Safehaven | Here's a Big Company Bailout by the Taxpayer That Even the Taxpayer's Missed!

November 06, 2009

Here's a Big Company Bailout by the Taxpayer That Even the Taxpayer's Missed!
by Reggie Middleton

Riddle me this. An industry gets into trouble due to chasing fads, loading up on debt and overpaying for property. Many participants in said industry flirt with insolvency due to difficulty meeting debt service and asset values that have dropped below liabilities. This industry has been gifted with a special tax provision that allows them to pay no corporate taxes as long as they pay out 90% of their income to their shareholders. By now I am sure you have guessed the industry, but let's move on.

After special meetings with the IRS, who were told that the world would end if these entities were forced to dump distressed real estate onto an already distressed market (in reality, commercial real estate prices will simply return to fundamentally supportable prices), these companies were given a special reprieve on top of their already gifted special reprieve that allows them to pay said dividends in stock rather than cash.

The need to conserve cash, as explained above, stems directly and primarily from imprudently participating in bubble binging, and from a tertiary perspective, the dwindling refinancing market - of which would not be such a big deal if companies didn't overpay for, and overleverage properties in the first place. The solution? Team up with the Wall Street banks that gave you the imprudent loans that most should have known couldn't be paid back in an effort to shift the losses to the retail investor. This is a win -win situation for the banks that made the loans as well as for the REITs that took the loans. Here is the playbook (for illustrative purposes only, of course):

Step #1: Pump the stock - Reference the upgrades, and notice they happen to occur right before a secondary offering - From ZeroHedge: Merrill Lynch In Full REIT Upgrade Mode - The Sequel. Notice that the upgrades are made despite the fact that the CRE market is in total shambles with no near to medium term improvement in sight.

Step #2: Dump the stock: Again from ZeroHedge: Bank Of America Merrill Lynch Gets Paid To Pay Itself Back In Developers Diversified.

Today, Developers Diversified Realty announced it was issuing $300 million in senior notes, with lead underwriter "BofA Merrill Lynch"...

... The final deal terms were $300 million of 9.625% notes due March 2016, priced at 99.42% to yield 9.75%. The syndicate, primarily BofA ML will pocket $5 million in underwriting fees (oddly, less than the customary 3% for a HY offering - are companies starting to demand more bang for their buck?).

And the ever crucial Use of Proceeds? Why paying back Bank of America's 2010 maturing credit facility, as if there was ever any surprise. More specifically:

We intend to use the net proceeds of this offering to repay debt, including, without limitation, one or more of:

Borrowings under our $1.25 billion unsecured revolving credit facility maturing June 29, 2010 (with a one-year extension at our option subject to the satisfaction or waiver of customary closing conditions); as of June 30, 2009, total borrowings under our $1.25 billion unsecured revolving credit facility aggregated $1,169.5 million with a weighted average interest rate of 1.5%;

Borrowings under our $75 million unsecured revolving credit facility maturing June 29, 2010 (with a one-year extension at our option subject to the satisfaction or waiver of customary closing conditions); as of June 30, 2009, there were no amounts outstanding under our $75 million unsecured revolving credit facility;

A portion of our 4.625% Senior Notes due August 1, 2010; as of June 30, 2009, there was approximately $260.8 million aggregate principal amount of our 4.625% Senior Notes due August 1, 2010 outstanding; and

A portion of our 5.000% Senior Notes due May 3, 2010; as of June 30, 2009, there was approximately $193.6 million aggregate principal amount of our 5.000% Senior Notes due May 3, 2010 outstanding.

Not a bad deal: the company refinances BofA's 2010 bank facility, which has a 1.5% interest rate with a 2016 term piece of paper, paying 9.625%. Any way you look at it, it goes to show the "solid fundamentals" behind the sector, where the cost of extending a maturity is 6 times the current interest rate!

This excerpt was taken from the ZeroHedge posted linked above. What I think they missed was that the yield on the secondary was much less relevant than it appeared, since DDR was probably going to pay it in stock (that's right, that funny stock split cum dividend thing).

Step #3: Shift the tax liabilities upon those who you dumped the stock on... The last step in this new REIT game, after dumping the unpayable debt converted into follow-on offering stock is to push the fake dividends and shift the tax liabilities of said fake dividends from the entity that generated the liability on to the investor. Normally, if the cash is not paid out, the REIT would have to pay the taxes on it. Now the REIT can keep the cash, dilute the stock by offering the pump and dump secondary, then pass the tax liability off to the guys that were suckered into buying the stuff, most likely by sell side brokers and analysts - as was exemplified by the BofA Merrill Lynch excerpts above.If you feel as if I (actually, Zerohedge since they broke the story) am being a little hard on the Merrill guys, check out what their ex-REIT analyst head had to say as soon as he left the company - More from Zerohedge: Some Totally Unexpected REIT Lack Of Love From Merrill Lynch -

"From a financing standpoint things are far worse; from a fundamental standpoint things are certainly getting worse."

As a matter of fact, this alleged "bait and switch" behavior was called out by ZeroHedge in an open letter to the SEC: Open Letter To The SEC Regarding Wall Street's REIT Bait-And-Switch:

Zero Hedge is well aware that our regulatory friends at the SEC and FINRA enjoy going through our articles in search of the "next big scam." We are always happy to make their lives a little easier and not only connect the dots but give them everything they need on a silver platter so that even a green securities lawyer, 4 hours fresh out of law school, would be able to comprehend and litigate.

A few weeks ago I caught on a troubling trend whereby Merrill Lynch/Bank of America embarked on an epic quest to underwrite equity follow on offerings for a vast majority of the lowest quality REITs including Kimco, ProLogis, Duke Realty and others. I say lowest quality, because Merrill's own analysts had a Sell rating on these names as recently as March 31 (for Kimco) and January 6 (for ProLogis). How the global economy has really changed for the better of REITs since then is still a mystery to me. But I digress.

The following is the dividend payment history as gaken from DDR's website, to help drive the point home on the dividend thing:

Historical Dividends Issued

Declared	Ex-Date	Record	Payable	Amount	Type
Sep 10, 2009	Sep 21, 2009	Sep 23, 2009	Oct 15, 2009	0.02	U.S. Currency
May 28, 2009	Jun 9, 2009	Jun 11, 2009	Jul 21, 2009	0.2	Optional dividend (cash or stock)
Mar 2, 2009	Mar 10, 2009	Mar 12, 2009	Apr 21, 2009	0.2	Optional dividend (cash or stock)
Oct 24, 2008			Jan 7, 2009		Dividend omitted
Total dividends paid in 2009:				0.4200
Aug 19, 2008	Sep 24, 2008	Sep 26, 2008	Oct 7, 2008	0.69	U.S. Currency
May 15, 2008	Jun 18, 2008	Jun 20, 2008	Jul 8, 2008	0.69	U.S. Currency
Jan 9, 2008	Mar 18, 2008	Mar 21, 2008	Apr 8, 2008	0.69	U.S. Currency
Nov 19, 2007	Dec 19, 2007	Dec 21, 2007	Jan 8, 2008	0.66	U.S. Currency
Total dividends paid in 2008:				2.7300
Aug 15, 2007	Sep 20, 2007	Sep 24, 2007	Oct 2, 2007	0.66	U.S. Currency
May 17, 2007	Jun 18, 2007	Jun 20, 2007	Jul 3, 2007	0.66	U.S. Currency
Feb 16, 2007	Mar 21, 2007	Mar 23, 2007	Apr 9, 2007	0.66	U.S. Currency
Nov 20, 2006	Dec 20, 2006	Dec 22, 2006	Jan 8, 2007	0.59	U.S. Currency
Total dividends paid in 2007:				2.5700
Aug 15, 2006	Sep 14, 2006	Sep 18, 2006	Oct 2, 2006	0.59	U.S. Currency
May 17, 2006	Jun 15, 2006	Jun 19, 2006	Jul 5, 2006	0.59	U.S. Currency
Feb 15, 2006	Mar 20, 2006	Mar 22, 2006	Apr 3, 2006	0.59	U.S. Currency
Nov 15, 2005	Dec 21, 2005	Dec 23, 2005	Jan 6, 2006	0.54	U.S. Currency
Total dividends paid in 2006:				2.3100

I guess they consulted some of their financial engineers, and decided a couple of pennies (literally) would do for now, though:

CLEVELAND, OH, Sep 10 (MARKET WIRE) --

Developers Diversified Realty (NYSE: DDR) today declared its third quarter 2009 common stock dividend of $0.02 per share. The common dividend is payable October 15, 2009 to shareholders of record at the close of business on September 23, 2009.

The Company has elected to maintain a cash dividend comparable to prior quarters but has elected to not pay the stock portion as the Company's most recent estimates indicate that the payment of the stock portion is not required to maintain REIT status. The Company will continue to review its dividend policy on a quarterly basis and make payments sufficient to maintain REIT status, receive favorable tax treatment and provide yield to shareholders while prudently assessing its current liquidity and the state of the capital markets.

This does tend to make one wonder what the hell income investors are thinking in buying a virtually income-less investment that has such potential for capital loss! To attempt to drive this point home, let's take an individual investor in the 34% tax bracket that has 10k shaes of Brand X REIT at $20 per share, and receives $1 dividend, 90% of which was paid in stock. This equates to $9,000 stock (re)distribution and $1,000 in cash. He will end up paying (.34 * $9,000) $3,332 in taxes on what amounts to a stock split, and will only have (.34 * $1,000) $660 in cash to cover it from the balance of the dividend distribution. In this scenario, the retail investor will be out of $2,672 in after tax cash for every $10,000 of 90% stock dividend distribution. Will he ever see that income again? Doubtful! Hey, what if Reggie Middleton is right (see "Boo!!! Will Halloween Scare the Market into Respecting the Fundamentals?" and "Re: Commerical Real Estate and REITs - It's About That Time, again...") and the CRE market tanks even more in the future? Well, Mr. Investor will have some capital losses with which he can try to convince his accountant to try to use in some creative and imaginative fashion to offset that phantom income (albeit attached to some quite corporeal taxes) that he never saw, touched, nor even had a chance to spend!

It appears as if we have been catching REITs in all types of mischevious things as of late. Remember GGP? In "If only more rich heiresses read my blog" I made note of the big lawsuit filed by the heiress to the ex-GGP's ex-fortune suing her law firm for misconduct. If she read BoomBustBlog she, her lawyers and the SEC would have seen that we practically laid out a roadmap of misconduct for all interested parties, complete with pretty charts and everything (excerpted from "blog readers chimed in with their expertise and opinions"):

I read your post on the redemption and share purchase with great interest. I reviewed the 13D filing and there seems to be an exhibit missing. The section summarizing the 500M loan facility, references the complete loan agreement as an exhibit. It is no where to be found. Where is it?

The prohibition of personal loans under section 402 of Sarbanes-Oxley amended section 13 of the 1934 SEC act, broadly prohibits public companies from making or arranging many types of personal loans, directly or indirectly, to their directors and executive officers.

As you aptly note, there are a boatload of questions. Not the least of which is the question concerning the terms of the Citi loan. I think what you're alluding to as the real purpose of these transactions follows: GGP issues shares 22.8 m shares at $36 dollars a share (821M). MBCP III takes 10% of the issue for $88M. MBCP III purchases division "B" interest from the Matthew Bucksbaum Trust and General Growth Corporation, paying for the "interest with GGP LP units the to Bucksbaum Trust.

Next up will be a list of REITs that didn't make my final shortlist, then next week I will debut the first of my 4th quarter 2009 REIT short candidates for subscribers.

Reggie Middleton
Reggie Middleton, LLC
Perpetual Interests, LLCTM
http://boombustblog.com/

Who am I?

Well, I fancy myself the personification of the free thinking maverick, the ultimate non-conformist as it applies to investment and analysis. I am definitively outside the box - not your typical or stereotypical Wall Street investor. I work out of my home, not a Manhattan office. I build my own technology and perform my own research - in lieu of buying it or following the crowd. I create and follow my own macro strategies and am by definition, a contrarian to the nth degree.

Since I use my research as a tool for my own investing to actually put food on my table, I can stand behind it as doing what it is supposed too - educate, illustrate and elucidate. I do not sell advice, I am not a reporter hence do not sell stories, and I do not sell research. I am an entrepreneur who exists just outside of mainstream corporate America and Wall Street. This allows me freedom to do things that many can not. For instance, I pride myself on developing some of the highest quality research available, regardless of price. No conflicts of interest, no corporate politics, no special favors. Just the hard truth as I have found it - and believe me, my team and I do find it! I welcome any and all to peruse my blog, use my custom hacked collaborative social tools, read the articles, download the files, and make a critical comparison of the opinion referencing the situation at hand and the time stamp on the blog post to the reality both at the time of the post and the present. Hopefully, you will be as impressed with the Boom Bust as I am and our constituency.

I pay for significant information and data, and am well aware of the value of quality research. I find most currently available research lacking, in both quality and quantity. The reason why I had to create my own research staff was due to my dissatisfaction with what was currently available - to both individuals and institutions.

So here I am, creating my own research for my own investment activity. What really sets my actions apart is that I offer much of what I produce to the public without charge - free to distribute and redistribute, as long as it is left unaltered and full attribution is given to the author and owner. Why would I do such a thing when others easily charge 5 and 6 digits annually for what some may consider a lesser product? It is akin to open source analysis! My ideas and implementations are actually improved and fine tuned when bounced off of the collective intellect of the many, in lieu of that of the few - no matter how smart those few may believe themselves to be.

Very recently, I have started charging for the forensics portion of my work, which has freed up the resources to develop the site to deliver even more research for free, particularly on the global macro and opinion front. This move has allowed me to serve an more diverse constituency, which now includes the institutional consumer (ie., investment turned consumer banks, hedge funds, pensions, etc,) as well as the newbie individual investor who is just getting started - basically the two polar opposites of the investing spectrum. I am proud to announce major banks as paying clients, and brand new investors who take my book recommendations and opinions on true wealth and success to heart.

So, this is how I use my background and knowledge in new media, distributed computing, risk management, insurance, financial engineering, real estate, corporate valuation and financial analysis to pursue, analyze and capitalize on global macroeconomic opportunities. I have included a more in depth bio at the bottom of the page for those who really, really need to know more about me.

Visit his blog Boom Bust Blog.