LDG, Part III: Penney's Thoughts on Ackman's Real Estate Dreams...

During my career as an analyst and an investment banker, I spent a lot of time looking at real estate transactions for a number of different companies. In most cases, the business model was better off owning the real estate, as it provided a level of stability to earnings. I will go as far to say that selling a company’s real estate portfolio is about as effective in creating shareholder value as an activist shareholder telling a company to use leverage to buy back stock!

Even during the bull market for real estate, monetizing a company’s real estate portfolio did not maximize value for shareholders. Today, given the secular bear market in real estate (and financials); I can’t imagine that an activist would still peruse a real estate strategy as a means of creating shareholder value. It is as if someone is still holding on to a dream. I guess if Bill Ackman can prove to the world that LDG’s real estate can add incremental value, it will validate his other consumer holdings. There could be a lot riding on this strategy for Ackman!

In short, selling a company’s undervalued real estate creates an enormous tax burden, which limits the cash available to maximize value for shareholders. I truly believe that Bill Ackman knows this, and I have yet to see a structure from him that would get around the tax issue completely.

Here is a list of companies with significant real estate holdings that I have followed that have had activists and others try to create value:

1. MCD – The McREIT has been a dream for years!
2. WEN – selling the real estate was part of the “grand” plan, but it never materialized.
3. CBRL – Nelson Peltz tried, but the bankers decided a leverage recap was better. The stock is significantly below where they did the recap.
4. RYAN - went private, did a sale-leaseback and now the company is bankrupt. The lender is going to end up owning the company.
5. OSI – owned 1/3 of its R.E before it went private. OSI did a massive sale-leaseback and now the company is teetering on the verge of bankruptcy.
6. BOBE - lots of speculation but nothing ever materialized. The margins in the business cannot support incremental leases. (i.e. RYAN)
7. DRI – The single largest casual dining restaurant company with over 1,100 pieces of property (and it sits in a REIT today). The real estate portfolio is a safety net for the company in difficult times. Management is on the record saying that the R.E is worth more as a part of DRI.

Two other high profile companies where real estate was the focus are SHLD and TGT. Both are key holdings for Pershing Square. The Eddie/Sears story was real estate based, and nothing ever materialized - thankfully for SHLD. SHLD is in trouble operationally! Can you imagine how bad things would be if they had sold off the real estate and had all that incremental leverage? I would bet money that SHLD would have already filed chapter 11 if they did a sale-leaseback two years ago. The same is true for LDG! LDG’s EBIT margins are 3.3% (6.4% for CVS and 5.8% for WAG). With 3.3% EBIT margins, the business can’t support doing a sale-leaseback on 142 stores.

The speculation is that the real estate is worth $1.0 billion, or $7mm per store. Seems a tad aggressive! A close look at the 10K will show that they own the land and building on 28% of the store base or 142 stores (I have seen numbers as high as 40 %). According to a highly regarded supermarket analyst, Publix recently paid $10 million/store for some Albertsons stores in Florida, or about $200 per sq ft. At $200/sq ft that would value LDG stores at $595 million. I know that LDGs real estate is in California, but who is going to pay a premium for California real estate today?

None of this matters because operationally, LDG’s business can’t support incremental leverage.

Howard Penney
Managing Director
Research Edge, LLC

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