It's the summer and I'm stocking up on wool hats in the form of HomeFed Corporation (HOFD), an interesting company that owns several properties for development in the evergreen real estate favorite state of California. On one hand, the continued weakness in the housing market bodes poorly for near term property sales. On the other hand, the business is unlevered with tons of excess cash to take its pick of promising development properties that come to market. The best part is that the business can be had for vaguely below its liquidation value in the current environment in addition to one of the best management teams out there.
Overview
HomeFed has 4 key assets in various phases of development all in California: several parcels in the Otay Ranch development, a 68% interest in the San Elijo Hills development, a grape farm, and the Fanita Ranch development. The company processes entitlements for the land and pays for the construction of community infrastructure – sewage, roads, lights, etc. – then sells lots to homebuilders. The business eschews debt, which is the main risk in property development as such an immovable force is not cooperative to the numerous pitfalls and obstacles in the business. This allows the company to be opportunistic as well as conservatively positioned to weather any storm.
Background
HomeFed is a post reorg equity if you go back to 1995. It consisted of several different small parcels of development land in California in addition to a nice slug of tax loss carry forwards. It caught the eye of Leucadia, as they enjoy developing real estate and sheltering profits with tax losses. I'm a big fan of their work. Leucadia contributed some land in California in exchange for an interest. You can find the details in the 10-Ks, but basically over the years some complex ownership interests have shifted around and land has been contributed. The situation is now simple to comprehend.
Leucadia’s original interest in HomeFed was spun out to shareholders in 1998 for $1.80/share, so Ian Cummings and Joe Steinberg own about 18% of the company combined. After the spinoff though, Leucadia got involved again by contributing more land to the company in exchange for a 30% stake. On one hand, this has resulted in stellar management but on the other it makes the stock quite illiquid (Steinberg’s address at the shareholder’s meetings is available on EDGAR and is the pseudo shareholder’s letter of HomeFed). The Leucadia culture trickles down to HomeFed and the idea of an investor relations department or pretty powerpoints about their developments is abhorrent. The entire situation is all the more attractive to individual investors because it is entirely unfeasible for anyone close to a financial professional to touch.
Valuation
The company carries its properties on its balance sheet with development costs capitalized. Since the company is unlevered and raw land isn’t taxed heavily, the land is likely undervalued due to the long holding period and opportunistic purchases. I will go into the specific properties and their valuation ranges below. The nice thing about the company is that they have $56m in cash net of all liabilities, with the potential that $9m of the $13m of liabilities is overstated. There is $82m in real estate net of a minority interest and a $13m deferred tax asset. The combined book value is $151m or $19.35/share. On the low end the real estate is worth ~$107m which can be sold mostly tax-free at such a price.
San Elijo Hills
SEH is a development north of San Diego, just outside of San Marcos. The development costs have already been paid for and the company is just letting the property percolate into cash. The company has a 68% interest in the development. The company just 325 single family home units and 30 multi family home units from an original 2,364 and 1,099 respectively. There is also 51,2000 of commercial space remaining.
The current carrying value of the property is $47.2m or $32m net of minority interest. Just to prove the point that the property is clearly undervalued, assume the remaining MFH units and commercial space is worth nothing, which implies the SFH units are worth $145k/unit gross. In 2010, the company sold 52 SFH units for $261k/unit on average. In January 2011 they sold 32 SFH units for $218k/unit. At the end of July 2011, they entered an agreement to sell 59 SFH units for $300k/unit.
You can extrapolate these prices over the remaining units – if the 59 SFH unit sale goes through, the company has 266 SFH units left – and get a value of $45-63m for the remaining SFH lots and about $12m in additional cash for the 59 SFH units in the process of being sold. If the sale doesn’t go through the company gets a $1.8m deposit and the remaining land is worth $54m-60m using extrapolated values excluding the $300k/unit price. My point is that the land is undervalued to the book carrying value. I’m not including the commercial spaces that got sold for $1.4m or $550k that are booking huge gains and what they mean for the remaining square footage. The company is also renting out some commercial space for $400k/year, which makes it worth something.
Otay Ranch
Otay Ranch is a large development in Chula Vista, a suburb between Mexico and San Diego. The company owns 2,800 acres in total but it is largely undeveloped. The company submitted its application to develop up to 6,050 residential units and 1,800,000 square feet of commercial space in 2008. It contributed some land and money to Chula Vista to build a higher education facility in exchange for the city promising to process the application by August 2011. If the city doesn’t the company gets the land and money back, so the incentive is for an announcement in the next few weeks. The company hopes to be fully done with approvals by early 2012 according to the recent annual meeting. This will allow the company to move forward with the development, although the real estate market in south San Diego is in the dumps. The company will be able to move forward with development though so that land sales can commence in the next 2-3 years.
The $9m environmental liability is attached to this property as one of the parcels used to be a shooting range. The company is in litigation to get the former owners to help with the lead clean up costs. This presents an opportunity that the liabilities are overstated.
The property is carried for $32m on the balance sheet. I have no idea how to value this with any type of precision. I could create big numbers, such as assuming the company just develops half the maximum residential units and nothing else and goes on to sell them for $50k/unit, which totals $150m in 5-10 years at a cost of $50m. For starters, I made those numbers up. Second, the discount rate’s effect on the NPV for property sold in 2016 vs. 2021 or any year for that matter is immense. The more precise the value, the more likely it is to be inaccurate.
Any figure I conjure up is guaranteed to be ridiculously wrong. The company has held the parcels since 1998, so it stands to reason the book value is at a minimum a decent approximation of the value. There has also been increased road access to the parcels and the surrounding land has been developed, so this isn’t some random plot in the middle of the Arizona desert or that variety of real estate. I’m just looking for a vague approximation of what the company can get for the property today in liquidation, although it will hopefully be worth a lot more as the company develops it.
Rampage
Rampage is a 1,500 acre grape farm. It was acquired out of bankruptcy in 2003. The company is just farming grapes right now and making about $1m/year doing so. The property is carried at $4.5m and is for sale for $25m. At the low end, this property is worth $10m or 10x earnings. They are just farming commodity wine grapes, which management claims can be found in the fine Charles Shaw vino. I’m already a big fan of the 08 merlot (what a vintage!) so this is welcome information.
The original plan was to develop the property but it is outside of Fresno in the Central Valley of California. It’s interesting to point out that the idea behind the purchase totally failed and HomeFed is still positioned to make a boatload of money compared to the original investment.
Fanita Ranch
Fanita Ranch was purchased in January 2011 for $11m out of bankruptcy. The prior developer had $27m in debt on the property then encountered a beast of a downturn and environmental litigation. The parcel is 2,600 acres of land that was entitled for 1,400 SFH units. The city, local merchants, and residents looking for move up housing are all in favor of development, although there is environmental opposition. HomeFed is uniquely positioned with a long term focus and bulletproof balance sheet to flexibly address the environmental opposition and develop the land. This video gives a good overview of the various constituents in the argument and the problems. I’m biased, but I think the economic benefits of a development (more taxpayers, more customers to local businesses) trump environmental considerations in a poor economy more so than in a booming one. Bureaucrats and businessmen are even hungrier for new sources of revenue. This video is a nice roundtable local PBS program on the issue.
An extension of SR 52, a highway, reached Santee in March, 2011 which makes the area more accessible and attractive to commuters into San Diego as well as locals. For now, the parcel is worth $11m, but there is huge upside if this development goes forward, especially within the next 3-4 years. It also gives the company an alternate project to work on while they wait for the Otay Ranch area to improve and uses the excess managerial capacity that is resulting from SEH being in runoff mode.
Property/valuation wrap up
Just looking at what the reaming SEH lots and Rampage can generate in the near future results in $25m increase in book value or $3.20/share on the low end and $40m or $5.10/share in a rosier scenario. This doesn’t assign any value in excess of the carrying value to Fanita Ranch or Otay Ranch, although there are identifiable factors such as development milestones and increased road access that have increased their values since purchase. If the planned sale of SFH units in SEH go through, the balance sheet will have a further bolstered cash balance that represents ~50% of the business. Even in such a shitty economy, the company is worth a vague amount more than the current market cap in liquidation, although patience will reveal that the company is worth substantially more if Leucadia's historical results in property development are anything to go by. This could very well take 5 years, but the share price may possibly rise sooner in anticipation of this all.
On the note of property sales, the company has $24m in NOLs and $31m in AMT credits that will be used to offset profits from sales. In addition to low to no taxes, the costs have all been paid for, so property sales going forward are more cash generative than just looking at net income would have you believe.
Conclusion
I’m sure this stock will see some bizarre price activity in the coming months as people perceive a worsening housing situation, which the company is clearly tied to. The short-term market fluctuation – both stock and real estate – have very little negative effect. If anything, further real estate doldrums offers the company the opportunity to scoop up some more properties, which is a positive when such competent management and a strong balance sheet are behind the purchases.
Long HOFD
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