Thursday, March 28, 2013

Can Mariano's Freshen up Roundy's?

The supermarket business is historically a highly competitive industry with razor thin margins.  In the past decade the competition has only increased with big box retailers and dollar stores squeezing the conventional supermarkets' bottom end customer base and the specialty and organic food retailers squeezing the top end customer base.

Roundy's is a Milwaukee based supermarket operator that was taken private in 2002 by Willis Stein, a private equity shop.  It returned to the public markets in February 2012 with a $112 million IPO, Willis Stein still controls 32.5% of shares, 41.3% of the voting rights, and 3 of the 7 board seats.  It operates mostly conventional supermarkets under three banners: Pick 'n Save (93 stores, mostly in Milwaukee), Rainbow (32 stores in Minneapolis/St Paul), and Copps (25 stores, mostly in Madison and Green Bay).  

Roundy's is the market share leader in Milwaukee and Madison, 40% share overall in Wisconsin, and the third ranked grocer in Minneapolis/St Paul.  Roundy's has gained share in the past decade despite the increase in competition from Wal-Mart and other big box retailers, with mostly smaller independent operators losing share, but despite this, sales have remained flat over the past 5 years and same stores sales growth is non-existent.  Roundy's growth strategy is centered around increasing higher margin business through promoting its own-brand Roundy's and Roundy's Select products and increasing the amount of perishable food it sells.  Their lack of top-line revenue growth is slightly masked by the gain in own brand sales as they are lower cost goods, but generally have higher profit margins.

Mariano's Fresh Market
Roundy's main outlet for their strategy is to expand their new Mariano's Fresh Market (9 current locations) concept in the Chicago market by opening 4-5 new stores annually over the next 5 years.  Named after their CEO, Robert Mariano (former executive of Dominick's in Chicago), the Mariano's concept features a smaller footprint store, focused on premium perishable/prepared foods and organic/natural offerings.  Roundy's is targeting the Chicago market due to the perceived missteps of conventional chains, the above average income levels, and the higher density population.  Being from Chicago, I've yet to actually visit one of their locations (moving with two blocks of one next month), I've heard nothing but great reviews, but does it make for an actionable investment idea?
Balance Sheet
I'm mostly a balance sheet guy, and Roundy's has a fairly simple, but also fairly weak balance sheet.  It's pretty obvious that the company is a former LBO buyout, Willis Stein streamlined the company by selling off the wholesale operations, piled on debt, and paid itself a healthy dividend in the process.  A quick glance at the balance sheet and you see $697 million in long term debt and capital leases against an equity market cap of $296 million, or a 2.35x debt-to-equity ratio.  However, I believe this understates the true leverage of the company for several reasons:

Operating Leases
Many struggling retailers, Sears or JC Penney, have a built in cushion to their valuation due to their vast real estate holdings, Roundy's doesn't have this floor.  Roundy's leases all but 2 of their stores and 1 of their operations centers, these leases are structured as long term net leases where the company pays for the real estate taxes, insurance, and maintenance of the properties.  By leasing, rather than owning, the company has effectively increased their leverage without accounting for it on the balance sheet.  Taking their $1.96 billion in future lease obligations and discounting it back at their cost of financing (5.75%) adds an additional $1.74 billion of long term assets and long term liabilities, bringing the adjusted debt-to-equity ratio to 8.23x

The company produced $199 million of adjusted EBITDA in 2012, add back the rent expense of $113 million (since if they owned their real estate it would be interest expense), giving an adjusted-adjusted EBITDA of $312 million, valuing Roundy's at a lofty 8.76 EV/EBITDA multiple when you capitalize the operating leases (most supermarkets trade in the 5-6x range).

Pension Fund Liability
Roundy's also has significant pension liability as 53% of their workforce is unionized.  As of year end, their pension plans were underfunded by $36 million (accumulated benefit obligation or "ABO" of $199.7 million versus assets of $163.7 million).  Their contributions are likely going to increase as the expected return on the portfolio (used to arrive at ABO) is 8.5%, yet they have a 35% allocation to bonds.  Vanguard's Total Bond Market Index Fund has an SEC yield of 1.67%, assuming Roundy's earns that amount on their bond portfolio (and bond prices don't fall), the equity component of the pension plan would need to return an average of 12.2%, a pretty lofty goal for a diversified plan.

Additionally, Roundy's participates in three multi-employer pension plans that are underfunded.  Multi-employer pension plans are particularly troublesome because as contributing employers become distressed and shed their liabilities, their liability shifts to those employers remaining in the plan, its almost a reverse pyramid.

Not surprisingly, given the lack of real estate or other assets, Roundy's balance sheet assets are made up of mostly goodwill.  In the fourth quarter of last year they took a $120 million write-down associated with the fall in the market value of their equity.  Usually a non-cash charge doesn't bother me much (see my investment in Ultra Petroleum) but there are no real assets here other than the operating business, in a distressed situation there's little for non-senior lenders to recover.

A highly leveraged, yet consistent earner could still be a valuable investment if management was disciplined about paying down debt, as any improvement in results would accrue disproportionately to the equity.  When Roundy's returned to the public markets in the first quarter of last year, its intention was to pay a quarterly dividend of $0.23, most likely to attract dividend focused investors for the IPO.  But in order to reduce debt, the company wisely cut the dividend to $0.12 per quarter in the fourth quarter.  Even at the lower dividend amount, Roundy's sports a dividend yield north of 7%, probably quite enticing for a lot of people.  However, if Roundy's held onto that cash and used it to pay off debt even faster, it would probably be more advantageous to shareholders (and would be tax deferred to the investor). 

All the above pretty much kept me from digging too much further, the company doesn't report revenues by banner segment, so I couldn't find much in terms of projected incremental EBITDA per Mariano's store, but that could be the key number for a more growth oriented investor.  I like companies in disliked industries that have a hidden gem asset, if Mariano's was valued at Whole Foods like multiples, what would those 25-30 to Mariano's stores be worth?  Quite a speculative investment given the challenges, and I'll pass for now, but when I move in a couple weeks, I'll be sure to check out their new store.

Disclosure: No position in RNDY

Wednesday, March 20, 2013

GKK = Gramercy Property Trust

So the transformation continues at Gramercy Capital, this week Gramercy announced their full year results and gave another business plan update presentation.  The level of management transparency is welcomed after being essentially in the dark as a shareholder under the previous management.  They also announced that on April 15, 2013, they will change their name to Gramercy Property Trust to better reflect the new equity REIT strategy and change the ticker to GPT.

CDO Sales
Gramercy completed the sale of their CDO management business, Gramercy Finance, on Monday for $9.9 million, plus they sold their senior CDO bonds they had repurchased for $34.4 million, and will eventually recoup servicing advances of $14 over the course of the next year, freeing up a total of $58.3 million to invest in net leased assets.  Best of all, they will be able to de-consolidate the CDOs on the balance sheet, making the company much easier to understand.

They also retained the equity, which they curiously put at a value of $25 million by 2018.  Being quite familiar with CDOs, I know how difficult they are to value and what level of assumptions are necessary even if you have all the relevant information at your fingertips.  Since these are very junior/highly leveraged tranches, the $25 million number seems reasonable if real estate values continue to pick up, although I wouldn't include it in any valuation estimate of the company, more think of it as a free option with huge upside.  The 2005 CDO has the best chance, followed by the 2006 CDO, and the 2007 CDO is long gone with no value.  One concern regarding retention of the equity, is the potential for "phantom income", they disclosed the risk in their 10-K.  I'm not familiar with the tax accounting rules behind it, but this could represent a major issue if Gramercy was forced to make a dividend distribution (probably would be in stock?) to holders even if the company didn't receive any cash flow, big problem for those of us holding Gramercy in a taxable account.

Current Portfolio and Updated Valuation
Gramercy continues to be active in deploying their dry powder, put at $154 million by management on the call.  That includes $104 million of cash, $43 million of borrowing capacity on unencumbered assets (so properties without a mortgage), $15 million coming from the CDO servicing advances, and $20 million from additional non-core asset sales.  The recently announced the purchase of a property outside of Memphis that's used a distribution center for retailer Five Below.  Below is the current short term pipeline, seemingly attractive assets.
So what's the company worth now?  Well Gramercy gave a peek into what the future cash flows could look like, the current assets have a projected annual net operating income of $20 million.  If all the dry powder was deployed, Gramercy would receive an additional $26-29 million in net operating income, lets use the low number, so the total NOI would be $46 million annually.  Add in $10 million from the asset management contracts for the KBS portfolio and the Bank of America JV (for simplicity, I'm going to net out the expenses against incentive income).  Total NOI projects out to $56 million.  At that point, debt is projected to be $346 million, using a 4% interest rate (Gramercy previously put financing at 3-4.75%), that comes out to $13.88 million of interest expense.  New core MG&A run rate has been reduced down to $13 million annually, and sounds like it could move lower as Gramercy ramps up and is no longer in growth mode.  Finally, subtract the preferred dividend (the dry powder number assumed the preferred dividend was caught up) of $7.16 million, and you get total expenses of $34.04 million.  Adjusted Funds From Operations would then equal $21.96 million, or $0.36 per share.  Pretty close to the $0.40 I originally came up with in my first post.  

Put an implied capitalization rate of 7% (or an AFFO multiple of ~14x) on the AFFO, and that puts Gramercy's potential price target at $5.17 per share, leaving some more running room.  Management also stated on the call how "favorable" valuations are right now for REITs, which I agree with, so hopefully they take advantage, deploy the cash as quickly as possible, return to REIT dividend normalcy, and potentially issue equity at a high multiple.  At that point I'll probably look to sell as traditional REIT investors rush in, but it's probably another year off.

Disclosure: I own shares of GKK/GPT

Tuesday, March 12, 2013

Tropicana Entertainment

Tropicana Entertainment owns and operates seven regional casinos in the United States and one temporary casino located in Aruba (Tropicana Las Vegas is owned by a separate entity).  Tropicana's predecessors went bankrupt in 2008, and Carl Icahn bought it out of bankruptcy in 2010, he now owns 67.89% of the outstanding shares through Icahn Enterprises (IEP).  Icahn seems to be everywhere lately and by now everyone has seen his confrontation with Pershing Square's Bill Ackman (also the Chairman of HHC) on CNBC, while Icahn ended up looking a bit foolish, it's hard to argue with his track record as an investor.  He's been particularly successful in the casino business.  For example in 2007 he sold American Casino & Entertainment Properties to Whitehall (Goldman's real estate funds) for $1.3 billion (Icahn paid $300 million), perfectly timed at the top of the market, and the casino operator has run into trouble ever since due to a heavy debt load put on it by Whitehall.  Could he do something similar with Tropicana?

Times have certainly changed, the company's largest casino is the Tropicana Casino and Resort located in the troubled Atlantic City market.  Atlantic City has been in a long term decline and now faces increased competition from neighboring states who are rushing to legalize gambling in an effort to shore up their state's finances with gaming tax revenue.  In the past Atlantic City marketed itself a destination resort for the northeastern corridor, but now with casinos popping up throughout the region, it should be considered just another drive-up market.  Unfortunately, a drive-up market with 12 casinos.

Tropicana's casinos in other markets also face increased competition from the proliferation of both commercial and native american casinos across the country.  Several states, including New Jersey, are creating legislation to legalize online gambling, creating yet another source of competition for regional casinos that don't have the non-gaming draw of Las Vegas or other destination resorts.

Below is a list of Tropicana's casinos (minus the temporary one in Aruba) which are located in markets where they primarily draw their revenue from repeat type customers who are within driving distance:
  • Tropicana Casino and Resort (Atlantic City, NJ)
  • Casino Aztar (Evansville, IN)
  • Tropicana Laughlin Hotel and Casino (Laughlin, NV)
  • River Palms Hotel and Casino (Laughlin, NV)
  • MontBleu Casino Resort & Spa (Lake Tahoe, NV)
  • Belle of Baton Rouge (Baton Rouge, LA)
  • Trop Casino Greenville (Greenville, MS)
  • Tropicana Aruba Resort & Casino (Noord, Aruba)
Tropicana does not have exposure to the Macau market like a lot of its larger peers; the Macau market continues to grow and now dwarfs the revenue of Las Vegas.  On the positive side, Tropicana emphasizes slot play, versus table games at larger destination resort casinos, leading often to higher margins and more consistent revenue (less luck).

Given the industry challenges, Tropicana doesn't deserve a market premium, but how cheap is the company?

Balance Sheet and Debt Refinancing
In the first quarter of 2012, Tropicana refinanced it's original credit facility and replaced it with a $175 million term loan from UBS as well as a letter of credit facility.  The new loan terms are LIBOR based with a 7.50% floor, which is the current rate based on today's interest rate environment.  The new loan facility replaces one financed by an affiliate of Icahn with a whopping 15% rate, so starting in the second quarter of 2012 you see a dramatic improvement in the company's interest expense and thus cash flow.

Tropicana now has a strong balance sheet with $242 million in cash, only $170 million in long term debt (rare in the casino industry), and it sells for only 70% of book value.  Not that anyone is eager to build casinos in the current environment, but many of Tropicana's properties are on the books for far less than replacement value giving the book value measure some creditability.  Tropicana has some plans for the excess cash, including capital expenditures of $30-40 million to renovate existing casinos and potential construction and development costs related Tropicana's planned permanent casino in Aruba, which could be highly accretive to shareholders.

In December 2012, Pinnacle Entertainment agreed to buy Ameristar for $869 million plus $1.9 billion in assumed debt, pegging Ameristar's enterprise value at $2.8 billion.  Both Pinnacle and Ameristar are regional casino players, so this transaction should be a perfect comparable for valuing Tropicana.  Since Tropicana has a much different capital structure than Ameristar, EV/EBITDA is probably the best multiple to use as its debt neutral, on that metric Pinnacle paid 8.37x (2.8B/334.45MM) for Ameristar.

In 2012, despite a unprofitable 4th quarter (partially seasonality, partially Sandy) Tropicana managed an EBITDA of $84 million and an enterprise value of $348 million ($421 million market cap minus $72 million of net cash), for a EV/EBITDA multiple of 4.13, or roughly half what Pinnacle paid for Ameristar.

Why is it cheap?  Well other than the already discussed over saturation of the industry, Tropicana trades over the counter and has a limited number of holders (only 41 holders of record) with a controlling shareholder.  Often after bankruptcy, the new equity ends up in the hands of the former creditors, in this case Ares through their management of a long list of CLOs.  CLOs are not a natural holder of equity securities (need cash flow), typically they get them post default and can only hold a limited portion of their portfolio in equities or must sell them following a certain timeframe (sometimes 1 year, sometimes 3).  So it will be interesting to see what Ares ends up doing with their shares, if Icahn wants to scoop up more shares in an efficient manner, its likely he'd buy them from Ares.  Given the limited liquidity, most institutions pass on Tropicana as they are unable to build a position large enough to move the needle, and other investors are precluded from investing in casino operators due to morality clauses in their investment policy statements.  I like to invest in companies like this, overlooked by most investors for reasons other than their performance and future prospects.

I see a few potential catalysts for Tropicana:

  • Internet Gaming: NJ Governor Chris Christie seems committed to seeing that Atlantic City's turnaround succeeds, and is pushing through legislation that would allow for NJ casino operators to conduct online gambling in late 2013 or early 2014.  I've yet to see Tropicana's plans for an online gambling operation, but competitor Caesars seems out ahead of the curve (probably because they're debt load makes them desperate).
  • Acquisitions/Capital Expenditures: Tropicana has plenty of cash on the balance sheet and a huge line of credit that was recently opened, presumably this was done to renovate existing casino assets to make them more competitive and strategically pick up struggling casinos on the cheap as less well capitalized competitors get washed out.  Capital expenditures could lead to greater foot traffic and revenue, but its a difficult game to play as each competitor tries to one up each other.
  • Outright Sale: Carl Icahn is always looking to do a deal, and has already shown his ability to flip casino assets in the past at a good price.
  • Leveraged Recapitalization:  Similar to what Carl Icahn is proposing at Dell, Tropicana could use their cash and draw on their credit facility to pay a special dividend to shareholders and leverage up the business if they don't find any profitable acquisitions or cap ex projects.
  • Improved Sentiment: With sentiment so poor, especially for Atlantic City casinos, any improvement in investor sentiment could send Tropicana's shares higher.  Additionally, with the wealth effect in full swing as housing and stock prices increase, consumers may increase their discretionary and entertainment spending.
I view Tropicana in a similar way as Asta Funding (both are fairly small positions for me), previously a distressed company that has a little too much cash and operating in disliked seedy industry without a clear strategy.  But like Asta, Tropicana is very cheap and the large net cash position limits the downside.

Disclosure: I own shares of TPCA

Monday, March 11, 2013

Finishing up Howard Hughes

Okay, so here I go with trying to value Howard Hughes Corporation on a sum of the parts basis.  There are a lot of assumptions and moving parts in the valuation of a company with such a wide array of assets across various real estate sectors, so I won't be surprised if I make a big error or omission.

The Woodlands
I'll start with The Woodlands, the master planned community located in Houston.  The MPC has limited real estate acreage available for residential and third party commercial developers.  I pulled sales information from conference calls, 10-Ks, and recent presentations to come up with price per acre and the costs numbers (40% of revenue).  I also assumed a straight line revenue and a discount rate in the range of what Howard Hughes has previous laid out of 10-20% (since The Woodlands is a fairly mature MPC I went with 15%).  I think the below might be understating the true value of remaining land as the Exxon campus gets built and Howard Hughes' own properties start filling up the Town Center area, but I think it's a good start.

Howard Hughes is currently very active in developing and operating commercial property at the Woodlands, and that's where a lot of the value could reside in the public market space as MPC acreage can be too long lived for the typical public markets investor.  Below are the properties that are currently operating in the Woodlands and the three assets that are under construction.  I based the market values off of NOI, Howard Hughes has advised that an appropriate market cap rate for Houston is 7%.

Lastly at The Woodlands, there is the remaining planned developments, both at the new Lake Woodlands development and in the Town Center.  With these estimates, I used Howard Hughes' guidance on the planned development opportunities and then extrapolated the costs and expected NOI of their current projects under construction.  Here is definitely where the numbers get a bit iffy, and you would need a bit of faith in management's estimates (also need to assume we don't hit another deep recession).  It's important to note that management believes the development of the Town Center will improve the value of the remaining acreage that is available for sale (hinted at an over $100MM increase in the value in the latest annual letter) which I have not included in either value estimate.

Howard Hughes' youngest MPC is Bridgeland, northwest of Houston.  The long term vision is to create a similar development as The Woodlands where Howard Hughes would own and operate many of the town center's commercial properties using the proceeds from the residential properties to fund the development.  To be conservative, I just applied similar assumptions to available acreage for commercial and residential development to Bridgeland and left out any planned ownership of commercial buildings as Howard Hughes has not laid out any specific plans.  This time I upped the discount rate to 20% since Bridgeland is relatively new and has a long remaining life.

Howard Hughes development west of Las Vegas is Summerlin, currently home to over 100,000 people but with plans for approximately 100,000 more by the completion of the MPC.  Again I applied similar assumptions as to Bridgeland and The Woodlands on the remaining acreage for residential and commercial development, utilizing data from recent sales (in a distressed pricing environment for Las Vegas).  Recently housing prices have increased substantially and inventories are constricted in Summerlin, so I've increased the price appreciation assumption to 6% and used the same discount rate as The Woodlands of 15% since Summerlin is a mature development.

Similar idea as The Woodlands, Howard Hughes is breaking ground on the Shops at Summerlin this year which will include 1.5MM square feet of retail space and 200,000 square feet of office space.  The Shops at Summerlin are part (106 acres) of a larger (400 acres) planned Downtown Summerlin development which will include additional office buildings, condos, and apartments.  I've left Downtown Summerlin out of the valuation, but upon completion it should boost the overall value of the surrounding land as well.

Victoria Ward/Ward Village
Management describes Victoria Ward and Ward Village as the "crown jewel" of Howard Hughes and its where a bulk of the eventual value of the company could be realized.  In its current state, it has 665,000 square feet of retail space, but the plan is to eventually build 22 residential towers for a total of 4,000 condo units and over double the retail space to 1.5MM square feet over the next decade.  Howard Hughes has announced the first phase of this development, adding two towers of 500 condos at an average of 1,200 square feet a piece.  Local condo towers are reselling for $1400 a square foot, and management is estimating the cost to build at $900 a square foot.  In this estimate, I'm also including the $73MM expected to be received upon completion of the ONE Ala Moana condo project and an estimate of the future value of the redeveloped shopping district.

The long-term value lies in the development of the remaining 20 residential towers in Victoria Ward, it would be wise to put another big asterisk on the value here, but for those bullish on beach front property, it could be a huge revenue generator for the company.

Another "downtown" development that Howard Hughes is planning is in Columbia, Maryland.  Expect to hear more about this development in the coming year from management as the MPCs in the area are fully sold out of residential lots.  Howard Hughes, along with a joint venture partner, is developing an apartment building with 380 units with plans for up to 5500 more units in the area.  Howard Hughes also has plans for an additional 4.3MM square feet of office space and 1.25MM square feet of retail space.

Other Operating Assets
Howard Hughes has some other miscellaneous retail and office assets that they operate.  For the sake of simplicity I grouped them all together and based their value off of a conservative 8.5% cap rate (my value here is below the book value).

Other Strategic Assets
One of Howard Hughes other strategic assets is the South Street Seaport in Manhattan.  The company recently outlined its vision to redevelop the property with SHoP to create a retail and functional space that both locals and tourists alike would frequent.  Currently rents go for $100 a square foot, clearly there is a lot of value to be created here, but given Superstorm Sandy and the unknown development costs I just included the development at half the book value along with Howard Hughes' other strategic assets that require a lot of development to bring up NOI to market rates.

Sum of the Parts
Like I mentioned at the start, there are a lot of moving parts and assumptions necessary to peg a value on Howard Hughes' assets given the publicly available information in their filings.  I've purposely valued some of their assets conservatively to make up for the fact that I don't know their future debt financing or joint venture plans.  There are likely many errors in my analysis, its a step up from back of the envelope, so do your own homework.

In summary, despite its recent run-up Howard Hughes still provides plenty of upside potential as the projects in the pipeline hit their development targets (future developments become actual and no longer require such steep discount rates) and investors start to take notice of the cash flow potential of the portfolio.

Disclosure: I own shares of HHC

Tuesday, March 5, 2013

Follow up on Howard Hughes

In hindsight I should have waited a few days to post about Howard Hughes and link David Weinreb's annual shareholder letter in which he does a superior job of laying out the value proposition of each of the company's developments.  It's a bit lengthy, but Mr. Weinreb is fantastic at communicating the company's vision via the annual letter, definitely worth the read.

The Howard Hughes Corporation Issues Letter to Shareholders

One transaction that I failed to discuss previously and wanted to highlight was the recent repurchase of warrants from the company's initial sponsors:

"Our long-term goal is to increase the value of the company on a per-share basis. We do this by improving our assets through the development process and by opportunistically deploying excess cash. In the fourth quarter, we purchased approximately 6.1 million of the 8 million Sponsor warrants issued as part of our emergence as a public company. These warrants had a strike price of $50.00 per share and a November 2017 expiration date. They were the most expensive and dilutive security in our capital structure. Before their retirement, the warrants represented an economic drag on our per-share progress as every dollar of appreciation of our stock price above $50.00 would require us to generate $1.16 of value. The repurchase of these warrants in exchange for $81 million of cash and 1.5 million shares is a break-even proposition for the company if our stock price equals $81.10 in 2017, a price which we expect will be well below the potential value of our stock at that time. As a result of retiring the warrants, our shareholders now own 10.1% more of the company."
Great transaction for the company and shows how focused management is on realizing shareholder value (great alignment of incentives, but I don't anticipate Mr. Weinreb giving up his warrants so cheaply).

Disclosure: I own shares of HHC

Friday, March 1, 2013

The Howard Hughes Corporation

I apologize in advance for the long post, but I've held HHC since October 2011, enjoying a great return, but I believe there's still a lot of potential for the company as its misunderstood by most investors.

The Howard Hughes Corporation (HHC) is a collection of interesting real estate assets that was spun out of General Growth Properties (GGP) in November 2010 following GGP's reorganization in bankruptcy.  The thought process behind the spinoff was rather simple, make GGP a pure play on shopping centers and spin out the assets that required significant development costs or that weren't shopping malls into a separate entity.  As part of the spinoff, Bill Ackman of Pershing Square became the Chairman; Pershing Square along with Brookfield Asset Management own 29% of Howard Hughes.

I mentioned in my last post that I believe REITs in general are overvalued, but Howard Hughes is a real estate company that has currently elected not to be a REIT and that could be a source of value as investors might not understand the value of their operating assets.  By not organizing as a REIT, Howard Hughes is also able to retain its earnings to invest in the development of their wide range of assets, eventually adding additional net operating income producing properties.

Howard Hughes groups its assets in three categories, master planned communities ("MPCs"), operating assets, and strategic developments.  I'll review and touch on the potential value of each one below.

Master Planned Communities
Howard Hughes' master planned communities consist of four segments: Summerlin, The Woodlands, Bridgeland and a group of four smaller MPCs in Maryland.  The MPC business is one with a very long time horizon, developers need to put up a large amount of capital initially to build out the infrastructure for an uncertain return that can take decades to realize.  Part of the beauty of the GGP bankruptcy and HHC spinoff, Howard Hughes received the MPC assets after predecessors had already invested in the initial capital.  MPCs are also hard to value because they have such long lives (what discount rate to use?) and their revenue can be very lumpy.

The Woodlands (Houston, TX)
The Woodlands is a large (1.5x the size of Manhattan) and mature master planned community located in Houston, Texas.  Houston has recovered nicely from the financial crisis as Texas has experienced an energy boom and has attracted businesses with its low tax rate.  For instance, ExxonMobil recently announced the construction of a large corporate campus that will be the home to 10,000 employees just south of The Woodlands, a potential catalyst for additional office building development and sales of residential lots to home builders in the area.  The Woodlands is a mature MPC, with limited residential lots remaining, but remains an important asset for HHC due to the robust downtown and opportunity to build out new many new operating assets. 

The Woodlands has 2,750 residential lots available, and they've averaged a sales price of $95,000 per lot over the past three years (trending up to $102,000 last year).  The commercial land has averaged $475,000 per acre over the last three years (both office and retail combined).  No matter the discount rate applied, clearly there's a lot of value left in The Woodlands.

Bridgeland (Houston, TX)
Bridgeland is a master planned community that consists of approximately 11,400 acres, residents first occupied the community in June 2006, giving the Bridgeland a long runway.  Predecessors invested $325 million dollars into Bridgeland before returning a single dollar, so the big initial outlay has already been made.  It's anticipated that Bridgeland will eventually have more than 20,000 homes with 65,000 residents.  

One key driver of future growth is the expansion of the Grand Parkway (State Highway 99) providing easy transportation from Bridgeland to the rest of the Houston area.  Construction of the highway began in 2011 and is expected to be completely by the end of this year or beginning of 2014.  The successful sales and operating team behind The Woodlands, is also in charge of Bridgeland, so once most of the development opportunities at The Woodlands have been completed, expect a lot of activity in Bridgeland shortly after. 

Bridgeland has 18,253 residential lots available, and they've averaged $53,000 a piece over the last three years.  I would expect as The Woodlands is completed, and the Grand Parkway built, that the average lot price would trend higher as Bridgeland matures and gains value.

Summerlin (Las Vegas, NV)
Named after Howard Hughes' grandmother, Summerlin is a large master planned community located approximately nine miles from downtown Las Vegas.  As of December 31, 2012, there were approximately 40,000 homes and occupied by approximately 100,000 residents.  The Las Vegas housing market was one of the hardest hit after the financial crisis, with housing prices down by more than 50%, but recently there's been some firming up of the local economy which should lead to some stabilization.

Even a modest uptick in prices and a return to the normalized long run average will provide substantial added revenue.  Howard Hughes is also developing a true downtown called the Shops of Summerlin, Dillard's and Macy's have already signed up as anchor tenants, with the ultimate plan to create 1.5 million square feet of mixed-use development.  Not only would the Shops of Summerlin produce NOI for the company, but the presence of a true downtown would likely increase the value and desirability for the remaining residential lots to be sold as well. 

Summerlin received an average of $78,000 per lot over the last three years, with 43,000 lots still remaining and after the completion of the Shops of Summerlin, there's a long runway to monetize this asset.

Maryland Communities (Columbia, Gateway, Emerson, and Fairwood)
All of the Maryland Communities are fully developed MPCs that have no remaining residential lots for sale.  Howard Hughes owns commercial and apartment buildings, as well as some commercial acreage for sale in each MPC.

Operating Assets
Howard Hughes owns nine mixed-use and retail properties, seven office properties, a resort and conference center, a 36-hole golf course, a multi-family apartment building, two equity investments and five other assets that currently generate revenues.  These operating assets generated $62 million in net operating income for 2011, putting an 8% cap rate on these assets puts the value at $775 million (or $1.4B if you use the 4.6% average REIT cap rate), a significant source of value for a company with a current market cap of just under $3B.  Howard Hughes is investing in or repositioning many of these assets to improve their operating performance.

Ward Centers (Honolulu, HI)
Ward Centers could be considered its own MPC as Howard Hughes owns approximately 60 acres within a mile of Waikiki Beach and downtown Honolulu.  In October, Howard Hughes announced plans to redevelop the site and include over 4,000 condominium units (two towers) and over one million square feet of retail and other commercial space. 

Hawaii's restrictive zoning laws (90% of the land is owned by the state) are going to put a major squeeze on development opportunities in Honolulu, with real estate prices there expected to jump 40% over the next several years.  The demand for luxury condos on the island is so great that Howard Hughes along with its partner sold out the ONE Ala Moana Tower in 29 hours.  In addition to the two residential towers, Howard Hughes is going to redevelop over one million square feet of retail.  Neighboring Ala Moana mall is the highest grossing mall in the country at $1500 per square foot (owned by GGP).  Currently, Ward Centers rents for $535 per square foot, so the redevelopment of Victoria Ward/Ward Village has the potential to unlock a lot of value for Howard Hughes.

South Street Seaport (New York, NY)
Howard Hughes has a long-term ground lease with the City of New York (expiring in 2072) that comprises three mid-rise buildings and the Pier 17 shopping mall located on the East River in Manhattan.  Howard Hughes recently announced the redevelopment of the site partnering with SHoP Architects of Barclays Center fame (infamy?).  Unfortunately, the South Street Seaport was damaged by Sandy in October, the company believes that insurance claims will cover most of the repair costs and lost income, however they reported only a $639,000 net operating income for 2012 (versus $5.65 million in 2011).  The South Street Seaport is only on the books for $5.9 million, so after the reconstruction and repurposing of the property, it's safe to assume this property is worth many multiples of its book value.

Other Operating Assets:
Mostly a collection of office buildings and Class B malls with redevelopment opportunities in different stages.  Many are being held on the books for well below market value.
  • Rio West Mall (Gallup, NM) - 520,000 square foot mall, $1,250,000 in NOI during 2012.
  • Landmark Mall (Alexandria, VA) - 880,000 square foot mall, $923,000 in NOI during 2012.  It has redevelopment opportunities with up to 5.5 million square feet of net new density.
  • Riverwalk Marketplace (New Orleans, LA) - 250,000 square feet, $221,000 in NOI during 2012.  Recently announced that it will be converted to a outlet mall, one of the few in an urban center.
  • Cottonwood Square (Salt Lake City, UT) - 77,000 square feet, $432,000 in NOI during 2012.
  • Park West (Peoria, AZ) - 250,000 square feet open air mall near the football and hockey stadiums, $830,000 in NOI during 2012.
  • 20 & 25 Waterway Avenue (The Woodlands, TX) - 50,000 square feet of retail space, $1,582,000 in NOI during 2012.
  • 110 N. Wacker (Chicago, IL) - 226,000 square foot building leased to GGP for $6,073,000 annually.  On the books for just $22.7 million, effectively giving it a cap rate of 26% at book value.
  • Columbia Office Properties (Columbia, MD) - HHC owns 5 office buildings, $2.4 million in NOI during 2012.
  •  The Woodlands Office Properties (The Woodlands, TX) - HHC owns 4 office buildings that are 100% leased, generating $9.4 million in 2012.
  • The Millennium Waterway Apartments (The Woodlands, TX) - 393 unit apartment building, 93.1% leased, and generated $2.6 million in 2012.
  • The Woodlands Resort and Conference Center (The Woodlands, TX) - 440 hotel rooms and 90,000 square feet of meeting space.  HHC recently announced a $70 million redevelopment of the property.
  • The Club at Carlton Woods (The Woodlands, TX) - Two golf courses, and like many golf courses in the current environment, its a losing money operation to tune of a $4.2 million loss in 2012.

Strategic Developments
Howard Hughes also has a collection of real estate assets and development rights that are not currently generating income, but have the potential to do so with investment.  Several strategic developments are currently under construction including office buildings (3 Waterway Square and One Hughes Landing) and an apartment building (Millennium Woodlands Phase II) in The Woodlands, ONE Ala Moana Tower in Honolulu which sold out in 29 hours netting Howard Hughes $47.5 million (versus a $22.8 million book value), The Shops at Summerlin, and an apartment building in Columbia, MD.

Once completed, many of these properties will become operating assets generating substantial income giving Howard Hughes additional cash flow to invest in other projects. 

Insider Ownership and Management
Unlike PICO Holdings which I previously wrote up (no position at this time), Howard Hughes Corp's management has a lot of skin in the game.  Where else have you seen a management team pay the company to accept the job?  That's essentially what David Weinreb did when he became CEO, writing a check for $15 million dollars worth of warrants that won't expire for another 4 years, he's clearly incentivized to realize the value of Howard Hughes' assets. 

The presence of Pershing Square and Brookfield Asset Management on the board is also a plus, as both are seen as long term investors with solid track records (despite Ackman's recent pain in both HLF and JCP).

There's a lot of moving pieces and your final value on the total value of their assets depends on a lot of assumptions, but I hope it's clear that Howard Hughes is materially mispriced.  Howard Hughes has a lot of options as it transitions from an asset based company to a cash flow based company in the coming years.  One option is spinning out some of the cash flow assets into a separate vehicle to take advantage of the tax advantage status of REITs (income only taxed at the investor level).

Disclosure: I own shares in HHC