are off because we actually assumed that they were going to raise more money than they did, but if anything, they are optimistic.

 

Summary of GGP Valuation (Before equity dilution)    
$ mn except per share data      
  Recession Base Case Optimistic Case
NOI Basis      
Consolidated valuation as per Portfolio Valuation $28,903 $29,487 $30,872
less: Debt ($24,282) ($24,282) ($24,282)
Estimated value using PV of NOI basis $4,621 $5,205 $6,590
Add: PV of other income $2,289 $2,412 $2,572
GGP's estimated market cap (NOI basis) $6,910 $7,617 $9,162
       
No of shares 243.8 243.8 243.8
Estimated share price ( PV NOI basis) $28.3 $31.2 $37.6
       
Current share price $37.9 $37.9 $37.9
Upward (Downward) - NOI basis -25.2% -17.6% -0.9%
       
Cash Flow After Tax basis      
Estimated Value using Cash flow basis $3,882 $4,520 $6,061
Add: PV of other income $2,289 $2,412 $2,572
GGP's estimated market cap (CFAT basis) $6,171 $6,932 $8,633
       
Estimated share price (PV CFAT basis) $25.3 $28.4 $35.4
       
Upward (Downward) - CFAT basis -33.2% -25.0% -6.6%
       
       
Summary of GGP Valuation (After equity dilution)      
$ mn except per share data      
  Recession Base Case Optimistic Case
GGP's estimated market cap (NOI basis) $6,910 $7,617 $9,162
Add: PV of interest expense $745 $745 $745
New estimated market cap $7,655 $8,362 $9,907
       
No of shares 243.8 243.8 243.8
Add:  Increase in number of shares 46.2 46.2 46.2
No of shares after dilution 289.9 289.9 289.9
Estimated share price ( PV NOI basis) $26.4 $28.8 $34.2
       
Current share price $37.9 $37.9 $37.9
Upward (Downward) - NOI basis -30.4% -23.9% -9.9%
       
Cash Flow After Tax basis      
Estimated Value using Cash flow basis $6,171 $6,932 $8,633
Add: PV of interest expense $745 $745 $745
GGP's estimated market cap (CFAT basis) $6,916 $7,677 $9,378
       
Estimated share price (PV CFAT basis) $23.9 $26.5 $32.3
       
Upward (Downward) - CFAT basis -37.1% -30.2% -14.7%

 

 

If you are new to the site, let me assure you that we have a decent amount of talent and knowledge represented by our regular members and subsribers. We share a lot of ideas and knowledge behind closed doors and on occasion I publish some of the discussion and debate. Here is a contribution from a CRE specialist..

Conclusions

This all implies they won't be able to make it through the end of 2009 without having to sell assets or do a very dilutive transaction.(This was written right before they announced their very dilutive transaction today)  After going through all this in detail, still looks great to me.  I get a fair value of 20, but should go lower as they dig themselves into a hole.


GGP
My basic view of the latest development is that they are simply trying to show progress on the refinancing end so that they can get their rating back from S&P. The timing was too perfect. They are pursuing a strategy of levering their un-levered properties to squeeze as much cash as they can out of their existing portfolio. This delays a process that cannot be delayed for too much longer. I believe this for 2 reasons:

  1. The core operations are losing money when dividends are factored in, and the new debt will only make future core operational cash flow worse. I estimate $150M and $250M of core operational cash outflows after dividends without any debt problems in 2008 and 2009, and $430M and $530M, respectively, inclusive of a full wringing of their existing portfolio.
  2. Wringing their existing portfolio dry will only last them through 2008, but will leave them requiring cash in 2009. Even after doing all the money raising that is possible, they will have $5.3B and $2.8B due in 2008+2009 if they spend the expected development capex and if they don't, respectively. Moreover, their LTV will rise from 72% to 85%, by my estimation, when 60% is a fair estimate for the LTV they will be required to have on these properties.

 

Bank Risk? Seems overblown.
Assuming this to be true, the only thing that they can hope for is to get debt forgiveness or a lower interest rate by strong-arming the banks they're dealing with. Perhaps they could say to their banks that they know it isn't possible for the banks to foreclose, and the debt is non-recourse, so it's best for everyone if the banks were to cut GGP some slack. This logic is a little tenuous. Regional banks are the guys who are expected to experience a rapid rise in bankruptcies due to their C&D exposure, prompting the FDIC to beef up their staff for the expected wave. They might not exactly have the ability to let things slide when they are cash strapped themselves and may slide into bankruptcy! "The agency, which insures accounts at more than 8,000 financial institutions, is also seeking to hire an outside firm that would help manage mortgages and other assets at insolvent banks, according to a newspaper advertisement."

This is my view of GGP's cash situation at this time in dirty detail:

$5.4B of total debt (consolidated and unconsolidated) due in total in 2008 and 2009 that will still have to be refinanced;
$400M of core cash burn on their core operations;
$2.3B of development capex;
$200-250M to pay off the equity piece of the Shoppes at Palazzo;
Total cash needs of $8.4B in 2008 + 2009 -- and $6.1B without any growth capex

"Private transaction" -- no magic bullet
They can attempt to raise additional capital through a private transaction, but my view is they will have to do so at a high cost. There is no one who has a strong incentive to subsidize a sunk loss - equity holders are all on the small side (well smaller than $1.75B), and debt holders are all non-recourse! As a result, anyone who does do a transaction with them would be looking at this purely from an independent risk adjusted return on capital standpoint. Centro is having difficulty finding buyers for itself, and I don't think GGP will be able to raise any more convertible debt at any sort of a reasonable cost.

Discussions on $2.5B of other mortgage debt
This statement seemed meaningless. Of course they are in discussions with their mortgage debt lenders -- they have a lot more debt that they need to refinance! Duhhh!!!

Conclusions
The only options that are left then involve diluting the current equity holders heavily, or selling prime assets into a bad market to sell assets. Both options destroy shareholder value per share. And both are what they are doing, in addition to getting a much higher market price per share from this trading rally. Hence, less per share value and higher per share price. If we connect the dots...


Other ways of looking at the thesis

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FFO-based Valuation

FFO Defined: FFO is basically Earnings before D&A, adjusted to remove some extraordinary items, available to everyone (stockholders and operating partnership units) from everyone (consolidated properties, unconsolidated properties).  My valuation method takes FFO from the core mall properties and adds to it the net market value of the residential assets, after which the shareholders get their pro rata piece of the pie.  I add the residential assets b/c recurring cash flow isn't how the business is run -- they sell assets, so a cash flow-based valuation method is inappropriate.  This forms the valuation basis for how GGP can think through its options.

Normalized FFO in 2007: FFO from the mall operations, or "Core" FFO, was $880.93M in 2007.  Adjusting for one-time litigation costs, Core FFO was actually $912M. 

After tax cash flow to shareholder calculation: FFO does not subtract maintenance capex, yet the ongoing business must spend that cash simply to maintain itself.  I knock off maintenance capex of $352M. This might seem like a lot, but one should keep in mind they have 55.5M square feet of property to maintain, so this implies around $6.3 of maintenance capex per square foot of property they own per year, which seems extremely fair.  I then make an adjustment for the expected future interest rate on GGP's debt (6.3%, versus the present 5.7%), as well as the expected decrease in Core FFO in 2009 versus today (5% drop).  Both are also subtracted. Shareholders receive their 82.4% share of the residual cash flows (operating partnership unitholders receive the rest), or $291M.   I take this after tax cash flow figure and slap a multiple on it (17x) to get the value associated with the mall operations.

Net Market Value of MPC Assets in 2007: Net book value provided by an "expert" was $1.64B.  I then took the Price / BV of 12 of the largest homebuilders, and pulled the median P/BV of the bunch -- 0.87x.  I used this to get a reasonable estimate of the real market value of those assets of $1.42B.  Again, could be optimistic, but is a good place to start.  I again adjust this down to the share available to the stockholders.

Adjustment for haircut on forced asset sales: Prior estimate of need to sell assets to raise cash was around $2B.  Assuming this to be true, we'll also need to deduct the % of fair value of these properties GGP will lose b/c it is in a stressed sale condition, in an unfavorable selling environment.  I assume a 20% haircut, or $400M.  This is probably pretty fair. The Bear Stearns to JP Morgan office building option valued that distressed transaction at about a 30% haircut. That was very distressed, although it was also ultra prime office space. GGP features mostly retail mall and some residential properties. I believe these properties will be hit sooner and harder than the office space in this current recessionary environment. So long story short, 20% seems feasible.

Putting it all together we have the following then:

The valuation method is pretty robust.  It is mathematically difficult for GGP's EIR to ratchet up much more than this b/c most of the debt is fixed, and only that which comes due will be eligible for a rate hike. And, we're assuming $2B of asset sales. 

Other Factor #1: Dividend Cut
GGP paid shareholders $450M in dividends in 2007.  This is clearly in excess of the normalized cash flow to shareholders from the mall business of $291M.  And $2B of cash from asset sales implies $2.4B of book value assets sold, while MPC only has $1.42B available from above, so there will be nothing left coming from this asset, in addition to the $1B of core mall assets that will need to be sold (which brings us to Other Factor #2). For those who are not REIT investors: REIT investors are highly reliant on income and a dividend cut would be highly detrimental to GGPs share price due to devaluation in the market place.

Assuming they reduce the dividend to an amount they can actually pay sustainably, they will have to cut the dividend by 35%.

Other Factor #2: Sale of Mall Assets on Core Profitability
One needs to factor into the 2009 projected FFO the fact that GGP will have to sell $1B of its $24B of mall assets.  Right off the bat this lowers FFO by 4%.  My projection simply assumes a 1% drop in FFO from here, which could be optimistic if things get bad.  If things get really bad, with FFO down 10%, fair value drops to 20.9.  If FFO goes down 14%, fair value drops to 18.8.

Conclusion
In sum, assuming we see a small amount of core operational weakness, GGP will have to cut its dividend 35% and will have a fair value of 23.5, implying downside of 34% from here.  If things get really bad on the retail side, GGP will probably have to sell more assets at more stressed prices just to stay above water, will have to cut its dividend further and imply a fair value closer to 19.

This is from an additional communication... 

From the point of view of being thorough and accurate, I've got some updated figures.  The conclusions are similar, but this takes into account the fact that the real LTV is the total secured debt divided by the total market value of GGP's properties.  I am not confident on the covenant-related cap on debt issuance, but would strongly recommend looking into that, as I will. The ability to screw the unsecured debtholders may provide them some wiggle room, but it won't last them through 2009 in any case, and will only further destroy value.

 

  I have diverted resources to the consumer finance and investment banking (again, I think I may have found something more) arena, so will not be digging any deeper into GGP for now. I wish to state, again, that no one should be taking my opinions (or statements or research or anything else), nor any opinion on this blog, as investment advice. I am not allowed to, do not intend to, and do not wish to dispense investment advice to the public. I am a very aggressive, high risk/high reward, contrarian, fundamental investor that often hurls himself against the crowd - which is very dangerous - even with the risk management procedures that I put into place. I also do not share my trading activities nor all of my research on the blog. There are plenty of people and entities who freely and legally offer investment advice such as James Cramer and the sell side investment banks. I, personally, do not have much faith in their track record of making people money, but the point is that advising is what they do - and not what I do. I am not allowed to do it. What I am doing on the blog is discussing my market and corporate opinions, viewpoints and experiences. 

 
With that being said, I do not believe this recent bear market rally is supported by the macro economic environment nor the fundamentals. In fact in flies in the face of them. Hence, I have been steadily adding to my CRE and investment banking short positions in the recent rally.