Thursday, March 24, 2016

Observations from 2015 The Howard Hughes Corp. (HHC) CEO Letter [3/24/2016]

Link here to 2015 Shareholder Letter (worth a read if interested in the company) LETTER or Here

Summary:

This letter is always a good read, as CEO David Weinreb goes into detail each Master Planned Community (MPC) and the primary locations of the Operating Assets. In a sense, each letter he does his best to share how to value The Howard Hughes Corp. (HHC). Even with him sharing how HHC should be valued, the stock still remains undervalued at ~$98/share and also represents a good investment over the 'long-term'.

I prefer owning companies that are run by capable management, have attractive assets, is inexpensively priced, and has a clear runway for reinvestment at above-average rates of return. Some of the best companies in the world have issues with the last quality: reinvestment runway at high rates of return. These companies often use their cash flow to pay dividends, repurchase shares, and make an occasional acquisition. For HHC, their pathway for reinvestment is fairly clear for at least the next 5 years, and they don't need to make any acquisitions to grow at above-average rates of return. 

Observations from 2015 Howard Hughes CEO Letter [released 3/23/2016]

Ownership:
  • Pershing Square Capital Management
    • 2014: owned 9.0% of outstanding common stock, excluding shares issued upon warrant exercise
    • 2015: owned 12% of common stock and warrants and an additional 12% economic interest through total return swaps (total 24%) 

Progress:
  • Increased Net Operating Income (NOI) from $43 million in 2010 to $120 million based on annualized Q4 2015
  • When stabilized, commercial properties under construction or completed expected to achieve approx. $219m NOI by 2019 (excludes South Street Seaport/Pier 17 projects)
  • Expect a 9.0% yield on approximately $2.0 billion costs (excludes legacy assets inherited via spin-off from General Growth Properties GGP)
  • Cap rates should be lower in NYC and Hawaii, versus Las Vegas and The Woodlands
  • Cash:
    • 2014: $560 million unrestricted cash
    • 2015: $445 million cash, add the $377 million from Seaport District Assemblage sold 3/16/2016 = $822 million cash
  • $781 million additional debt needed in next 2 years for development, $541 million is for short term debt for Waiea and Anaha condos in Ward Village (repaid in full by end of 2017)

  • South Street Seaport:
    • Jean-Georges and David Change announced restaurants in Pier 17 building
    • Renovation of Historic District completed by late 2016
    • Not announced expected cash flows yet due to complexity and plans
    • Still working on concept for “Project Two” (700,00 SF additional) 

New Projects (not mentioned in 2014 AR or 2015 Q3 10-Q)
  • One Merriweather (199k office, 49% preleased to Medstar) in downtown Columbia, MD
  • The Constellation (124 unit luxury apartments/ Joint Venture) in downtown Summerlin, Las Vegas
  • Begun process of master planning remaining 184 acres in Summerlin, NV. Envision over 5 million square feet of density
  • One Constellation (mentioned above) is first multifamily development in Summerlin
  • Plan for Columbia, MD, approved in 2015 by Howard County, for:
    • 2,300 residential units
    • 1.5 million square feet office
    • 314,000 million SF retail
    • 250 hotel rooms
    • 4.9 million SF density on 35 acres surrounding Merriweather Post Pavilion 

New Comments:
  • Estimated MPC gross valuations (not yet done, that I’ve seen) = $4.749 billion undiscounted
  • Weinreb shares his belief that most land is discounted at 15% - 20% for raw undiscounted law; should not be the case for HHC land, as located in established MPCs
  • The Woodlands: sell-out date is certain and soon, “single digit” discount rate should be used
  • HHC provided estimated pro-forma “average price per acre” for The Woodlands Hills (~$253k per residential)
  • The Summit (JV with Discovery Land) is selling lots from $2 mil - $8 mil, will hold 270 residences by end 2023. “Sales well ahead of schedule”. Project has 39 lots under contract for $119 million, collected $45 million in deposits from this already. This land was contributed at book value of $13.4 million.


The Woodlands:
  • Commercial land in The Woodlands – 785 acres – should be valued at undiscounted amount of $737 million due to values increasing from $10 per sq./ft. in 2010 to $22 per sq./ft. currently. (Note: I had $485.7 million undiscounted)
  • The Woodlands MPC cash margin = over 90% as infrastructure built = $237m undiscounted (note: I had $193.6 million undiscounted)
  • The Woodlands  = owner and developer of virtually all of the remaining commercial land in The Woodlands, do not have competitive pressures to quickly lease or monetize properties
  • Slowdown in Houston helped HHC because competitors have retreated and HHC continues to strengthen their dominant position in the market
  • 48% of occupied office space leased to investment grade companies
  • Retail portfolio has average remaining lease term of 8.5 years
  • Office portfolio has average remaining lease term of 7.8 years
  • No tenants carrying significant balances more than 30 days past due

 Taxes:
  • Do not expect to pay taxes over next few years due to $255 million of NOLs
  • Higher NOI from commercial properties would incur taxes, but they are burdened in short-term by mortgage debt, depreciation, interest, and thus taxable income from these properties should be “near zero” in next several years
  • HHC holds non-core assets that, if sold, could provide more than $340 million of additional tax deductions 

Valuation Notes:
  • My MPC valuations had a $5.775 billion undiscounted value (although I used 12% - 15% discount rates), yet HHC used $4.749 billion undiscounted.
  • Adjusting my MPC valuation based on:
    • The Woodlands at 9.0% discounted
    • Lowering the price/acre of Summerlin
    • Using 13.0% discount rates for all other MPCs
    • Adjusting The Woodlands Commercial Land to be somewhat closer (but still $50m + off undiscounted), using 13.0% discount rate
  • All in, adjustments to MPC values lowered my MPC “NAV” by ~$2.00/share, from ~ $30/share to $28.00/share