GGP Update

Hi, I got some feedback from one reader on GGP. He has some rather interesting insights. He brings to critical issues to the fore:

1. Can the bankrupt REIT take the massive interest rate hikes in order to emerge from bankruptcy? More importantly for the equity investor, how much of its massive debt must be swapped for equity in order for it to emerge a healthy entity? In other words, how much dilution is going to hit the equity holders? And at what price will it be justified to buy GGP stock given the dilution that is about to occur?

2. There is another issue going on in this saga - substantive consolidation. Substantive consolidation (Brasher, Substantive Consolidation: A Critical Examination) is the pooling of the assets and liabilities of technically distinct corporate entities. In simple terms, an individual property secured by an asset is securitized in this case into a CMBS tranche. The key question here is: can you take those cashflows to service other debt in bankruptcy?

I've done some digging on the second issue. It still remains undecided in the US courts. No definitive judgement has been passed on it. If the courts decide that you can't use cash flows of one asset to service other debt in bankruptcy. This will have disasterous consequences for GGP. It will mean it can't cross service its debt held under various structures.

On the first issue, I've run some basic models with the following assumptions.

A. Net Operating Income (NOI) haircut of 10%

B. Average interest rate rise from 5.2% to 10% post bankruptcy

27-Jun-09
GGP (10K) (in M)
Total Debt 24,853
Interest Exp 1,299
Interest Rate 5.2%
NOI 2,105

Assumptions
Debt for Equity 35.0%
Debt Left 16,155
Est Interest Rate 10.0%
Interest Exp 1,615

NOI Haircut 10.0%
NOI (predict) 1,895

Net Profit 279


From the simple model, we see that a 35% reduction in debt is required to get GGP back on its feet again. The model is simple and leaves out a lot of other possible variables, like maintenance Capital expenditure. The point I'm trying to make is the level of debt reduction that must take place for GGP to emerge from bankruptcy is going to be significant.

I took a hard look at Ackman's model as posted in Zero Hedge. There are a few things I'm not too comfortable with. First, maintenance capex is predicted ranging from $156M to $210M over the next 5 years. Now I back checked against GGP's capex in their 2008 10K was $1.19B. That number includes acquisition/development of real estate and property additions/improvements. I've looked through the document the 10K doesn't really mention how much maintenance capex is required. So it's hard to figure out how much maintenance capex is really required on a year to year basis.

Second, I think that the increase in the interest rate to 6.02% post bankruptcy from an average of 5.2% in 2008 is kinda low. What happens if the debtors want an increase interest rate to a higher number (I used 10%) to compensate for the increased risk they are having to take with GGP?

I pose these questions as points to think about. There are probably no right or wrong answers, just educated guesses. On a personal note, I'm going to continue to keep the GGP saga in view before investing in it. I do believe that there is value but I'm waiting to see what the negotiations with the debt holders yield before getting my feet wet.

I want to once again thank my readers for their excellent feedback and insight. If you have something to add to the issues and ideas that I've posted here, please feel free to either post it or contact me at shaunhhh@gmail.com.