Intellectual Activism's Impact On General Growth

Hedge funds have started waging the debate on the merit of investments in bankrupt mall owner General Growth Properties in public, raising a number of questions.
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) -- It used to be that activism was conducted by poison letters to management from Dan Loeb, or by acerbic rhetoric leaked to the mainstream press from Carl Icahn. But a new kind of activism is being waged by leading hedge funds with positions on both sides of the trade in bankrupt mall owner

General Growth Properties



Pershing Square Capital Management


Hovde Capital

, and

T2 Partners

are taking turns exchanging their analyses on why they think the stock is under- or over-valued. These intellectual arguments aren't just academic pursuits. They're having large effects on the stock price. Some of the smart money will be right, while others won't look so smart a year from now. Here's what you need to know to take advantage of this new kind of activism.

General Growth started in 1954, when two brothers founded a strip mall in Cedar Rapids, Iowa. The company hit a $20 billion market capitalization in April 2007 and is now one of the top mall owners in the country today. But General Growth took on a lot of debt in the credit expansion and was unable to roll over this debt when the lending markets froze, leading to their bankruptcy in April.

The company entered bankruptcy on April 16 with its common shares trading then at 60 cents each The shares have had quite a run since then, touching $12 two weeks ago.

Back in May of this year, Bill Ackman of Pershing Square profiled the bullish case for General Growth at the Ira Sohn Research Conference. He laid out a convincing case for the unique value embedded within General Growth. Unlike the vast majority of bankruptcies, Ackman argued General Growth's was unusual because its net assets were greater than its net liabilities. The company had a liquidity issue, not a solvency issue, Ackman said. Occupancy rates were still high, net operating income (NOI) was steady, and the company owned some of the more prestigious malls in the country across a wide footprint, he contended.

In the extremely conservative scenario, Ackman suggested that the equity value of General Growth was $10 per share at that time. With more normalized assumptions, giving value to the management company and several undeveloped properties and assets, Ackman said the equity value per share would be above $30. As long as the broad economy didn't sink into a severe recession, Ackman said he expected there would be value for equity holders after creditors were compensated.

The stock has been on a steady climb over the seven months since the presentation, and Ackman's thesis has looked remarkably prescient.

Then, about 2 weeks ago, another hedge fund, Hovde Capital, went public with its arguments for shorting General Growth's equity. The fund argued that General Growth had both a solvency issue and a liquidity issue, and posited that General Growth's cash flow had shrunk meaningfully since 2008 and was far less than Ackman had assumed in his May speech. Because of this, Hovde said equity holders were more than likely to be wiped out in the restructuring process after creditors were recouped.

Hovde criticized Ackman's analysis for reporting 2008 cash flow rates that had dropped 20% since. Ackman's assumed capitalization rate of 7.5% -- a key metric in determining the company's equity valuation - was lower than the current market rates, which they said should be above 8%. By attaching a high cap rate to General Growth with lower cash flows, Hovde got to a target equity value for the shares of between zero and $5.

The new analysis had an immediate impact on the stock. When published on Dec. 14, the stock closed at $10.80. Two days later, after word spread of the analysis, the stock hit a low of $7.15 -- a 34% decline from two days earlier.

But, the response from the bulls was immediate. Whitney Tilson of T2 Partners and investor Todd Sullivan published their counter-arguments to Hovde on Dec. 16. They took Hovde to task on the cap rate assumptions, pointing out a key "comparable transaction" that Hovde had used to arrive at its conclusion was for a joint venture and, therefore, not relevant. With accurate recent comparables, they said a cap rate of 6.5% was more reasonable today than Ackman's prior 7.5% assumption -- greatly increasing the estimated value for General Growth equity holders.

Taking General Growth's most recent NOI data and comparing it to

Simon Property Group

(SPG) - Get Report

, Tilson gets to an equity value for General Growth of $22 per share. Rumors circulated on Dec. 16 that Tilson was aggressively adding to his position.

By the end of the 16th, General Growth's stock had rebounded from its session-low of $7.15 to close at $8.81. It now trades at $9.20.

There are a few takeaways here for investors. The first is to do your homework. Your thesis for a current stock holding is only as good as your analysis or the analysis of others that you trust. There are many assumptions that go into an analysis. Slightly tweaking any of them can have a major impact on the final target price.

We might be on the precipice of more cases like General Growth, where opinionated investors make the case for or against a company's stock. Those investors who get it right, will be rewarded for the efforts and followed more closely when they prognosticate their next picks (such as when John Paulson, who made a killing by shorting U.S. housing mortgages last year came out with bullish views on gold and banking stocks a few months ago).

Sometimes, investors will argue the opposite sides of the trade, as is happening here. In most cases, you'll likely only hear one side. In many situations, you'll hear more from the investors than you will from the company's own management teams. In any case, you still need to do your homework. Just because some fancy New York hedge fund says so doesn't mean they're right -- especially if their analysis is sloppy. Question assumptions.

-- Written by Eric Jackson in Naples, Fla.

At the time of publication, Jackson was long on General Growth Properties.

Eric Jackson is founder and president of Ironfire Capital and the general partner and investment manager of Ironfire Capital US Fund LP and Ironfire Capital International Fund, Ltd. You can follow Jackson on Twitter at or @ericjackson