HHH - Seaport Spin-Off To Unlock Value For Howard Hughes Holdings Inc.

2024-01-20 10:35:08 ET

Summary

• Over the past decade, Howard Hughes' stock price has performed poorly, notwithstanding its high quality real estate assets, including master planned communities.
• The company's assets have not gone unnoticed as Bill Ackman's Pershing Square has acquired more than 37% of the Company, and Mr. Ackman is Chairman of the Board.
• Incentivized management, and the spin-off of the company's Seaport Entertainment division in 2024, should help the company unlock the value of its asset for the benefit of shareholders.

Introduction

Per its mission statement , Howard Hughes Holdings, Inc. ( HHH ) (the " Company " or " Howard Hughes ") aims to "enhance people’s lives by building inspired, award- winning communities." Among other projects, the Company develops and is most known for its high-quality collection of well-located master planned communities (“ MPCs ”).

I am currently bullish on the Company for a number of reasons, including 1) its poor stock performance over the last decade (in August 2014, Howard Hughes traded at $155/share versus about $80 at the time of writing), 2) Bill Ackman's large and growing stake in the Company (owns more than 37 % of shares), 3) Mr. Ackman overseeing that investment by serving as Chairman of the Board, and 4) the Company's high quality real estate assets which are likely to hold up well in an inflationary environment, particularly in today's housing market when the supply of housing is constrained.

In addition, because its MPCs are generally located in low cost-of-living, low-tax states like Texas, Arizona and Nevada, such assets of the Company are likely to continue to benefit from significant in-migration into those states (both legal and illegal).

Finally, the expected 2024 spin-off of the Company's Seaport Entertainment division (" Seaport "), which will include the Company's entertainment-related assets in New York and Las Vegas, including the Seaport in Lower Manhattan, a Minor League Baseball team, its ownership stake in Jean-Georges Restaurants, and other interests (collectively, the " Spin-Off "), should be a key catalyst that unlocks value for shareholders.

As such, I consider the shares a Buy and purchased a starter position in January at $78.89.

Background

General Growth Properties, acquired by Brookfield Asset Management ( BAM ), spun Howard Hughes off in 2010. Howard Hughes has four main business divisions or segments: 1) Operating Assets, 2) MPCs, 3) Seaport, and 4) Strategic Developments.

The Operating Assets division includes the Company's developed or acquired retail, office, and multi-family properties.

The MPCs division consists of a high quality collection of well-located master planned communities and development projects, including projects located in Las Vegas, Houston and Phoenix.

The Seaport division includes the entertainment assets of the Company, which are described and defined in the "Introduction" section above. Subject to market conditions, the Company is going to spin this division off as a separate publicly traded company in 2024.

The Strategic Developments division includes the Company's residential condominium and commercial property projects currently under development, as well as other properties held for development.

The four divisions are managed separately. Management currently believes that each division requires its own operating strategies and management acumen. In assessing the four divisions, the Company often uses Earning Before Taxes (" EBT ") as the key operating metric. Notably, EBT excludes corporate overhead expenses, which are not allocated to the business segments for reporting purposes.

Overall, according to the most recent investor presentation , Howard Hughes operates a 6.8 million square foot office portfolio, a 2.6M square foot retail space portfolio, nearly 5,900 multi-family units, approximately 2,700 condominium units, and eight (8) MPCs. In addition, the Company has a land portfolio consisting of 36,00 acres of raw land.

Q3 2033 Earnings

Per the Company's 10Q , for the nine months ended September 30, 2023 (the " 10Q "):

Total Company – Net income attributable to common stockholders decreased to a net loss of $544.2 million for the current quarter, including an after-tax impairment of $555.0 million related to the Seaport. This compares to net income of $108.1 million for the prior-year period. Excluding the after tax impairment, the year-over-year reduction was primarily attributed to the timing of condo sales... We continue to maintain a strong liquidity position with $491.7 million of cash and cash equivalents, $1.1 billion of undrawn lender commitment available to be drawn for property development and limited near-term debt maturities."

The information included in the following four paragraphs describing segment results is taken from the 10Q.

1) Operating Assets – Net Operating Income (" NOI ") totaled $60.7 million in the current quarter, a $2.1 million increase compared to $58.7 million in the prior-year period. Excluding dispositions, Operating Assets NOI increased $2.7 million. Multi-family NOI increased primarily due to continued lease-up at the Company's newer properties and rent growth increased across the portfolio; Office NOI increased primarily due to continued lease-up activity and abatement expirations at various properties; and Retail NOI increased due to modest improvements in all regions.

2) MPCs – EBT totaled $84.8 million in the current quarter, a $9.4 million increase compared to $75.4 million in the prior-year period. The increase was primarily due to higher residential land sales (net of costs).

3) Seaport – During the third quarter of 2023, the Company recorded an impairment charge related to the Seaport segment. Seaport NOI totaled a loss of $0.9 million in the current quarter, a $2.5 million decrease compared to income of $1.6 million in the prior-year period.

4) Strategic Developments – EBT totaled $0.7 million in the current quarter, a $123.4 million decrease compared to $124.1 million in the prior-year period. – The decrease in EBT was primarily attributable to a $119.9 million decrease in profits from condominium sales. The lower volume of condominium closings in 2023 is expected as completed towers are almost 100% sold and the next tower, Victoria Place, is not scheduled for completion until 2024. As of September 30, 2023, 97.8% of the units at the Company's three towers under construction, Victoria Place, The Park Ward Village, and Ulana Ward Village, are under contract.

***

As the results above show, operations have been growing, notwithstanding the higher interest rate environment. Of course, Seaport had a poor quarter, but its operations, including ownership interests in restaurants and a minor league baseball team, are quite complicated and subject to seasonal and other factors -- indeed, part of the reason that Howard Hughes is eager to spin off Seaport.

Strategic Developments earnings will also be lumpy depending on where the Company's condo projects are in the development cycle. Fortunately, as the sale numbers attest, there is a lot of interest for the Howard Hughes condo offerings.

Debt and Debt Compliance

Howard Hughes has approximately $490 million of cash on its balance sheet and 100% of the company’s $5.2 billion debt is fixed, capped or hedged, with approximately 87% of the balance due in 2026 or later.

Per the Q3 2023 balance sheet included in the 10Q (linked above), the Company's total current assets of $1.835 billion exceed total current liabilities of $1.007 billion. This is a positive.

While the Company's balance sheet and debt profile are healthy, not all of the Company's current projects at the property level are progressing satisfactorily.

Certain defaults at the property level are described in the two paragraphs below (taken from the 10Q):

1) The Company was in compliance with all property-level debt covenants with the exception of six (6) property-level debt instruments. Cash flow after debt service from these properties is now restricted and must stay at the property level (it cannot be used for general corporate purposes).

2) Howard Hughes was in compliance with all guarantor debt covenants tested as of the last day of each fiscal quarter with the exception of the leverage ratio covenant for an $11.0 million property-level debt instrument. The lender waived the covenant failure.

***

In addition to the risks noted below in the "Risks" section, an acceleration in the number of project defaults could have a material adverse effect on the Company. This is an area for investors to monitor carefully.

The Spin-Off and Other Catalysts

The Spin-Off

In October, 2023, Howard Hughes announced its intent to form Seaport as separate division with the intention of eventually spinning it off as an independent, publicly traded company in 2024. Of course, there are no guarantees that the Spin-Off will occur in 2024, if at all; however, the Company is in process of preparing audited financials for Seaport, a sign that it is clearly committed to the Spin-Off (see the earning call transcript link below for some Q&A around the Spin-Off).

According to Management per the most recent earnings call , the thesis for the Spin-Off as follows:

The planned separation of Seaport Entertainment from Howard Hughes will refine the identity of HHH as a pure-play real estate company focused solely on its portfolio of acclaimed master planned communities and allow the new company, Seaport Entertainment, to operate independently as an entertainment-focused enterprise."

I agree with the thesis and would expect to sell my Seaport shares and use the proceeds thereof to buy more shares of Howard Hughes. As management alluded on the recent earnings call, that transaction is designed to be in the long-term interests of the Company, and whether it is accretive right away is not as important as the long-term value the Company is trying to create.

Constrained Supply of Homes

The supply of home resale inventory in the United States remains limited as homeowners with fixed low interest rate mortgages are reluctant to sell their existing homes and incur more expensive mortgages. As a result, there has been increased demand for newly built homes. The affordability of the Company's housing units at its MPCs, which are generally located in low cost-of-living and low-tax states like Texas, Arizona and Nevada, is a key advantage which is likely to continue to drive sales going forward.

Going Private Transaction

Post spin-off of Seaport, one has to wonder whether Bill Ackman will consider taking the Company private. His company, Pershing Square, already owns more than 37% of this publicly traded company with a current market capitalization below $4 Billion. This is pure speculation on my part , but Mr. Ackman's recent foray into culture war politics has put a (political) target on his back, which might provide the incentive for him to consider taking Howard Hughes private at some point in the future. Clearly, Pershing Square's ongoing purchases of Howard Hughes shares demonstrates that he sees substantial unlocked value in the Company.

***

In sum, while there are several potential catalysts to propel the Company's stock price, the Spin-Off is clearly the key one. I would speculate that the Company would like to announce the Spin-Off prior to releasing its annual report, if at all possible.

Risks

There are several risks associated with owning shares in Howard Hughes and similar real estate companies. First, the real estate business is cyclical in nature and subject to changes in macroeconomic conditions, volatility in capital markets, and downturns in the national economy or any of the local economies in which Howard Hughes operates. Second, risks include competition for tenants and potential decreases in occupancy at the Company's properties, increases in real estate construction costs, the impact of rising interest rates on residential housing and condominium markets, local real estate conditions, and competition from competing retail properties, as well as the Company's ability to manage and service its debt and comply with related debt covenants (notably, certain project level defaults have been highlighted above). Third, the Company's exposure to the office market is also a risk in the current post-COVID, work-from-home environment; however, its office portfolio has held up reasonably well, perhaps benefitting from tenants being drawn to its walkable and amenity-rich MPCs. Fourth, the Spin-Off might not occur, and even if it does occur in 2024, it might not be immediately accretive to shareholders of the Company. Fifth, there is a risk that management will not execute on its current business strategy. Other risks of owning shares in Howard Hughes are outlined in the 10Q.

Conclusion

Howard Hughes has performed poorly over the past decade, falling more than 35% according to its stock quote on Seeking Alpha. The Spin-Off of Seaport, together with the Company’s portfolio of well-located land and high-quality operating assets, should propel the Company's stock going forward, assuming management can execute. With Bill Ackman leading the Board, and his Pershing Square fund aggressively increasingly its ownership of Howard Hughes, I am confident that management is properly incentivized to unlock the value of the Company's assets for the benefit of shareholders. For these reasons and the reasons noted above, I believe the stock is a long-term Buy.

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