Analysis: GGP Declares Chapter 11

Well, the loss of my lunchtime bolt hole has proved a bit of a problem for me in finding time to post in the last couple of weeks. To be fair, I have been working on (and completed) a draft of the business plan, and have also selected a group of vendors to approach in the coming weeks for a build estimate.

Meantime my next major task is completing a functional spec for the site, as there's no way I trust the average coding monkey with the all-important design and usability. Overall it is going very well, and I am feeling really positive that I can create something unique, useful and commercially viable.

Of course the big news of the last fortnight was GGP finally filing for Chapter 11 bankruptcy protection.

The final straw was the combination of the bond solicitation process failing to persuade sufficient Rouse bondholders to extend, and the threat of action from disgruntled creditors ready to file a claim on certain malls - that meant GGP had little choice but to seek to protect its assets from being effectively raided.

GGP filed with $27.3 bln debt and $29.6 bln assets - figures that are of course disputed - and obtained $375 million in debtor-in-possession financing courtesy of Pershing Square.

Bill Ackman is a canny operator, and clearly used this to hedge Pershing's existing position (at 25% they are the third largest shareholder in GGP currently). By providing DIP financing, Pershing yields a healthy 12% annual return on the debt. Additionally Pershing gain warrants to buy 4.9% of the new equity when it emerges from bankruptcy, and most interestingly the potential to convert the $375m DIP into equity.

The latter option has to be admired, as it ensures Pershing Square will be guaranteed equity whichever way the firm emerges from bankruptcy. I am confident however that it remains strongly in Ackman's interests to maintain common shareholder value, although this does now raise the spectre of dilution. I have analysed this in some detail, and believe that dilution risk is a minimal factor: if the event occurs, that means GGP will have successfully restructured, emerged from bankruptcy and the huge upside potential to the shares will offset and limit any impact.

GGP President, Tom Nolan, gave several interviews subsequently, and placed the blame squarely on the frozen credit markets as the primary cause of GGP's current problems. It will clearly form the central crux when outlining the company's argument as to why a loan extension agreement is justified, and increases the likelihood of approval by the courts.

Certainly the fact that no major rivals who wanted to buy some of the best, revenue-generating properties put up for sale could secure funding is a powerful illustration of the wider market problems, and in favour of GGP.

Nolan also stated that GGP does not see an immediate need to tap DIP financing for 8 weeks, due to cash flow business running costs illustrates the relatively healthy position of the business model. Once again, GGP stands out as an unusual case. Bill Ackman also immediately went to the press to rubbish assumptions by many that GGP's weakness would be to the gain of rivals, by effectively meaning Chapter 11 meant liquidation and an eventual firesale of assets.

Today Fitch downgraded some of GGP's CMBS debt, citing that:

"If the properties remain in bankruptcy, General Growth could seek to load up the properties with additional debt to help repay their corporate unsecured debt."

So far, everything has progressed exactly as I had hoped with regards to the Chapter 11 filing, with the exception of Pershing's DIP equity conversion option. Liquidation and/or widescale share dilution remain the only scenarios in which being long in GGP would not produce significant returns.

It will be interesting finding out what the restructuring proposal submitted to the court contains.  The above illustrates another mechanism by which GGP could pay off unsecured lenders and/or the bondholders without necessarily needing to sell properties.  A key point mentioned here but not considered is that GGP are completing a strategic review, with a specific aim of only offering to liquidate lesser malls as part of the court proposal.

A combination of financial re-engineering, some limited asset sales, and a wider extension request for loans until the credit markets recover sufficiently to enable normal refinancing is the most likely right now.

Speculation Drives GGP

I have been making some positive progress on the business plan for the financial website I am planning to create (sorry, will not be discussing specifics as you would expect on a blog!) A high level plan for its initial marketing and revenue generation has been completed, and since I have brain dumped most of the site ideas, I am going to formalise those along with specifics on the design and structure this weekend in a functional spec.

I have started to look into vendors that can build the site, but am so far fairly unimpressed with the package solutions on offer - not to mention all the bullshit extras thrown in like registering the domain name (and controlling it), that presumably appeal to the average lamer they are targeting. I will be telling them exactly what I want, and otherwise will need full control over the daily content management.

It will require some time and effort to assess what is on offer, but I am looking to approach around about 10 vendors for build estimates, options and support contract costs over the next week. I need that not least so that I can complete the financial component of the business plan, including necessary start-up capital and first year trading costs.

After my last entry on Saturday, discussing my increasing confidence in GGP's prospects - not least from Bill Ackman's recent comments - the share price on Monday underwent such an unusual increase (greater than 200% at one point), that the firm issued a statement on the trading activity to confirm there was no known basis.

I was not entirely surprised to see speculation growing from institutions and others that GGP has significant potential for common shareholders. A 98% discount alone tells you that it is clearly not a fair reflection of value. The price as of today has predictably dropped back to around 85 cents since the highs of $1.35 earlier this week - since I was waiting at around 75 cents for falls to buy more, I am happy to hold and continue waiting for a better buying opportunity (ideally somewhere under 50 cents).

In the meantime, additional support for the notion that GGP will eventually complete negotiations with lenders and file for a prepackaged bankruptcy came in the form of real estate magnate Sam Zell, who commented:

"I do not believe GGP will be liquidated," Zell said at a recent New York University real estate investment trust conference. "I expect the company to file bankruptcy. It will do a prepackaged. It will be reorganized and it will be taken public."

The net impact of this would be a controlled bankruptcy application with a pre-agreed plan of restructuring - this would enable the firm to sort that out under Chapter 11 protection in much less time, and theoretically with less court interference. It would then emerge from this and should see a huge increase in share value.

At the same time, the existing evidence points to TALF funding continuing to trickle down through the system and have an increasingly positive impact on the credit markets throughout the remainder of 2009 and into 2010.

Everything right now seems to point towards GGP being an excellent long hold for anybody not risk averse. Consider this final point: the consensus view in and outside the US government now is that the commercial real estate sector is a huge and vital component of the US credit market that must be supported. As well as CRE being more viable than the multitude of small home owners in the domestic market, many have also commented on the devastating impact that a Chapter 7 (liquidation) of GGP would have - not just on the firm and its shareholders, but more importantly on the wider market.

Too big to fail? I think people are soon about to work out that this doesn't just apply to the banks, and that the major REIT's are also in that same boat.