Our firm owns The Howard Hughes Corporation (HHC) and we have owned it since November 2010, when it was spun-off from General Growth Properties (GGP). We are pleased that our investment has nearly doubled in this time. We are more pleased with the fact that Howard Hughes is no longer buried under GGP’s ownership and now is its own independent company. Howard Hughes saw its revenues bottom out in 2009 at $136.3M, which included $34.6M in Master Planned Community land sales. We expect HHC’s total revenue to easily surpass $300M in 2012 and MPC land sales to potentially top $150M. Our expectations are based upon HHC’s solid Q1 2012 performance in which the company generated $79.8M in total revenues, and the key driver was $36.1M in MPC land sales.
Howard Hughes enjoyed excellent performance in the first quarter of 2012. While seeing a $112.26M loss in a quarter is never pleasant, we noted that it was due to a $121.85M loss on its warrant liabilities that it issued to its management and its institutional investment sponsors. This loss was due to the fact that HHC issued long-term warrants to these investors that allow the investors to buy into HHC’s stock at $50 per share. HHC’s stock racks up an explosive 44.6% gain in Q1 2012 and when the stock shows impressive gains, HHC incurs a large, but non-cash loss on its income statement. When HHC reports impressive financial results that are shrugged off by the market and HHC’s stock declines by 3.49% as it did in Q2 2012, HHC realizes a non-cash loss on its income statement. HHC issued 10,862,687 warrants to management and its sponsors. Based on the non-cash warrant liability loss incurred in Q1 2012, we estimate that HHC will realize a small, non-cash warrant liability gain of
Source: Howard Hughes Q1 2012 10-Q Report and Saibus Research Estimates
Howard Hughes saw strong year-over-year revenue growth, which was driven by its acquisition of the minority interest in The Woodlands that it did not previously own. The company also saw growth from its conference center and resort properties, minimum guaranteed rents from operating properties and other land and rental property revenues, which more than offset a sharp decline in condominium unit sales revenues and other related strategic developments revenues.
Because Howard Hughes is now owns The Woodlands outright, we believe that this will provide the company with positive operating leverage from this properties and a better ability to convert its revenues into profits. We are already seeing this thesis proven out, as HHC’s pro forma pre-tax profit margin from Master Planned Communities business segment has increased from less than 27% in Q1 2011 to nearly 39% in Q1 2012.
Not to be outdone, an in-depth analysis of the Operating Assets segment generated showed a 6.45% increase in pro-forma revenues and a 16% increase in pro-forma pre-tax income. Operating Assets benefitted from increased occupancy at the resort and conference center as well as higher tenant occupancy at the operating properties located in The Woodlands. This segment also benefitted from positive operating leverage, which was due to lower property taxes, depreciation and amortization and net interest expenses.
In conclusion, we are pleased with our holding in The Howard Hughes Corporation. We believe that investors who want to invest in the real estate industry should look no further than Howard Hughes. We like the fact that the majority of Howard Hughes’s stock is backed by four leading institutional investors, which includes Bill Ackman (Pershing Square) and Brookfield Asset Management’s (BAM) Brookfield Retail Holdings subsidiary. We like that Howard Hughes is now an independent company, no longer subject to the bureaucracy and capital needs of the highly leveraged General Growth Properties and we like Howard Hughes’s portfolio of high-end properties. While GGP is a highly leveraged company that must pay out 90% of its pro-forma taxable income as ordinary dividends to shareholders in order to qualify as a tax-exempt Real Estate investment trust, Howard Hughes utilizes shareholders’ equity in order to finance 65% of its assets. Mortgages and stock warrant liabilities only account for ~25% of asset financing and the rest is financed by operating working capital liabilities, which are more than offset by cash and operating working capital assets. Finally, we are long Howard Hughes because we find that very few companies can even hope to replicate Howard Hughes’s portfolio of high-end master planned communities, retail properties, office buildings and strategic land development. Since Howard Hughes has gone public, it has outperformed its former parent as well as the iShares Dow Jones US Real Estate ETF (IYR) and the iShares Russell 2000 (Small Cap) Index ETF (IWM). Despite HHC’s strong performance relative to other real estate companies, it is only trading at a 5.4% premium to book value.
Past performance is not necessarily indicative of future results. All investments involve risk including the loss of principal. This report is confidential and may not be distributed without the express written consent of the original author and does not constitute a recommendation, an offer to sell or a solicitation of an offer to purchase any security or investment product. Any such offer or solicitation may only be made by means of delivery of an approved confidential private offering memorandum.
Investments may currently or in the future buy, sell, cover or otherwise change the form of its investment in the companies discussed in this letter for any reason. The author hereby disclaims any duty to provide any updates or changes to the information contained here including, without limitation, the manner or type of any of the investments.
All of the views expressed in this research report accurately reflect the research analysts’ personal views regarding any and all of the subject securities or issuers. The research analyst is not registered with FINRA, and may not be subject to FINRA rule 2711 restrictions on: communicating with the subject company, public appearances, and trading securities held in the research analysts’ account. No part of the analysts’ compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report. The analyst responsible for the production of this report certifies that the views expressed herein reflect his or her accurate personal and technical judgment at the moment of publication.
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Disclosure: Our firm is long HHC shares.
Copyright 2011-2012 Saibus Research. All rights reserved. This report or any portion hereof may not be reprinted, sold or redistributed without the written consent of Saibus Research.
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