General Growth Properties (GGWPQ)

So, why invest in the common stock, does bankruptcy destroy it, why aren't lenders forcing it, will it be a Chapter 11 (reorganization) or Chapter 7 (liquidation)?

The answers are all tied up and related so lets go through it:

If (when) there is a bankruptcy filing, why 11 and not 7? The simple answer is having the second largest mall operator go into liquidation and throwing 200 million square feet of retail space up for sale would destroy the commercial real estate market. Why? The sudden supply of properties without bidders (loans still are very tough to get) would mean they would have to be placed on the market below "fire sale" prices to sell. Because of that, all other operators real estate values would fall, dramatically, and in turn, causing debt covenants for them to be tripped. That would create a cascading effect on the whole industry. For those not sure, this would be a very, very bad thing. You think you have seen write-downs in home mortgage loans at banks? Force liquidation of GGP and as the saying goes "you ain't seen nothing yet".

It also means the banks holding the loans on the properties would then be forced to take pennies on the dollar, very bad for them. In a Chapter 7, shareholders, debt holders and the industry as a whole suffer. No one wins.

So, if we rule out liquidation. What happens in Chapter 11? Who wins there? Here is what Bill Ackman said yesterday in the WSJ:

Some investors, however, consider a bankruptcy filing likely. Among them is activist investor Bill Ackman of Pershing Square Capital Management LLC, who bought 7.5% of General Growth's stock in recent months and put another 18% under swap contracts in a bet that the company's equity will survive a bankruptcy unscathed. Mr. Ackman also expects to soon get a seat on General Growth's board.

"We think the company will ultimately have to file for bankruptcy, but we think that it's a wholly solvent company with a liquidity problem," Mr. Ackman said in an interview Monday. "I don't think they'll need to dilute shareholders. All they need to do is extend the maturities [in bankruptcy court] and they can refinance those debts as they come due."

Now, one must know that Ackman took his stake AFTER GGP's troubles were known. This is not a situation where we have an investor trying desperately to save a bad investment. He bought in knowing this scenario we now face was likely.

The typical bankrupcty is forced because the liabilities (debt) outsize the assets. In this case the common shareholders are wiped out. But, we know that the assets GGP has are in excess of the liabilities. In this case, even in a worse case Chapter 11, shareholders are not wiped out.

But, this goes even further. Again from Ackman “Most of the time, insolvent companies go bankrupt,” Ackman said. “It’s rare for a solvent company to go bankrupt. This is a solvent company with a liquidity problem.”

General Growth is not losing money. Rents are stable, occupancy rates are over 90% and FFO (funds from operations) remain healthy. What is the problem? Credit. GGP has loan due that they typically just rollover into longer maturities. With the current credit "lock down", they cannot do that. That means bulk payment come due and the cash is not there. It should be noted that this is not an odd situation, this is what REIT's typically do with their debt.

With a Chapter 11 debt holders are put in a room and told by a Judge, "we can pay you all 100% but we need to change and lengthen maturities OR we can liquidate and you can pick up scraps for pennies on the dollar". Here are the new terms. The choice is rather obvious

The banks all recognize this too. This is the reason they have not been paid a dime since late last year and have not forced a Chapter 11 filing. They do not want to take the risk of writing down loan portfolio's. Remember, our mark-to-market world means they just do not just write down GGP loans, they then have to write down ALL of them on their books. Again, this is very bad. So we get endless extensions to pay.

Why? The banks are riding this out. If we get MTM changes in Congress then we may see the log jam break. In that case a Chapter 11 would not have a cascading effect on their whole portfolio and restructuring the loans to again begin receiving payments makes perfect sense. They may be hoping for an economic turnaround late this year that enables GGP to sell some property to pay them off. They may all be playing a waiting game hoping someone restructures and set the bar for the rest of them that is better than a bankruptcy judge will do.

Who knows the exact reason why for each lender. We do know what they don't want right now, a Chapter 11 filing. If they wanted it they could force it easily.

Because of the financial situation of GGP, there is no need to convert debt to equity. Restructuring the loans would allow for payments to be made, equity holders would remain intact, the banks again have performing loans on their books and everyone is happy.....VERY happy.

I think the specter of Ackman going on the board must give the banks pause and perhaps want them to restructure sooner rather than later. Then knowing he wants a Chapter 11 I am guessing will bring people to the negotiating table a bit faster...

Amerco took the action in 2003 to restructure its debt, officials said, adding that since the its assets are greater than its debt, it intends to repay its creditors in full pursuant to a full-value plan of reorganization. Amerco obtained a commitment from Wells Fargo Foothill (WFC) for a $300 million debtor-in-possession facility, officials said, and for a $650 million bankruptcy emergence facility.

On Oct. 15, 2002, Amerco defaulted on a $100 million principal payment owed to holders of 1997 asset-backed notes. That default triggered defaults on other debt outstanding. Until the filing, the company had been in negotiations with creditors about restructuring its debt.

"Business fundamentals at the company remain strong," said Joe Shoen, Amerco's chairman at the time. "Amerco has taken a positive step in choosing Chapter 11 to facilitate the restructuring of its debt. We are getting our financial house in order."

Specifically, the Debtors believe that their businesses and assets have significant going concern value that would not be realized in a liquidation, either in whole or in substantial part. According to the valuation analysis and the liquidation analysis prepared by management with the assistance of the Debtors' restructuring advisors, Alvarez & Marsal, Inc. ("A&M"), and the other analyses prepared by the Debtors with the assistance of A&M, the Debtors believe that the value of the Estates of the Debtors is significantly greater in the proposed reorganization than in a liquidation.

So, as debtholders were made whole, through restructuring of the debt, this is what was proposed for the common and prefered stock

Existing Common Stock means shares of common stock, par value $0.25 per share, of AMERCO that are authorized, issued and outstanding prior to the Effective Date. Other Interests means the preferred share purchase rights issued by AMERCO pursuant to that certain stock-holder rights plan adopted by the Board of Directors of AMERCO in July 1998, with each such right entitling its holder to purchase from AMERCO one one-hundredth of a share of Series C Junior Participation Preferred Stock (Series C), no par value per share of AMERCO, at a price of one one-hundredth (1/100th) of a share of Series C, subject to adjustment. The Plan does not alter or otherwise impair the Allowed Existing Common Stock and Other Interests.

Here was the thought process behind the debtors plan: Shortly after filing for relief under Chapter 11 of the Bankruptcy Code, the Debtors focused on the formulation of a plan of reorganization that would allow them to quickly emerge from Chapter 11 and preserve their value as a going concern. The Debtors recognize that in the competitive arena in which they operate, a lengthy and uncertain Chapter 11 case may detrimentally affect the confidence in the Debtors by their respective vendors and employees, impair their financial condition, and negatively impact the prospects for a successful reorganization. The terms of the Plan are based upon, among other things, the Debtors' assessment of their ability to successfully restructure their capitalization, make the distributions contemplated under the Plan, and pay their continuing obligations in the ordinary course of the Reorganized Debtors' business.

Also, like GGP, Amerco had a very higher percentage of insider ownership of the common stock.

This is the most backwards thing you'll ever see. It also gives more confidence of the equity surviving even should they be forced to file.

From the WSJ:

But a bankruptcy filing isn't imminent for the mall giant, according to people familiar with the matter, and General Growth's (GGP) ability to remain out of bankruptcy shows the unusual dynamic between lenders and distressed companies in the recession-ravaged commercial-real-estate market.

Bondholders have refrained from forcing mall owner General Growth Properties into bankruptcy court, despite lack of a deal on a debt extension.

Under normal circumstances a company with as much past-due debt as General Growth would have been forced into Chapter 11 bankruptcy protection by now. Creditors so far have been willing to let deadlines pass because they believe there is little to be gained and much to be lost through a bankruptcy. General Growth's mall operations are stable and many bondholders hope for a greater recovery outside of bankruptcy court.

"This is really rare," said Kevin Starke, an analyst at CRT Capital Group LLC, a research company that tracks distressed securities. "It is corporate-bond limbo like I've never seen before."

This piggybacks on the thesis laid out here recently that lenders want to avoid a Chapter 11 here at almost all costs.

It continues:

Many creditors say that General Growth's management is doing a good job running the company. Its 200 U.S. malls, a portfolio second in size only to Simon Property Group Inc., generate enough cash to cover interest on the debt. But its properties are overleveraged and it lacks the borrowing capacity to retire those debts as their principal comes due.

"There's no question that General Growth is a liquidity issue," said Jeff Spector, an analyst with UBS AG. "The properties, for the most part, aren't broken."

General Growth, based in Chicago, isn't the only real-estate borrower that is getting a reprieve from its lenders these days. Hundreds of property owners have had loans come due without a repayment made in recent months. But most lenders have agreed to extend loan terms, hoping that the credit market will improve.

For those who did not see it previously, here is the legal basis should it go into bankruptcy for the equity staying in tact. The point that cannot be forgotten here is the company is technically solvent and that alone separates this Chapter 11, should it occur, from 99% of all other Chapter 11's when the companies entering them are insolvent.

It continues:

A person familiar with the bondholder talks said that, while some creditors are angry, none appears ready to insist on an involuntary bankruptcy petition yet. It is possible that bondholders didn't go along with the consent solicitation primarily because they feared that making such a pledge would reduce the value of their bonds.

General Growth has told lenders that they'll have more influence over the outcome if it restructures outside of bankruptcy court, according to people familiar with the talks. A bankruptcy filing could force the company to liquidate its assets for less than the whole company would be worth if it remained a single entity for the long term, these people said.

Another deterrent to an involuntary petition is that bankruptcy wouldn't bring immediate payment of General Growth's debts. "It's such a large company that the bankruptcy would definitely last at least a couple of years," said Heidi Sorvino, a lawyer leading the bankruptcy practice of law firm Smith, Gambrell & Russell LLP.

The timeframe could be shorter if General Growth did a prepackaged bankruptcy in which the creditors agree to terms prior to the company entering bankruptcy, Ms. Sorvino added. But wrangling so many creditors without the threat of a judge making and enforcing decisions is "almost impossible," she said.

This is the classic "everyone wins" or "everyone loses"scenario. Banks facing liquidity issues cannot have billions tied up in a Chapter 11 proceeding for years. The viability of common equity, while in my opinion is safe in an 11, can never be assured once the courts get involved. By restructuring out of court and now, everyone wins...

Boilerplate ending for this investment: Now as usual, a warning. I know people have been following into this investment. If you do, you must be prepared to lose all of it. There is no guarantee of the above outcome. Buying this stock now is essentially buying a call option on the company's survival. It is hits, you win big, very big. If not, what you invested is worth nothing. I believe the above scenario plays out, I am also not going to be broke should it not.

Uncertainty to weather through the subprime crisis