Pershing Square hedge fund manager Bill Ackman presented his latest short idea at the Great Investors Best Ideas conference in Dallas, TX where he spoke with other prominent hedge fund players such as David Einhorn of Greenlight Capital. At the conference, Ackman laid out a short thesis for Realty Income (NYSE: O).
The rationale behind his play is as such: He thinks Realty Income (O) will suffer because they have tenants with poor credit quality, many with junk ratings. Additionally, he cites the fact that many of their tenants are in the dreaded consumer discretionary segment. This sector has been notably hit due to the recession and many stores have closed down over the past 12+ months. He also mentioned that Realty Income also trades at a 7.5% cap rate or so, whereas the private market value is a 10-11% cap rate, a 40% premium.
Ackman's presentation also touched on the $26 share price level, as the stock can never seem to go all that much higher recently given the fact that they keep issuing shares around that level. They are essentially 'serial equity raisers' and their stock vesting program is a bit odd in that the older you are, the quicker your stock vests. We've certainly seen a massive wave of REIT equity dilutions over the past year, and Realty Income seems to be no different. If anything, they're even more aggressive in this regard.
Ackman also noted that the REIT is very levered to occupancy as they essentially doubled their asset base at the peak of the market during the years of 2005, 2006, and 2007. So, they certainly have their share of fundamental problems, as many other REITs in the space do. In the end, Ackman basically said that this company is appealing to your everyday retail investor due to the monthly dividend stream that they tout. He thinks this dividend will have to be cut and this would play out similarly to what we saw earlier in the year with many other major REIT players cutting dividends or paying dividends in the form of stock. And, he feels that once the dividend starts fading, so will all the retail investors. This is all the more interesting to note given that Realty Income just raised their monthly dividend to $0.1426875 per share, up from $0.142375 per share (hey Realty Income, can you guys squeeze anymore decimal places into that amount? Geez). They've now boosted their quarterly dividend each year for the past 15 years as the name currently yields 6.2%.
Pershing Square was already short in the REIT space to some degree in an effort to hedge their long position in General Growth Properties (GGWPQ). Their largest short position is a valuation hedge on this investment and they had also previously mentioned in their letter to investors that they were short a REIT that has weak assets, trades at a higher valuation, and has poor business prospects. So the question now becomes, was Realty Income the company he was talking about in his letter? It definitely appears as though it was. Once word of his presentation got out, shares were down over 7% at one point on Wednesday. We found this interesting given that Ackman typically doesn't short equities on the short side of his portfolio, preferring instead to use derivatives as a means to maximize the reward of their play, as we noted in our profile & biography on Ackman.
In the WSJ the other day, Analyst Andrew DiZio from firm Janney Montgomery Scott cited both the long and short cases for Realty Income, noting that shorts are centering in on a potential bankruptcy by some of their tenants. He says, "shorts believe large-scale vacancy from bankruptcies will reduce cash flow, necessitating a dividend cut and resulting in the exodus of [Realty Income's] large retail shareholder base." On the long side, he notes that "In the event of a Chapter 11 filing, a tenant will likely affirm the leases of profitable stores, closing those that are cash flow negative. Realty Income's due diligence process results in the REIT purchasing only those units that are cash flow positive, increasing the likelihood of lease affirmation in the event of a bankruptcy." He currently has a 'neutral' rating on the company, but has interestingly enough said that dips provide an opportunity.
Ackman has been pretty actively involved in real estate plays with his portfolio, most notably with his position in General Growth Properties debt and equity (GGWPQ). So far that position has done extremely well for him as he's up more than 12-fold on the equity since their buy at $0.34 per share and the unsecured debt they own has tripled in value over the same timeframe as noted in their latest investor letter. Additionally, he also has a large stake in Target (TGT), whom he proposed a REIT spin-off for earlier on that never panned out. Not to mention, his experience stems back to his former hedge fund Gotham Partners who closed two of their funds back in 2003 after a merger was blocked between one of his top holdings and a real estate player. Ackman certainly has ties to the sector though, as his father Lawrence D. Ackman is chairman of the Ackman-Ziff real estate advisory firm.
Overall, an interesting set of thoughts from Ackman and we'll be sure to cover more developments regarding his thoughts as we obtain them. Don't forget that you can hear more investment ideas from both Ackman and David Einhorn at the upcoming Value Investing Congress on October 19th and 20th and we highly recommend attending. We also wanted to mention that at the same Dallas conference, Einhorn mentioned that he was buying interest-rate options that he will make money on if yields head higher. This is likely a very similar to Julian Robertson's curve caps play, as we now see yet another prominent hedge fund player enter this trade. These plays are definitely inflationary in nature and Einhorn has set his sights on this outcome, as he also holds a lot of physical gold. We'll also watch developments in this regard and will post up further information as we obtain it.
You can view our coverage of Bill Ackman's Pershing Square portfolio here and David Einhorn's Greenlight Capital portfolio here. Lastly, make sure you check out our profile/biography on Ackman & Pershing Square.
Taken from Google Finance, "Realty Income Corporation, The Monthly Dividend Company, is organized to operate as an equity real estate investment trust (REIT). The primary business objective of the REIT is to generate dependable monthly cash distributions from a consistent and predictable level of funds from operations (FFO) per share. The Company’s monthly distributions are supported by the cash flow from the portfolio of retail properties leased to regional and national retail chains."
(from marketfolly.com, October 9, 2009)