Wednesday, December 30, 2009

Tilson's Response To Hovde's Response To Pershing Square's Response To Hovde's Response To Pershing Square's Views On Mall REITS And GGP Specifically

Whitney Tilson (T2 Partners) re-inserts himself into the Pershing Square vs. Hovde debate on GGP. To be fair, Hovde did take a shot at Tilson's GGP analysis on page 63of its Dec. 29th presentation. For those wondering, T2's analysis is largely a derivation of Pershing Sqaure's, which is not surprising given the two firms' histories of sharing research and investment ideas (and Tilson and Ackman's long friendship).

Tilson emailed the following to his regular distribution list:
Hovde Capital yesterday released its response (link here) to Pershing Square’s rebuttal (link here) (and, to a minor extent, and our rebuttal (link here)) of Hovde’s initial report on GGP (link here).

Our quick take is that it’s more of the same – like Hovde’s first report, there are a few good points (nothing we hadn’t already considered) mixed in with many arguments that are either factually incorrect or misleading, or with which we simply disagree. In short, there’s nothing new that changes our view regarding the attractiveness of GGP (it remains by far our largest position).

Before proceeding, we want to make clear how much we enjoy the debate and think our markets would be much healthier if there were a similarly detailed exchange of viewpoints for EVERY stock!

To some extent, the debate is now about different views of the future: Hovde believes that consumer spending will be terrible for an extended period and that bankruptcies among mall-based retailers will continue or worsen, which will translate into severely declining NOI for GGP over time. Pershing believes that the worst is behind us: that unemployment has peaked, consumer spending has stabilized and may even be picking up a bit, and that retailers are in remarkably good shape in light of what they’ve been through over the past 18 months, all of which will translate into approximately stable NOI. Whether Hovde or Pershing is right about GGP over time will, to some extent, depend on future macro factors, which are obviously impossible to predict with certainty.

That said, good analysis matters and we think Hovde’s is sorely lacking, primarily in the following areas:

1) Hovde’s most serious mistake is misunderstanding (or misrepresenting) what will likely happen to GGP’s unsecured debt. Hovde assumes that it either remains outstanding (throughout its presentation, Hovde calculates GGP’s leverage and interest payments assuming that the debt remains outstanding, which is the main reason its analysis differs from Pershing’s and ours – see page 63, for example) or that it converts to equity, which will result in “significant dilution” (page 72). Hovde makes explicit this assumption when it claims that Pershing “does not use consistent assumptions” regarding what happens to the unsecured debt on page 35 of its report.

Hovde doesn’t appear to understand bankruptcy law and what will likely happen to the unsecured debt. There is almost no chance that it will remain outstanding: it will either be refinanced or, more likely, be converted into equity (this is what Pershing assumes – there is no inconsistency). But here’s the key: it will NOT BE DILUTIVE because it will convert AT FAIR VALUE, as determined by the bankruptcy judge. Of course, if the judge determines that fair value is $1/share, then it would be massively dilutive, but that’s not going to happen. The judge has a great deal of discretion in determining fair value, but will certainly take into consideration the current stock price, comps and the price of any equity offering(s) GGP might do.

For example, as soon as GGP exits bankruptcy and its stock is relisted (it currently trades on the pink sheets, which means most institutional investors can’t own it), it will be a must-own stock for every REIT fund (a big catalyst Hovde misses). To meet this demand and pay down some debt, GGP might issue equity – and the negotiated price at which this stock is sold would likely weigh heavily on the judge’s determination of fair value (and would not be dilutive). Of course, if someone like Simon were to buy GGP at, say, $20, the debt would convert at this price – and again, it wouldn’t be dilutive.

2) Hovde takes seven pages (6-12) arguing for its definition of NOI, but there’s no right answer here. NOI is like free cash flow: different people calculate it in different ways. But however one calculates it, it’s important to be consistent – which Hovde is not. It uses the most conservative assumptions to minimize GGP’s NOI, but then fails to do so for Simon, making its comp analysis deeply flawed.

3) Speaking of comps, Hovde writes: “to suggest GGP should trade at the LOWER cap rate than SPG is LAUGHABLE in our view” (pages 22-23). Hovde can laugh all it wants, but there are very good arguments for why Simon is, in fact, the best comp for GGP. For starter, both have very similar mall portfolios with a national footprint (unlike Macerich, which Hovde cites as a better comp on page 63; MAC also has debt issues that are more significant than what GGP will likely have post-bankruptcy). In addition, GGP will likely have a BETTER liability profile post-bankruptcy, with no maturities until January 2014. Finally and most importantly, GGP is for sale and Simon isn’t, so there should be a premium for GGP reflecting a possible sale of this strategic asset.

4) Hovde’s analysis treats GGP as a collection of assets, but it’s more than that. The fact that GGP is in bankruptcy has put it into play, so there is a once-in- a-lifetime opportunity for Simon, Brookfield or someone else to acquire a national platform, as highlighted in this quote from the WSJ:
The opportunity “is a potentially transformational event that doesn’t come along very often,” says Steve Sakwa, an analyst with International Strategy and Investment Group Inc.

5) Hovde dismisses the likelihood that GGP might be acquired (pages 51-55), focusing only on Simon and not even mentioning Brookfield, which may in fact be the more likely acquirer due to fewer anti-trust concerns and the need for a national platform (which Simon already has). As noted above, Hovde misses the value of GGP as a strategic asset – no doubt, there’s lots of distressed inventory out there, but only one national platform for sale like GGP.

Finally, Hovde finds it “telling” that Simon and Brookfield bought GGP’s unsecured debt, but not the equity, even when the equity was at a much lower price. But it’s not as telling as Hovde thinks for a number of reasons. First, it’s possible that Simon and/or Brookfield do in fact own the equity – if either bought less than 5% of GGP, it wouldn’t have to file (in any case, for anti-trust reasons, they couldn’t acquire more than 7.5%). Also, at the time they bought GGP’s debt it was very cheap and they might have reasonably concluded that it represented a better risk-reward than the equity.

6) Hovde argues that GGP’s rental rates and leasing spreads are very poor and will likely get worse (pages 15-18). They have indeed been under pressure, but Hovde is making the classic investing mistake of projecting the immediate past indefinitely into the future. What Hovde is missing is that GGP over the past year, knowing that it was in a poor negotiating position due to the macro environment and its own bankruptcy, has been renewing leases mainly on a short-term basis. These renewals have indeed been done at low rates, but this isn’t likely to be a permanent state of affairs. The macro environment has at least stabilized and may be improving and GGP will soon either be acquired or exit bankruptcy, so its negotiating position will strengthen and therefore rental rates and leasing spreads will likely improve.

7) On pages 28 and 33, Hovde repeats the charts from its first presentation (pages 33-34), showing that “Commercial Real Estate Prices Have Dropped 43% Since the Peak” and that cap rates are moving higher under the heading: “Despite Speculation to the Contrary, Cap Rates for All Property Types Are Moving Higher, Not Lower. Does Pershing Square Believe These Transactions Did Not Happen?” But the CRE chart doesn’t include mall real estate and the cap rate chart, while showing cap rates for virtually every other type of commercial real estate, is MISSING data for malls! (The cap rate for mall REITs has fallen dramatically from earlier this year.)

8) Hovde paints a very bearish picture of retail sales (page 61), but the latest data contradicts this – for example, an article in the NYT earlier this week noted:
Over all, retail sales from November through Dec. 24 rose 3.6 percent from last year, according to SpendingPulse, an information service of MasterCard Advisors that estimates sales for all forms of payment, including cash, checks and credit cards.
That number — which does not include sales of automobiles and gasoline — was helped this year by an extra shopping day between Thanksgiving and Christmas. Adjusting the results for that extra day cuts the retailing industry’s sales increase to about 1 percent, in line with what many retailing professionals expected.
While the numbers do not suggest a turnaround for the industry, they signal an improvement over last year’s 2.3 percent sales decline…
… “Last year was just a storm and retail was all about dropping prices to get rid of inventory,” said Mr. Katz of AlixPartners. “This year it was much more of a planned strategy: low inventories and tight expenses. And controlled promotions.”
That means most stores did not erode their profit margins the way they did in 2008, though in the days before Christmas, Mr. Katz said, some chains discounted more deeply than they should have.
Perhaps the best news is that the double-digit declines that plagued nearly every retailing category last year are gone.

9) Hovde spends many pages (38-43) questioning whether GGP’s Master Planned Community Segment has any value – but Pershing already assigns no value to it so it’s not clear who Hovde is disagreeing with. Another note: on page 39, Hovde makes this ominous statement: “The heirs of the Hughes estate hold a contingent claim related to the valuation of these assets. If there is significant value in these assets, the resolution of this claim could result in a substantial unfunded liability, which Pershing Square has failed to include in its analysis.” This is a red herring: the only claim by the Hughes estate is for half of any profits. Thus, the only way there could be a claim, leading to a “substantial unfunded liability”, is if there are profits, which would be wonderful for GGP (even if GGP only received half of the profits, this is more than zero, which is what both Hovde and Pershing expect).
This is a great debate and it will be very interesting to see how this plays out.

Happy new year to all!
TILB is on record as saying we love to see the debate. It's healthy for markets and educational.