Banking on Bankruptcy

The situation with my GGP trade is continuing to progress (slowly), and looks to be gradually moving towards some significant news. That will bring a resolution to this period of financial limbo, which has seen continual loan extensions that only prolong the uncertainty and depressed share price.

On Friday, GGP announced that they were cancelling their quarterly analyst call outright, and postponed their earnings release by a fortnight.

There are a range of possibilities why, but this article gives some detail into one - namely the expiry this week on a forebearance agreement (this is an effective extension to a loan while the lender promises not to force a default and the borrower negotiates and is unable to comment in public). If GGP were to file for Chapter 11 this week, its quaterly earnings becomes "a sideshow" by comparison.

Hopefully GGP will file for Chapter 11 bankruptcy protection. As I have said before, I believe this scenario will also work well for GGP and its shareholders. It just may take 3-12mths before I start to realise the gains, which is unfortunate but as I have said - a key rule of investing is patience.

As this article illustrates in some detail, the prospects from an REIT going under are considerably different from a normal company - particularly one with assets that exceed liabilities. To quote an unnamed source from a Reuters article: "General Growth has problems with liquidity [i.e. servicing refinancing its debts] rather than solvency [i.e. operating cashflow]." With assets that exceed liabilities on its balance sheet (ignoring marking to market that should improve that further), and a positive cashflow, it all points to this being very profitable for shareholders when it emerges from Chapter 11 in the future.

Two interesting quotes:

"Bankruptcy experts, however, say that many of the worries may be unfounded. The sector may not have been tested by a big bankruptcy yet, but enough is known about how the companies are structured and how a bankruptcy proceeds that experts think the industry should emerge fine, even from a series of bankruptcies. Further, there is reason to believe that because REITs control a tangible base of assets through large portfolios of real estate, these firms may be more likely to survive bankruptcies than other companies that’s value is harder to pin down or could be subject to liquidation."

"Experts say REIT shareholders are more likely to retain some value simply because of a REIT’s underlying assets. “Most shareholders get nothing in a bankruptcy because most companies have no assets, and that’s not the case with REITs,” Jerome says. “It all comes down to valuation of the real estate assets. Even if those valuations have decreased, it’s going to come back up. And, if the REIT has to go into bankruptcy, it’s not the end of the story for shareholders as long as the company still has something of value.”"

I remain confident that GGP is hugely undervalued. Its share price is so depressed at present due to shareholder fears that Chapter 11 would wipe out the value of their holdings. However given that GGP ought to have a share price of around $20/share by my valuation (half what it was at its peak in the summer), and is currently at a mere 80 cents, you get a sense of just how low it is right now. Certainly $10/share within 2 years is very realistic.

Therefore it will not require even much excess value of assets versus liabilities to remain on its balance sheet for common shareholders to see a huge increase in the stock price and their returns. Another possibility would also be that GGP is bought out during the process, which again would mean big returns for me as it would doubtless be at a share price upwards of $7/share. To put that into context, I would be looking at a £250k profit in such a scenario.

There are other factors to stir into the mix - opportunisim and political. There remains a distinct possibility that one of its rivals will take advantage of the huge discount to merge (or buy outright) GGP. One candidate would be Developers Diversified Realty Corp (DDR), which has a market capitalisation approximately twice that of GGP at present, due to it having less issues around solvency. A combined entity would instil all-importance confidence in lenders and would realistically lead to GGP shareholders receiving a shareprice in the $5-10 range I would estimate.

The political element comes from the extension of the TARP for funding commercial real estate lending, and the progress of Barack Obama's current funding bill through the Senate. I need to complete more research into this as I am not particularly up to date, but it is possible that lenders are receiving indications that funding will be made available at some point in the future, which would enable refinancing.

That would certainly explain why there have been continual extensions without apparent resolution - an effective delay until the TARP situation is clarified, as that is obviously the preferred solution for all parties. If so then there may be another extension again with regards to loans due on 12 February for the two Las Vegas malls mentioned in the Forbes article.

So much to consider, and all you can do with a trade of this complexity is complete analysis, stick to your strategy and remain detached from emotion throughout. If I were to lose my entire stake on this trade (around £80,000) then so be it and I will have learned a huge amount along the way. However all my analysis points towards my acceptance of this risk yielding a significant reward in the future.