Investment Thesis for Howard Hughes Corporation (HHC) and Diana Containerships (DCIX)
With all that in mind here are a couple of investment ideas from Grey Owl Capital that may or may not be of interest:
Martin Scorsese titled his 2004 biopic of Howard Hughes The Aviator after the main character’s love of flying machines. The Real Estate Mogul would have been more descriptive, though probably would not have sold as many tickets. The Howard Hughes Corporation (HHC) was spun out of General Growth Properties (GGP) on November 9, 2010 as part of the latter company’s emergence from bankruptcy. HHC gets its name from the Summerlin property in Las Vegas, Nevada originally acquired by Hughes in the 1950s. Today, HHC is a collection of master planned communities, operating properties, and strategic development opportunities.
Spinouts often present compelling opportunities for value investors. As investors in the parent company receive shares in the spinout, selling is often a rote and indiscriminate exercise. The new holders do not know anything about the new company they own and they did not “buy” it on purpose. Thus, as initial investors sell, spinout shares can offer very favorable valuations. In addition, released from the shackles of the parent company, new management is able to focus 100% on their operations so attempts to unlock value typically increase. We think this is the case with HHC.
At $60/share the company trades at a slight premium to the very marked down book value on the de novo balance sheet. In fact, prior to the spinout, book value was over $30/share higher. Today, we estimate that even a fire-sale liquidation of all properties would be within 10% of current book. However, a rapid liquidation is not why we invested in HHC.
While subject to a far wider range of potential values than our typical investment, we see significant upside in HHC. Equities and fixed income have seen incredible rallies over the past two years. Real estate, on the other hand, even commercial real estate, has not. In HHC, we have a highly experienced and incentivized real estate development team at the helm. CEO David Weinreb has over twenty-five years of real estate development experience along with the prescience to have sold most of his assets prior to the recent downturn. Mr. Weinreb, along with the company’s president and chief financial officer has invested over $19 million of their own capital in the enterprise. Their incentives are aligned with ours. In addition, HHC’s assets reside in terrific locations including Manhattan, Chicago, Honolulu, the Las Vegas strip, and even Alexandria, VA (right in our back yard) to name several. If we assign valuations based on reasonable development expectations for the strategic development properties and assume modest increases in residential land values and sales dribbled out over many years for the master planned communities, it is easy to come up with values 25% higher than today’s share price. There is a lot of room between lip and cup, but we are backing a solid team. To top it off, we have an excellent inflation hedge should the government continue its profligate ways.
No Ship of Fools
We initially began researching Diana Containerships, Inc. (DCIX) subsequent to its January 2011 initial public offering at $15/share. The company is a spinout from the well-run Diana Shipping Inc. (DSX). Shipping is a capital intensive, cyclical business with the typical company employing significant leverage. The business is volatile, as are the stocks. Employing lower leverage, the folks at Diana chart a somewhat smoother course. At $15/share we thought DCIX was close to fair value, so we passed. However, the spinout phenomenon was in effect. The share price proceeded to drop as holders of the much larger DSX began to sell the DCIX shares they had received automatically. In addition, after using a credit line to buy additional ships and given its dislike of debt, DCIX announced a secondary stock offering to pay down the credit line. Short sellers then drove the stock down further in anticipation of covering their shares via the secondary. When the secondary broke its offer price, the stock fell further as anyone who participated for a flip quickly dumped his shares. After the smoke had cleared, DCIX traded around $7/share and presented what we think is a compelling opportunity.
We estimate DCIX’s net asset value (NAV) at $9.30 based on recently delivered ship value (in other words the going rate for these ships, not some value based on cost at the peak of the market). In addition, due diligence indicates that market rates are approximately 25% below new build prices or “replacement cost.” At $7/share we can in essence buy these ships at 75% of NAV. Further, the current EBITDA yield is just over 20% unlevered. A slowdown in global trade would hurt both the business (if the timing of the slowdown coincided with their charter renewal schedule) and the stock, but the strong balance sheet will allow DCIX to weather such a storm. Over the long run, we believe global trade will only expand. Jefferies’ estimates DCIX will be able to pay out a $0.85 dividend in 2012, which at $7/share is over a 12% yield. Even if the stock were to trade to just an 8% yield (still quite high in a world of the 3% 10-year Treasury), the price would be over $10.50/share.
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