Positions Revisited

I want to revisit some of my stock decisions and see what was the outcome and analyze if there is anything I should have done better. I will try to be intellectually honest with my assessments and recognize my errors. Also i want to look back and see if there are any mental traps that affected my decisions and recognize when i fall for these psychological biases.

Below is all the positions that I have talked about on this blog for over a year or so. All are businesses that I looked to own but did not or I bought and sold.

General Growth (GGPWQ): I have dismissed the value in this name when it was trading at $.35. now the stock is over $4.5 an impressive 600%+ return. Was I wrong? Off course I was. Would I do the same decision again? Probably yes. There is nothing inherently wrong in how I analysed the situation. I came to the conclusion that there is a probability of permanent loss of capital; this probability excluded the equity of GGP right away.

I honestly can live with the consequences of such decisions. I prefer to err on the side of preserving capital than take a speculative position like General Growth.

Coach (COH): I liked the business and its management but I decided I will only buy at $18 or below to give me enough margin of safety. Coach is trading at $33; some 80% return if I have gone ahead and bough at my buy decision.

My inaction cost me here. This one hurts more than General Growth because there was no reason not to buy. I scummed to the fear and paralysis during the market tumble earlier this year. My bias for the status-quo and regret avoidance have cost me.

Hawk Drilling (HAWK): I did not like this spin-off for various reasons. However, the stock has gone from $22 to $35 in the span of several weeks. The business has a lot of ugly factors in it, which is what you want to buy in a spin-off. But again this one I can live with. The price has gone up not to the specifics of the company but because of movement in natural gas as evident of a similar move by its competitor Hero Drilling as seen in the chart; Natural Gas has also moved from $2.7 mcf to $3.7 during the same period. I concluded that this was a leveraged play on Natural Gas and I did not want to call its direction.

Switch of Bank of America to American Express: After BofA bought Merill Lynch I decided to get out and switch to AMEX. My analysis were right that BofA would have tough time with Merill and I am better with a company that have a great brand name and much more easily understood and analysed than a bank. AMEX return 65% from the switch to BofA -14%.

In this instance I did not have any status-quo bias I acted and I did not have a loss aversion bias. I hope I can have the same capacity to perform the same decision in similar situations.

Preferreds (Brookfield and Bombardier) and Senior Loans Positions: I have bought several positions with the credit theme to be a better proposition than equity. All worked very well with most of them 70% gains plus their yield.

However, equity performed very well since its March lows. All my buying from late 2008 to early 2009 has been tilted toward credit instruments rather than equities. There were several companies that I liked that could have provided me with handsome returns over the last six months. Again, some paralysis on my part to pull the trigger on stocks with attractive prices, similar to Coach above.

Teck Resources (TCK): This position has worked as I expected. The assets were too valuable. When it was trading at $4, I did not think there was any chance of loss of capital. Now that the stock is trading at $30 it still has some room to high 30s.

However I made a silly mental error. I sold too early and left a lot of profit on the table by halving my position. The business did not hit my value estimate and I reacted to the price run and I fell to regret avoidance mode. I should have asked what is the value?

FirstService (FSV): I sold at 8% loss when I realized I made several errors in valuation and business model assessment. My mistake here is that those assessment should have been made before hand not afterwards. I rushed to take advantage of price decline before the opportunity escapes me. Little I know the price declined further. Here it was a process violation; the position should have never been established and because of the error I am 8% poorer.

NorthStar Realty (NRF): I am down some 50% on this one. I can be wrong on this one but I followed my process and my thesis still good. I am willing to hang onto it until I see another opportunity with better return profile.

Sears Holding (SHLD): I am down 30% on this position. Again so far I am wrong and the intrinsic value has declined with the name as its real estate assets have went down in value. Moreover, I realize now that valuation discount alone is not enough it has to be coupled with good business model and economics.

Cardinal Health, Peyto Energy, and Burlington Northern: All of these positions are recent and any analysis is not worth its trouble.

I just wonder how this post would have been different if the market have not rallied. I come to remember the quote " rising tide lifts all boats". So I am thankful that I did well but I always think that there is an element of luck in my decisions.

Commercial Real Estate: Some Observations

I have taken a beating on my commercial real estate holdings (CRE). So it is time to reevaluate my position on the sector.  

My original buys of these names were in late 2008 on the premise that unlike previous down cycles in CRE, office real estate is not overbuilt and will not experience any thing close to late 1980 collapse in prices. I guessed that the market had overreacted to CRE and the market though a repeat to the  collapse in residential housing will occur in CRE.  I expected cyclical down pressure on their operation to be mundane. You can see my earlier views here:  post 1, post 2, post 3, post 4.

What is the status of CRE, here are few observations:

• Credit underpins the valuation in all capital markets, including commercial real estate. To that extent lack of credit have downward pressure on CRE prices. The fact that CRE did not overbuild dampen that downward pressure.
• As deleveraging occurs, credit for CRE will not be available. Private equity and investors are not rushing to pour money into CRE.CRE upleveraged and needs to deleverage, while debt value are constant it follows that asset values came down so equity is wiped out.
• As property owners have no equity in their holdings they have no incentive trade or sell their assets. They will hang on in hope of something to happen. For example, GGP did not want to trade with Simon Property even in bankruptcy because they do not gain on these sales, so they will hang onto their properties in bankruptcy in hopes of something happening.
• No transaction will occur for few years so valuation will not be visible. Valuation will decline but will be mundane at least in what is reported in indices. 
• Transaction will occur in two instances:
• loans come due and the majority will occur in 5- 8 years. Lenders will extend loans rather take loses.
• transactions will occur when there is growth prospects of leasing, rental agreements..etc. so far the prospects of performance is not visible so highly likely no transactions to occur.

• The 20% drop in values are for small properties and not indicative of values in CRE space. publicly traded CRE companies have gone some 55-60% may be that is more accurate for CRE values.
• REITS that have announced equity sales have gone up and when completed have gone up even more. These REITS Ent. value has expanded as it reduced its debt/ equity ratio. Raising more equity will increase value rather it will dilute ownership as earning are decompressing.
• office will hit hard as unemployment will be high for few years so demand will go down although no overbuilding happened. 
  

Am I to abandon the space? I think not. But I will reduce some exposure as I take advantage of this rally. There are interesting development in some areas that can lead to opportunities especially on debt and distressed debt front. Still my preference is to buy long term assets in supply constrained markets, Like Brookfield Properties and Boston Properties. 

General Growth Properties Bankruptcy

This is one of the biggest bankruptcies in commercial real estate history; Olympia & York is close second. This is also one of the most complex as well. The company is operating relatively well but is being crushed by a mountain of debt that can't be refinanced. Their operating metrics are not stellar but they are not bad either. 

Bill Ackman, the famed hedge fund manager, have bough into all levels of the capital structure. His fund not only bought sizable portion of the common but only some senior debt and he is the Debtor In Position financier. Many retail investors have been following him by buying the common. The question is: is there value in owning the common shares? 

Examining the most recent supplemental and 10K, we find 2008 total NOI (Net Operating Income) of $2,576.51M. Assuming a 5% decline in NOI in 2009, our NOI estimate is $2,447.2M. The 5% is realistic for two reasons: 

1. their more recent quarter have seen their NOI drop by 4% from 2007 quarter and 
2. The retail environment have gotten worse since the Q4 of 2008 with sever retail sales declines in Q1 2009  
   

To calculate the value of GGP we use potential cap rates that are appropriate in this environment. I think a range between 8-10% is appropriate. The value of commercial real estate is simply NOI/ Cap rate. Under the different cap rate the potential value for GGP is as follows:

	8%	9%	10%
Value	30,587	27,189	24,470
Add: Other Assets	3,833	3,833	3,833
Less Liabilities	30,500	30,500	30,500
Value per share $	12	2	-7

So unless market cap rates go up beyond 9.5% then there is value in the common equity. However there are many other considerations:

• The bankruptcy will be a long process which most retail investor do not have the attention span for.
• complex and not transparent process.
• GGP's debt is owned by many CMBS holders that might not play ball like large lenders and could negatively affect the outcome of restructuring. 
• Equity holders have no voice and no ownership in CH 11, so GGP's bond holders can strike deals that may wipe out equity regardless of value.
• Legal fees and other bankruptcy fees will eat a lot of the cash generated from restructuring. Lehman Lawyers so far have reaped over $ 150 million. The fees alone can wipe out any value for the commons. Some other bankruptcies like Enron costs more than $250 million. 
• Bill Acman can make good return on his debt even if the equity is wiped out so he is different from you and I owning only equity.
• The game of distressed investing is a different ball game and require set of skills and legal expertise that many of us do not have.

So GGP may have value but the margin of safety and parameters are out of the scope of my competence. And if this is the same for you you should stay away.