Bankrupt on Friday?

By Travis Johnson, Stock Gumshoe, December 11, 2008

Porter Stansberry, whose newsletters I write about from time to time, is revamping his new Porter Stansberry’s Put Strategy newsletter to focus not on his original plan — which was selling puts to buy bargains at even lower cost — but on betting on the demise of companies, and particularly (at the moment, at least) companies in commercial real estate.

And here’s the “tease” for the recent letter he sent out about this Put Strategy newsletter:

“America’s Next Major Bankruptcy (it’s not GM or CitiGroup)… Happens this FRIDAY at Midnight”

What is this one?

“… the company I’m talking about, which is the 2nd biggest in its industry, and is headquartered in Chicago, has until Friday, December 12th at midnight to pay back a $900 MILLION loan.

“In the current market, this amount of debt is lethal….

“There is absolutely no way the company can make this $900 million payment or raise this kind of money.

“And there is absolutely no way they can continue as an ongoing business. The firm basically said as much, in their most recent Quarterly Report (10-Q), dated November 10th of this year.

“Our potential inability to address our 2008 or 2009 debt maturities in a satisfactory fashion raises substantial doubts as to our ability to continue as a going concern.”

So what is this company? Porter goes on to provide a few other clues, including that they operate about 200 locations throughout the country.

And the Thinkolator and a dozen or so alert readers agree:

This is General Growth Properties (GGP)

They do indeed have $900 million in debt that comes due tomorrow — that debt is essentially a mortgage on a couple of their large properties, and the due date has already been pushed back by a couple weeks to give them a chance to dig out of their hole, but I’d have to agree with Porter that I don’t see many options for them to refinance that debt. Of course, they have some big institutional shareholders, so it’s always possible that they’ll find a way to make good … at least with this debt expiration.

I suppose their best hope in the near term, absent a quick turnaround in the economy, would be the sale of some properties, but as you might expect they’re worth much less now than they were a while back (the company trades at a small fraction of its stated book value, a value they’d have a really hard time realizing at the moment). And with probably few buyers out there with the interest or wherewithal to buy malls right now, you’d imagine that any buyers will be those who smell blood in the water and make lowball bids.

General Growth Properties is a developer and operator of regional malls, the traditional large type with big anchors and hundreds of little stores. With the soft retail environment and expected poor Christmas sales, many folks expect empty slots to proliferate in malls across the country as retail bankruptcies emerge as a major issue next year. The short term theory is that many of these retailers have pinned their hopes on survival on a decent Christmas, and they’ll be forced to give up the ghost once those sales fail to materialize.

I spent a few minutes at the mall yesterday, and even in the wealthy suburb where I was the traffic was very light, the discounts were immense, and the weakest “anchor” store of all, Sears, looked like it was desperate to make a sale, any sale, at below cost. (Just as an aside, I can’t believe Sears has bounced so nicely with our little December rally, they still look doomed to me.)

So what does one do with that information? Well, even if General Growth Properties is forced to declare bankruptcy, either on Friday or, if they make a rescue deal, perhaps later, there’s not necessarily a fat pitch for making lots of money on that eventuality — it’s probably tough to short the stock right now, and the potential downside of doing so is dramatic if you’re wrong. GGP shares trade at about $1.60, so if the company was rescued by someone or managed to avoid or even postpone bankruptcy it wouldn’t be shocking to see the shares double or triple in a relief rally — not likely, perhaps, but certainly important to consider. After all, even GM has had some big snapback rallies in the last few months.

If you use Porter’s strategy on GGP specifically, you could buy puts on GGP shares for either December or January — the December bet is extremely short term, since those puts expire a week from tomorrow and that would mean the shares would have to fall materially within the next eight days. GGP puts for December 19 at $2.50 are currently going for $1.15, which means you’re assuming the shares will fall through $1.35. It will cost you another 20 or 30 cents to extend that expiration to January.

Those bets would potentially allow you to come close to doubling your money, but be careful — bankruptcy almost always means that equity holders get left with nothing and the common stock goes to zero, but it doesn’t necessarily happen right away, or every time. Sometimes investors keep trading stocks that are going through Chapter 11, betting on little swings or just taking advantage of unsophisticated retail investors who, usually for foolish reasons, speculate on the company’s value in bankruptcy. GGP has less than $500 million in stock market value right now and nearly $25 billion in debt, so those debtholders, as is typical, will be splitting the spoils amongst themselves in any bankruptcy reorganization or liquidation (assuming that they do indeed go bankrupt).

But this short-term deal is probably not Porter’s main focus right now — if he recommended that his readers buy puts against GGP in past issues, they’re probably doing extremely well on those bets, but what he’s promising to do is tell you about the next failed stories in commercial real estate and recommending puts on those stocks to bet on their fall.

Here’s the scenario that Porter lays out for us:

“JANUARY 15th: A Colorado firm in essentially the same businesses has a huge $50 million debt payment they can’t afford that’s due on January 15th, just over a month from now. The company owes another $200 million in June of next year.

“JANUARY 30th: An Ohio company in the exact same business has a $275 million debt payment they can’t afford due on January 30th, just seven weeks from now. They have another $500 million due in 2010… and another $500 million due in 2011.

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“MARCH 7th: A Georgia company in the same business has a $400 million payment they can’t afford due on March 7th.

“MARCH 15th: A New York company in the same business has a $200 million payment they can’t afford due March 15th.

“I believe–as strongly as I have believed anything in my financial career over the last decade–that at least a half-dozen of these companies will go bankrupt over the next year.

“In short, I predict the first bankruptcy will take place this Friday, December 12th, before midnight. It will start a domino effect over the next 12 months, in which we’ll see plummeting share prices and bankruptcy for these highly-leveraged firms.”

The argument he makes is that these companies are going to fall like dominos because the failure of GGP will destroy the market for retail real estate (if there’s a fire sale on their malls, the value of all malls will fall — just like what happens when a neighborhood starts to see a lot of foreclosures and short sales). And he also points out that the structure these companies operate within, the Real Estate Investment Trust, sets them up to fail. This is an interesting point, since the tax status of a REIT requires that they pass through essentially all their income to investors as dividends … so, as Porter says, they don’t have much flexibility or incentive to save money or hoard cash even when it might be wise to do so. They can, of course, pay down debt with their cash flow — but that doesn’t boost dividends, and until a few months ago investors would have complained that they wanted more leverage.

So if we accept Porter’s stipulations, that General Growth will go bankrupt, and that this will start a chain of bankruptcies across the commercial real estate sector, how do we “play” that?

Well, I want to get this note out quickly, so I’ll just tell you that those clues don’t seem to match the other big regional mall operators (Simon Property Group, Macerich, and Taubman), but they could well match one of the more numerous strip mall, outlet mall, and shopping center owners — there’s one list here if you want to start your own research, and there are many other diversified REITs that have some shopping center exposure — to say nothing of the fact that many folks think we’ll have severe problems with commercial real estate in general, not just in the retail space. There are some more conservative players in this space, too — Realty Income, for example, is still often teased as a buy and I wrote about it recently.

Remember, the man who is often called “The Grave Dancer” because of his skill in buying distressed property at bargain price