January 26, 2010
Mexico
Mexican Navy Petty Officer Melquisedet Angulo fought dying for his country. He was killed in a Special Forces operation that killed Arturo Beltran Leyva, a high-profile Mexican drug lord. Mr. Angulo was hailed as a hero and buried with a military honor guard in Mexico City on Monday, December 21. Later that evening, around midnight, a dozen hit men carrying assault rifles burst into the home in eastern Mexico occupied by Mr. Angulo’s family. They murdered his defenseless mother, aunt, sister and brother. Previously, family members were thought to be off limits in the drug wars that are tearing apart America’s southern neighbor. But the public take-down of Leyva was perhaps the most direct challenge to the hegemony of the drug cartels over Mexican society in recent memory, and the public funeral of Mr. Angulo was a further affront to the cartels’ belief that they are beyond the reach of the law. Wiping out Mr. Angulo’s family lent a bloody exclamation mark on their refusal to live under the laws of civilized society.
The drug cartels have deeply corrupted the Mexican government and law enforcement, and it will be very difficult for Mexico to solve this problem alone. While the last thing the U.S. needs is further foreign entanglements, Mexico remains a vital border state whose stability is of vital national importance to this country. Violence has already poured over the border, and the drug trade had caused countless damage to our country.6 The U.S. should treat this issue as a matter of national security and lend its power and military to its neighbor before the Mexican state crumbles into anarchy. Congress is not oblivious to the problem, having agreed to contribute $1.3 billion of aid to Mexico to fight the cartels. The problem will only worsen as the Mexican state suffers further economic weakness with the slow but steady draining of its sole national resource – oil. As noted in last month’s report, Mexico remains a source of economic instability for the U.S., and U.S. investors should pay close attention to what is happening there. The attack on Mr. Angulo’s family is a tragic and historically significant event in Mexico’s decline.
The investment markets are currently undervaluing Mexico risk. As of December 28, 2009, Mexico’s five year benchmark bond, the 5.875s of 2014, were trading at a spread of only 130 basis points over U.S. Treasuries. Mexico’s sovereign credit default swap spreads were trading only slightly wider at 140-145 basis points.7 These spreads are far too tight in view of Mexico’s deteriorating oil industry and the threat posed to civil order by the drug cartels. HCM believes that these spreads are likely to widen significantly in the year ahead and should be shorted.
General Growth Properties, Inc. (GGP)
Hedge fund manager Bill Ackman has been engaged in a public debate about the value of bankrupt mall REIT operator GGP with another money manager, Hovde Capital Advisors LLC. Mr. Ackman, who is a member of GGP’s Board of Directors, believes that GGP’s common stock is undervalued at its current trading price of $11-12 per share, while Hovde argues that the stock is overvalued and could even be worthless. Mr. Ackman’s Pershing Square Capital Management, L.P. has reportedly already earned hundreds of millions of dollars of profits on its positions in GGP’s debt and equity securities, but Mr. Ackman believes there is more to be had from the bankrupt mall operator.
HCM did a little digging into GGP’s numbers and into the analysis on which both Pershing Square and Hovde based their investment recommendations. We came to the conclusion that GGP’s stock is fairly valued at about $12.50 per share. This is based on using a NOI (net operating income) figure for 2010 of $2.29 billion, which is about $200 million lower than the $2.478 billion figure Pershing Square uses in its latest public presentation (dated December 22, 2009, “A Detailed Response to Hovde’s Short Thesis on General Growth Properties,” p. 26) and about $550 million more than the $1.734 billion figure Hovde used in its December 15, 2009 presentation that briefly drove the stock lower. We believe Hovde’s NOI figure is understated because it includes $538 million of non-recurring impairment charges related to GGP’s bankruptcy filing. On the other hand, we believe Pershing Square’s NOI number is too generous because it does not properly reduce recurring cash flow for the costs involved in luring new tenants to the properties. We believe Pershing Square’s analysis of the company’s fundamentals is superior to Hovde’s, but we are more sympathetic to Hovde’s negative long-term view of the retailing and mall businesses and the consumer outlook. We also note that REITs have traded historically at a 7.6 percent capitalization rate, and applying that rate to $2.29 billion of 2010 NOI at GGP gets us to a $12.50 stock price. Pershing Square argues that the cap rate should be below 7 percent (implying a much higher valuation on the company) based on where the market is currently valuing Simon Properties (at a cap rate of about 6.6 percent), which it believes is the most appropriate comparable for GGP. HCM would argue that Simon deserves a lower cap rate (higher valuation) than GGP because its properties are higher in quality by a number of important measures.
We would also concede that a strong stock market, especially one driven by a belief in economic recovery, could lead GGP stock higher over the first half of 2010. One thing is certain – Pershing Square and Hovde will continue to battle it out, and GGP will be a stock to watch in 2010.
Michael E. Lewitt
Disclosure Appendix
This publication does not provide individually tailored investment advice. It has been prepared without regard to the circumstances and objectives of those who receive it. This report contains general information only, does not take account of the specific circumstances of any recipient and should not be relied upon as authoritative or taken in substitution for the exercise of judgment by any recipient. Each recipient should consider the appropriateness of any investment decision having regard to his or her own circumstances, the full range of information available and appropriate professional advice. Harch Capital Management, LLC recommends that recipients independently evaluate particular investments and strategies, and encourage them to seek a financial adviser’s advice. Under no circumstances should this publication be construed as a solicitation to buy or sell any security or to participate in any trading or investment strategy, nor should this publication or any part of it form the basis of, or be relied on in connection with, any contract or commitment whatsoever. The value of and income from investments may vary because of changes in interest rates or foreign exchange rates, securities prices or market indexes, operational or financial conditions of companies, geopolitical or other factors. Past performance is not necessarily a guide to future performance. Estimates of future performance are based on assumptions that may not be realized. The information and opinions in this report constitute judgment as of the date of this report, have been compiled and arrived at from sources believed to be reliable and in good faith (but no representation or warranty, express or implied, is made as to their accuracy, completeness or correctness) and are subject to change without notice. Harch Capital Management, LLC and/or its employees, including the author, may have an interest in the companies or securities mentioned herein. Neither Harch Capital Management, LLC nor its employees, including the author, accepts any liability whatsoever for any loss or damage arising from any use of this report or its contents. All data and information and opinions expressed herein are subject to change without notice.
The HCM Market Letter
Michael E. Lewitt, Editor
The HCM Market Letter is published on a monthly basis by The HCM Market Letter, LLC. Offices at One Park Place, 621 NW 53rd Street, Suite 400, Boca Raton, FL, 33487. Telephone (561) 226-6199; Fax (561) 995-4946. Delivery is by electronic mail. Annual subscription rate is $395 for individuals and $995 for institutions. Visit our web site at www.hcmmarketletter.com. Copyright warning and notice: It is a violation of federal copyright law to reproduce or distribute all or part of this publication to anyone (with the exception of individuals within the same institution pursuant to the subscription agreement) by any means, including but not limited to photocopying, printing, faxing, scanning, e-mailing, and Web site posting without first seeking the permission of the publisher. The Copyright Act imposes liability of up to $150,000 per issue for infringement. Information concerning possible copyright infringement will be gratefully received.
6After this was initially written, an American citizen (an El Monte, California school board member, Bobby Salcedo), was abducted and murdered along with five other men in the state of Durango, Mexico on December 31. It is unknown whether the murder was drug or cartel related.
7Price source: Goldman Sachs Group, Inc.
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