Vornado Seeks Respect by Simplifying

Steven Roth, the veteran CEO of Vornado Realty Trust VNO, sounds a bit like Rodney Dangerfield in his latest annual letter to shareholders. It comes down to respect.

Vornado's core portfolio of office and retail properties in New York City and Washington D.C. has performed well over the past several years. But outside of these earnings, the real estate investment trust has also made very profitable opportunistic investments in retail stocks such as McDonald's MCD and Sears Holdings SHLD.

Roth, who is considered one of the smartest real estate investors around, says in the latest shareholder letter, filed this week with the Securities and Exchange Commission, that he and the firm still don't get enough respect for these non-real estate deals. He's probably right.

And now he hints that Vornado may not be doing many more of these transactions in the future in an effort to make the firm's business look less complex, which Roth hopes will boost the stock's valuation.

'Complexity Discount'

While Vornado shares have more than doubled over the past five years, in the last year they have trailed the U.S. MSCI REIT Index. Vornado's stock is down 26% over the last 12 months, vs. the 19% decline in the REIT index.

Vornado trades at 14 times estimated 2009 funds from operations, or FFO, a common REIT performance metric that adds back depreciation charges. This is roughly the same valuation as mall owner Simon Property Group SPG but lower than pure-play urban office landlord Boston Properties BXP, which gets a 19x forward-FFO multiple.

Vornado's most profitable non-real estate play was investing in McDonald's stock, a move that netted a $289 million gain for Vornado shareholders from 2005 to 2007. Vornado exited the investment in October 2007. Vornado also made profitable trades in Sears Holdings and Sears Canada, exiting both positions in 2006.

"Many of these investments have resulted in special dividends to our shareholders. Notwithstanding these results, Mike [Fascitelli, Vornado's president and Roth's right-hand man] and I don't think that we get any credit in our share price for these earnings," Roth writes in the latest shareholder letter.

He goes on to suggest that Vornado might be less willing to make such deals in the future. This is a slight negative for investors in retail stocks. Vornado's involvement in the sector helped boost the stocks since Vornado was considered to eye the retailers as hidden real estate plays.

"In fact, these investments seem to attract too much attention, taking away focus from our much, much larger, strong core business," Roth writes. "Worse yet, we are also coming to the conclusion that our share price may suffer a complexity discount. And, after all, share price is the main event for us. With all this in mind, the order of the day is to simplify and prune."

Dean Frankel, a portfolio manager with Urdang Securities Management, agrees with Roth. "We value all the different pieces. We give them credit," says Frankel, while adding that the stock price has probably not reflected all of these wise investments by Vornado in recent years. Urdang owns Vornado shares.

So does this mean Vornado should no longer be considered a REIT that is really a hedge fund, as some like to call the company?

With its strong balance sheet, Vornado likely will remain an opportunistic player in all sorts of interesting real estate deals. As Roth says in the letter, "For sure, the trouble in our economy will create opportunities for Vornado."

But for the time being, Vornado is solidifying its balance sheet by keeping debt levels low and cash levels high to ride out the current credit crunch in the commercial real estate industry.

The company's story is now a little more boring, but Roth's hope is that investors will now start valuing Vornado at a higher earnings multiple.