By Ben Strubel of Strubel Investment Management
There has been a lot of press lately over St. Joe’s (JOE), a Florida-based real estate development company. Two prominent investors have taken opposite sides of the stock. Leading the short case is hedgefund manager David Einhorn of Greenlight Capital, who contends that the JOE’s land in Florida is no more valuable than cheap rural or timber lands. The chief bull is Bruce Berkowitz of the Fairholme Fund, who believes that the land can be developed into much more valuable real estate. With super investors on either side, other investors are left with a dilemma. If you go long and Einhorn is right, you stand to lose a lot of money. If you go short and Berkowitz is right, you could lose a significant amount of money. Investors are essentially left with a coin flip.
But what if you could buy St. Joe at an Einhorn price and experience the upside that Berkowitz sees? Then if it turned out that the Einhorns of the world were right, you wouldn’t lose very much. If the Berkowitzes of the world turn out to be correct, you would have significant gains. It’s not a pipe dream—if you are willing to look in California instead of Florida. A different real estate development company, Tejon Ranch Co (TRC) in California, fits our “what if” scenario. TRC owns 270,000 acres of real estate primarily in Kern County, with a small amount in Los Angeles County. TRC’s stock price currently implies that its real estate holdings are not much more valuable than run-of-the-mill farm or ranch land despite the fact that much of the land has entitlements that allow development and some of it has been developed.
About Tejon Ranch (NYSE: TRC)
As stated above Tejon Ranch owns 270,000 acres of land in Kern and Los Angeles counties in California. The land is a mix of ranch land, rolling hills, mountains, and crop land. Interstate 5 cuts through a portion of the land, so 150,000 vehicles a day pass through Tejon Ranch. The company conducts ranching and farming operations, receives royalties from oil and gas drilling and water storage operations, and leases land to National Cement Company of California. A map of the land holdings is shown below.
(Source: company website)
Tejon Ranch was founded in 1912 and incorporated in 1936 in California. The company went public in 1973 and the stock moved to the NYSE in 1999. For much of its history, the owners did not pursue any commercial development of the land. Then in the 1980s, TRC announced that it would finally begin development. It wasn’t until 1999 that the first development took place.
The chart below shows TRC’s stock price over the past 32 years. Circled in red are two time periods where TRC reached almost $60 per share before plunging back down to lower prices.
The large jumps in price in the 1980s were due to a combination of the company’s announcement of development plans, rampant speculation, and extremely small float, which necessitated several trading halts during the run up. In the early 1990s, the California real estate market crashed and development of TRC was put on hold. Then in 1998 a new (and still current) CEO Robert A. Stine was named. Stine promptly replaced many of the company’s directors with ones more familiar with real estate development and began plans in earnest to develop the land. In 1999 the first development, what is now known as Tejon Industrial Complex, was started. With the 2008 real estate bust and recession, development has slowed and the stock price has once again fallen.
While the past of Tejon Ranch has been marked with a boom and bust stock price, incoherent or nonexistent development, and rampant speculation, we do not believe this will be the pattern in the future for several reasons.
1) As we mentioned in the previous section, the new CEO Robert Stine and the new board have committed themselves to developing the land commercially. The 1980s and 1990s waffling and refusal to sell off portions of the land is unlikely to repeat itself under the new management. Indeed, the company has been steadily selling off portions of the land , and development has been continuing steadily but for the current recession.
2) Third Avenue Fund Management, run by legendary value investor Martin Whitman, owns 26% of the company. One of Third Avenue’s fund managers, Michael Winer, is a member of Tejon Ranch’s board of directors. Thus shareholders have a powerful voice to encourage prudent and profitable development of the land. Value investors Michael F. Price and Royce and Associates also own small stakes.
3) A landmark environmental agreement was signed allowing three developments: Tejon Industrial Complex and Tejon Mountain Village are already entitled, and TRC is in the midst of the entitlement process for Centennial (a master planned town). It is extraordinarily unlikely that the company will turn back now and not develop the land.
In summary, Tejon Ranch’s relatively poor performance in the past was due to management’s inability to execute a coherent strategy to unlock value in TRC’s assets. With new management in place since 1999 and clear vision for development, we believe TRC will be a much more rewarding investment than it may have been in the past.
It is important to realize that real estate and most real estate development companies are best valued by looking at the market value of their real estate holdings. Traditional valuation metrics and methods of evaluating other companies, such as price to sales or price to earnings, margins, return on assets, sales growth, etc., are all relatively meaningless when discussing real estate. The best way to value TRC is to look at the book value of the company. There is one problem with that method. Much of Tejon Ranch’s land is carried at historical cost, and the purchase of some of the land dates back to the 1800s. The company in its current form was incorporated in 1912. The current book value of the land is $118M, which is well below market prices. To properly value the company, we have to adjust the value of the land to reflect its worth at today’s prices.
To value TRC we will use a sum-of-parts analysis. Tejon Ranch’s holdings can be broken down into six parts. The first two parts are land that will be permanently conserved and the conservation easement. The next parts are three existing and planned developments: Tejon Industrial Complex (TIC), Tejon Mountain Village (TMV), and Centennial. The final part is existing farm and ranch land not included in current development plans.
Dedicated Conservation Holdings (178,000 acres)
In 2008 Tejon Ranch negotiated a conservation agreement with Audubon California, the Endangered Habitats League, Natural Resources Defense Council, Planning and Conservation League, and the Sierra Club. Under the agreement 240,000 acres of the total 270,000 acres TRC owns will be set aside for possible conservation. Of this, TRC will set aside 178,000 acres for permanent conservation and make 62,000 acres available for optional conservation easements. In return the environmental groups agreed not to oppose any of the planned development of TRC’s remaining 30,000 acres.