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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:

• Mr. Smart Guy: Normalized comp NOI growth wasn't all that strong when you normalize for their abnormally high amount of lease termination fees in Q4 2007. It was actually 3.8%, not the 5.8% headline figure (though they neglected to mention this).

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.

• The abnormal spike recently (past 2 Q's) in lease termination fees is something to keep watch on. There was a spike in Q1 2006, but it was talked about a lot in that conference call as being a source of future revenue growth -- that they were actively churning their portfolio to get the fees and cycle to new customers, picking up the lease spreads without much downtime.  The past couple Q's there has been no real mention of it -- perhaps a leading indicator of tenants going out of business?

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  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.

• As yet another indication of management hypocrisy, back in Q1 2006 when they registered very high comp NOI growth because of lease termination fees, COO Bob Michaels says they don't give same-store NOI growth without lease termation. "CHRISTIE MCELROY: Can you give us your same-store NOI growth, excluding lease termination fees?  BOB MICHAELS: I don't know exactly what it is. We don't track it that way. Lease termination fees are a part of our business today. They may be higher or lower in any given quarter, but we view them as part of it. Next year when we report same-store numbers in the first quarter, we'll obviously be comparing to this quarter with a larger than normal number. But it's part of the business and we don't separate it from quarter to quarter."  When Q1 2007 rolled around and comp NOI came up low because of a lack of lease termation fees, they very strongly emphasized same-store NOI growth ex lease termination, displaying it prominently in their supplementals and making it very clear on the conference call.  Here in Q4 2007, we see this same sort of behavior once again.

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...

• Cash flow remains extremely vulnerable.  Normalized free cash flow ex-capex has continued to drop (basically, EBITDA - Capex - Interest - Taxes - Dividends - Distributions) -- see spreadsheet for exact calculation.  I hold off on calculating what the capex requirement will be given its fungibility, but as a reference point, D&A was $670M and $690M in 2007 and 2006.

• Assuming their EIR in 2008 goes up to 6.2% from 5.7%, no NOI from MPC and flat NOI from Retail implies $39M of FCF ex-capex.  This would put them majorly in asset sale territory, because maintenance capex is probably at least $300M, and they have other projects to deal with.

Our explanation above explains this point.

• GGP is way, way more levered than SPG or MAC.   GGP's interest expense takes up 6-8% more as a % of revenues, holding back their core cash flow.  They would need to pay down debt by $4-9B to bring their leverage in line with these 2, which is virtually impossible given their present cash flow situation.

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.

• So GGP's credit metrics, on all conceivable levels including the bond rating, imply relatively lower credit quality, yet the weighted coupon rate is exactly the same for GGP versus SPG and MAC.  An EIR of 6.2% or higher seems more justified than the rate they have right now.  As another point of reference, BBB CMBS trades at a spread of 1,700 bps, or 17 percentage points.  This spread on its own is almost 3x wider than GGP's current coupon rate.  CMBS market rates would drive GGP bankrupt.

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.

• Valuation relative to SPG is 20-50% expensive, giving us the liquidity risk exposure for more than free.  The figures below flesh this out.  As another way of thinking about it, GGP's effective cap rate is 6.6% right now (NOI is basically EBITDA + certain corporate expenses), which is dangerously low, especially considering NOI does not take into account all of their operating expenses.  Their effective debt cost is 5.7%, implying a < 90 bp spread off their financing, which they have squeezed to the max by growing interest expense to 34% of their revenues and Debt / GLA to $483 (!), well north of the comps.  Their debt cost deserves to be higher, based on the figures above.

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.

• Conference call had no real new data on the willingness of their lenders to refi their debt.  H2 2008 and the middle of 2009 will be when key blocks of debt come due.  Their main arguments for their ability to refi revolve around their estimates of property value, which feeds its way into their financing capacity (which they say they're only at 30% of) and the LTV of the debt they have coming due (which they say is only 50-60%).  The only incremental pieces of information we have are the willingness of GGP to defer expenses and sell assets, both of which they indicated they may do over the next 1-2 years.  This will help them avert a liquidity crisis, but the fact remains that they are still unhealthily levered and lacking in actual cash flow from their operations, in addition to being fundamentally overvalued. 

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.

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.

• GGP's CFO took a direct shot at you, and got a bit defensive a few times in the call.  "What isn't obvious to people, a lot of people have done very shoddy inaccurate analysis and put numbers out there. They have talked about what they believe are cash flow from our properties and what they represent relative to loan amounts. What they don't know is, there are lot of things they don't know, but many of our properties for example as I said, we've been funding expansions out of working capital for the last ten years, not using construction loans because they were more expensive." "We feel as comfortable as anybody could possibly feel. We are not in any danger. I don't know why you and others think that we are. But we're very solid there's no issue there and there won't be any issue in the future."  "We are in absolutely no danger of not being able to repay any loan when it matures. Those that say otherwise are probably short sellers of our stock that are talking their book."

• 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. 

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written by Sunni Middleton, February 18, 2008

Hi Reggie,

While I understand the concept of lease termination fees being a 'bad thing', I don't see why they shouldn't be included in NOI. Is it that the income isn't typical of normal operations?

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Yes, Termination fees should be non-recurring or extraordinary
written by Reggie Middleton, February 18, 2008

If such fees are reliable enough to be considered recurring or normal, then it is a strong indication of a fracture in the leasing model that exhibits such excessive turnover.

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