Horizon Kinetics Small Cap Strategy selected holdings commentaries.

The Howard Hughes Corporation (“HHC”) is a developer and manager of commercial, residential, and mixed use real estate assets. The company was spun off from General Growth Properties, Inc. (ticker: GGP) in 2010 as part of GGP’s reorganization. At that time, Howard Hughes was trading at a significant discount (as much as ~50%) to book value, and the book value itself represented assets recorded at valuations far below fair value. For example, the South Street Seaport property in lower Manhattan was carried at approximately $3 million on the balance sheet at that time—about the price of a decent sized apartment in that area. In fact, the current book value multiple of approximately 2.6x represents a considerable discount to fair value, even when using GGP current multiple of 3.5x. GGP is a good, albeit, not ideal comparable, as the company’s real estate portfolio was restated at “fair” book value during the reorganization. Our original investment was based on the thesis that the land and property portfolio was worth significantly more than the market capitalization of the company, and that the very purpose of the spin-off was to properly develop these properties, a number of them having unusually significant redevelopment value. Early support for this thesis was provided when the management team that was hired to run this company was required (and, obviously, agreed) to invest $19 million of their own capital in warrants that were locked up for seven years and priced, effectively, significantly out of the money—in essence, a negative sign-on bonus, perhaps unique in the annals of senior executive hiring. Clearly, these insiders, with decades of industry experience and with access to all of the company’s information, believed deeply in the long-term value of these assets. This management team has made consistent progress in developing various company assets that have compounded book value and which are expected to generate an additional $16 million in Net Operating Income when stabilized.

  • Valuation: As of November 14, 2014, HHC shares were trading at a price to book ratio of 2.6x. While much higher than when the investment was initiated in 2010, we do not believe this decline reflects the earnings potential from assets still in development.
  • Revenue Growth: In 2013, revenues totaled $475 million, up 26% from 2012.
  • Index ownership: Not held in S&P 500, S&P 400, or Russell 2000 Index
  • Balance Sheet: Debt to equity ratio = 0.87
  • Number of analyst estimates: 4
  • Selected Predictive Attributes:
    • Owner-operator management: Chairman of the Board Bill Ackman (of Pershing Square L.P.). beneficially owns 13.2% of shares outstanding. As noted above, management has a significant vested interest in warrants which are not yet exercisable.
    • Dormant Assets: The company has many major assets in development or recently completed, including South Street Seaport, The Woodlands Texas, Ward Village (Hawaii), and Summerlin (Las Vegas). While some of these assets are beginning to produce cash flow, at the moment, there is little visibility into their true earnings potential.
    • Spin-Offs: HHC was spun off from GGP in 2010.
    • Long Product Lifecycle: HHC owns assets that are difficult to replace, such as the South Street Seaport and coastal property in Honolulu, Hawaii.

Horizon Kinetics: IEP traded below book value

Icahn Enterprises, L.P. (“IEP”), Carl Icahn’s holding company, may be to Mr. Icahn what Berkshire Hathaway is to Warren Buffett—his publicly-traded investment legacy. Despite Mr. Icahn’s investment skill, IEP traded below book value and at a discount to estimated net asset value (“NAV”) until 2013. On a sum-of-the parts basis, which is a somewhat limited analysis, IEP appears to be worth approximately $90 per share, given the recent stock prices of its publicly listed companies and conservative estimates for some of its private holdings. An investment in IEP provides diversified exposure to a wide variety of industries, such as technology (Apple and Netflix), energy (Chesapeake, CVR Energy), real estate (including the dormant, almost-finished Fontainebleau Casino in Las Vegas), gaming (Tropicana), metals, food packaging, home furnishing, auto parts (Federal Mogul), and rail cars (American Railcar and leasing company AEP), as well as additional public and private positions Mr. Icahn holds in his investment portfolio.

In fact, IEP contains a number of very sizable investments that could each have a dramatic impact upon the company’s NAV. It had more than $5 billion (as of June 30, 2014) invested in Mr. Icahn’s hedge fund, which generated annualized gross returns of 36.5% between April 1, 2010 and September 30, 2014. Since its inception in November 2004, the hedge fund has averaged 15% annual returns. If that level of returns continues, IEP stands to record $750 million per year in profits from this segment alone—in fact, the company’s entire market capitalization is 16x the earnings of just this segment, ignoring the significant profit potential from the company’s private and public investment stakes. Similarly, the company generated slightly more than $1.5 billion of adjusted EBITDA during the trailing twelve month period ending September 30, 2014. The current enterprise value of IEP is slightly more than $12 billion, resulting in a multiple of approximately 11x. Thus, shares of IEP are available for purchase at an 11x adjusted cash flow multiple, while also paying a dividend of $6 per unit (approximately 6.5%).

  • Valuation: IEP shares frequently trade based on the results of the hedge fund; however, this largely overlooks the successful investments in operating companies held by IEP. As detailed below, the company trades at a modest premium to net asset value, after years of trading below NAV.
  • Index ownership: Not held in S&P 500, S&P 400 or Russell 2000 Index
  • Return on equity: 18.7% as of 12/31/2013.
  • Balance Sheet: Debt to equity ratio was 0.70x as of 12/31/2013
  • Number of analyst estimates: 1
  • Selected Predictive Attributes:
    • Owner-operator management: Mr. Icahn owns approximately 88% of IEP’s shares.
    • Bits & Pieces: Adding IEP’s investment stakes in publicly-traded companies (based on most recent disclosures), conservatively estimated fair value for private investments as of November 11, 2014, and the market value of public investments via the investment fund, and adjusting for net debt, one arrives at a NAV of $9.9 billion, compared to the company’s market capitalization on the same date of $12.6 billion. We believe that the significant return potential from many of these holdings justifies the modest premium to NAV.
    • Industry History: Mr. Icahn is a consummate activist investor, with a long history of excellent results.

Horizon Kinetics

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