Seriously, I don’t know what attracts me to them so much. Perhaps it’s the high degree of asset protection. Perhaps it’s the strong catalyst in the form of dividends receipts or, in the case of my favorite (busted preferreds), eventual dividend reinstatement. Maybe it’s because anytime time there’s an asset class that most investors instinctively avoid (in this case, preferreds that have stopped dividend payments), I’m immediately interested.
Or maybe I’m just a sucker.
Anyway, in the past year I’ve bought Gramercy’s busted preferreds (still long, plus the common!) as well as NCT and RAS‘s preferreds (since sold) when they were trading below the value of their corporate cash.
But today I come with a completely different type of preferred: MPG preferreds.
MPG has a lot in common with all of the other preferreds. Much like GKK (and the other two), MPG’s balance sheet is a mess. Much like GKK, much of the balance sheet problems are caused by non-recourse debt, with MPG actually carrying a serious net positive cash balance at the corporate level.
However, unlike the other preferreds, there is certainly some possibility here of permanent impairment to an investment. With the other three prefererds, there was no doubt they were trading below immediate liquidation value. All that had to happen for an investor to get paid at full was for management not to completely screw up.
That is definitely not the case with MPG. MPG (for reasons to be discussed) could not liquidate today and completely pay off their preferreds despite their huge cash balance. And while MPG’s management does not have to be Warren Buffett, Jack Welch, etc. to realize great returns for the preferreds (or, for that matter, the common), they do have to be competent in their deal execution to realize full value.
All that risk, however, is offset be the substantial upside offered by the preferreds, the very tight time horizon for value realization, and the high probability favoring success (management would have to really, really screw up the deals we will discuss to cause a serious loss for the preferreds).
Ok, so enough talk. Let’s get to the business.
MPG is the largest owner of class A office properties in Los Angeles.
The company’s basic strategy, traditionally, has been to buy/build a huge, beautiful class A building, fully lease it out, and lever it to the hilt. In the boom times of the mid-2000s, everything was going well for them. Tenants were plentiful, as sub-prime companies had a seemingly unlimited appetite for office space as they rapidly expanded (remember, even if MPG’s tenants weren’t subprime companies, subprime companies had huge demand for office space which drove MPG’s rents up), and banks couldn’t fall offer themselves fast enough to offer MPG leverage for their property.
Then, when the bottom fell out of the sub-prime market, MPG was hit with a triple whammy- property values dropped like crazy, subprime companies went bankrupt (not only exiting leases, but causing newly vacant space to be dumped on the market), and banks pulled back on credit and stopped refinancing properties.
However, MPG was saved from certain bankruptcy by one simple fact- virtually all of the massive, massive amounts of leverage they used was non-recourse mortgages. This simple fact allows MPG to turn the keys over to their underwater (mortgage > property value) properties. You can see the effects of this on-going turnover in their balance sheet- mortgage debt is down from $5b in 2007 to $2.9B in the most recent balance sheet.
Obviously, that’s still a huge amount of debt considering it is supporting under $2.2B in total assets. But all of the debt is non-recourse, and over $900m of it is related to properties that will be “turned over” by year end (you can see the basics of one of these turnovers through this press release)
So, given all of their debt is non-recourse, what we can begin to estimate MPG’s equity value simply by doing the following:
- Take each property and estimate a value for it
- Look up how much debt is associated with the property.
- If the debt is greater than value, assume MPG will turn over the property and it is worth $0. If the property is worth more than the debt, the excess flows through to the equity.
- Finally, add any cash and other goodies at the corporate level
Now, this is obviously a bit rough. But it’s a good start.
But it’s a start we will save for tomorrow.
Disclosure: Long MPG preferreds, as well as GKK preferreds and common