The Howard Hughes Corp (HHC) Analysis [Slides]

The Howard Hughes Corp (HHC) Analysis

Conclusions from My Analysis:

• At current prices ($91.00/share on 2-25-2015) investors are discounting quite a bit, such as potentially:
  • $0 value to any future development in The Woodlands
  • $0 value to any future development, besides the current 6 towers, in Ward Village
  • $0 value to the redevelopment of Ward Village operating asset, which should add an additional $500m -$1 billion of total value (undiscounted)
  • Deterioration of The Woodlands commercial assets, which make up about 20% of the current market price, due to oil prices/concerns with Houston
  • $0 value to South Street Seaport Project #2, which is up to 700,000 SF of development
  • $0 value to the Discovery Land joint venture
  • Potentially higher cap rates on each asset, due to perceived higher risks or higher overall rates without commensurate pricing power

Is the 40%+ Decline an Overshoot?

About: The Howard Hughes Corp. (“HHC”)

• Mission: To be the preeminent real estate developer and operator of master planned communities and mixed used properties across the United States
• Owns assets across 16 states
• Three Business Segments:
  • Master Planned Communities
  • Operating Assets
  • Strategic Developments
• Created from spin-off in November 2010 from General Growth Properties (GGP)
• Original portfolio was underdeveloped, unmaintained by GGP
• Pershing Square’s Bill Ackman helped formation of Howard Hughes, hand picked the executives, and currently owns ~13.2% of HHC in his hedge fund
• CEO, President, and CFO collectively invested $20 million in cash in the forms of warrants and common equity that can’t be hedge or sold until earliest November 2016

Premier Portfolio of Assets

The Legacy of The Howard Hughes Corp

The Creation of The Howard Hughes Corp

• Spun-off from General Growth Properties (GGP) when it emerged from bankruptcy November 2010
• Bill Ackman (Pershing Square) joined the board of GGP after it filed for bankruptcy, learned about specific assets
• Ackman decides to spin off assets that were not ideal under a REIT structure: development assets, master planned communities (MPC’s) and other assets whose current cash flow wasn’t reflective of the long-term potential
• REITs are typically valued based on distributable free cash flow, the new “HHC” barely had any consistent FCF
• Howard Hughes was spun-off specifically to create value to avoid a takeover from Simon Properties, also had risk of transaction failure from antitrust issues
• Ackman personally sought out the management team for newly formed HHC
• David Weinreb, a Dallas-based real estate investor for 25+ years
• Grant Herlitz, partner of Weinreb
• Weinreb, Herlitz, and CFO Andy Richardson committed $19 million of their own money to purchase long-term warrants of HHC at the fair value at the time of purchase
  • Cannot be sold, hedged for 6 years of the 7 year life
  • Meant to align shareholders with management
• Ackman became the Chairman of the Board, protecting his hedge fund’s investment in HHC as well

How to Value HHC?

• 2010 Annual Report: “With respect to the valuation of Howard Hughes, the easy answer is that you should calculate the value of our assets –cash, real estate, and tax attributes –subtract our liabilities and then divide by fully diluted shares outstanding. The difficulty is that the real estate assets owned by HHC are notoriously difficult to value. First, you should consider that their long-term value –the value that can be achieved by a long-term owner –is, in my opinion, materially higher than their liquidation value.” –Bill Ackman
  • “For our MPCassets, one can make assumptions about the timing and number of future lot sales and then discount back these cash flows over the 30-or-so-year life of the project at a discount rate you deem appropriate. The problem with such an approach is that small changes in assumptions on discount rates, lot pricing and selling velocity, inflation, etc. can have an enormous impact on fair value.”
  • “For our development assets, one needs to make assumptions about what will be built, when it will it be built, to whom it will be leased, what rents it will achieve, what expenses it will incur, and what multiple an investor will place on these cash flows. Again, evenhighly sophisticated real estate investors will assign substantially divergent values to the same assets when using their own assumptions.”
• Usual metrics like: net income, operating cash flow, EBITDA, AFFO, earnings per share, etc. do notoffer much help due to the timing of the sale of assets, build out costs, the book value of the assets.

The HHC Fly-Wheel

• Originally, Howard Hughes helped fund the “strategic asset” development costs through a combination of selling MPC land and raising outside capital (debt)
• Now, there is a substantial amount of earnings stream (and growing) in the “operating asset” category that is self-funding, and provides additional flexibility in terms of:
  • When/if HHC wants to sell MPC assets/land
  • Utilize NOI to fund new strategic developments
  • Can utilize non-recourse debt on a majority of the assets supported by the cash flow of the asset
• Additionally, Howard Hughes has been using its assets –specifically, their land –as the only contribution in joint ventures with other development companies (apartments, other facilities/projects) and avoids borrowing money, using any cash, and receives 50% (or more) of the future economics from the joint-venture
  • Discovery Land (Summerlin)
  • Millennium Waterway Phase II
  • Parcel C (Ketler)
  • Summerlin Apartments, LLC
  • Metropolitan Downtown Columbia Apartments (Maryland)

HHC’s Transition (2010-current)

See full presentation below.