Description
This idea has been written up by Sag301 and Tickles839 and I'm indebted to them for their work. There's been quite a bit of confusion, however, especially regarding the company's strategy and tax liabilities. In recent months, several uncertainties have been resolved and GYRO has established a clear roadmap. It's therefore a good time to revisit this idea with scenarios that reflect the company's stated plan.
STRATEGY
Shortly after Sag's write-up, GYRO made a presentation at its annual meeting that outlined its value realization strategy. I recommend the 12/12/05 8-K to anyone not already familiar with this situation. Among other things, the presentation has some nice aerial photos that help investors understand GYRO's properties.
A key decision is that GYRO intends to convert to REIT status and, using the tax deferrals available under Federal and State code, exchange most of its properties into income-producing assets without generating current tax liability. GYRO is confident that it will be able to complete exchanges under Section 1031 and 1033 for all of its Flowerfield property. An exchange is not feasible with the Callery-Judge Grove property and tax liability therefore needs to be assessed when this property is sold.
Assuming the exchanges are completed, the net proceeds from the Grove are invested in income-producing assets, and GYRO qualifies as a REIT, the company would then be a small REIT that, hopefully, would be an attractive acquisition candidate for another REIT. GYRO shareholders might receive cash or stock from an acquiror but, in either case, should not be subject to more than capital gains taxes.
VALUATION
At 4/30/06, GYRO has four principal assets:
a. $28 million in net working capital, mostly cash
b. A claim of $158 million in additional compensation from the State of New York
c. The balance of 68 Flowerfield acres, including 127,000 square feet of commercial space
d. An 11% interest in the Grove
Certain details of these assets (other than the cash) are as follows:
Flowerfield Compensation:
The SUNY system appropriated 245 acres of the Flowerfield property, including approximately 225 acres of undeveloped land and 20 acres of land developed with 52,000 square feet of commercial space. SUNY paid $26 million and GYRO has filed a claim in State court for $158 million more. GYRO's claim values the entire property at $750,000 per acre.
Obviously, that's quite a bid/ask spread and Sag and Tickles have both offered ranges of values. It's very probable that the low end value is $26 million - meaning GYRO would get zero additional compensation -- though the court could conceivably order a partial refund to SUNY. The high end is almost certainly the $158 million claim plus 9% annual interest as provided under New York law. I estimate a “base case” of $28 million using $450,000 per acre as the value of the developed acreage and $200,000 per acre as the value of the undeveloped acreage. This yields a gross value of $54 million, which is then reduced by the $26 million initial payment.
The $450,000 per acre price for developed land is comparable to GYRO's sale of 12 developed acres - with 18,000 square feet of buildings -- in 2002. Without more information, it's hard to know how much was paid for the land vs. the buildings, but it appears to me that, in this case, the land valuation is more relevant than the building value. The 2002 sale would translate to $300 per square foot of commercial space, which is far too much to pay for buildings that rent at $12 per foot per year.
For the undeveloped land, $200,000 per acre is at the low end of Tickles' range and at the mid-point of Sag's range. I believe this is conservative, but we shall see. I am also giving myself some room for error by not assuming any interest on amounts that may be due from the State.
Flowerfield Acres:
The same values as above would yield $16 million -- $4.5 million for the 10 developed acres and $11.6 million for the 58 undeveloped acres. For my base case, however, I make two adjustments. First, I estimate the buildings' value at $60 per square foot or $7.6 million for this parcel. Second, I expect GYRO to make progress toward changing the entitlements on the raw land and realizing higher value. Estimating the sale value of the raw land at $250,000 per acre - a total of $14.5 million - is still, in my view, reasonably conservative. My base case for the remaining Flowerfield property is therefore $22 million.
Callery-Judge Grove:
A June 2005 appraisal suggested GYRO's interest in this property is worth $18 million. Real estate conditions have softened since that time, but there have been several positive developments regarding changes in entitlements. A new appraisal should be available in the near future and I'll be surprised if it doesn't indicate a significantly higher value. Nonetheless, I use $18 million as my base case value. Assuming 40% tax on the proceeds, the net value to GYRO could be $11 million.
OUTLOOK
For my base case, I assume all existing assets are liquidated and the proceeds invested by the end of 2008. This is obviously an arbitrary assumption that could prove modestly pessimistic or wildly optimistic. Nonetheless, it allows me to get a picture of what “Gyrodyne REIT” might look like at some point in the future. In this scenario, GYRO's equity in income-producing properties might look like:
$28 million from net current assets
$28 million from State claim proceeds
$22 million from Flowerfield
$11 million from net Grove proceeds
$3 million from interest income
$1 million from stock option exercises
($5 million) approximated G&A expense
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$88 million ($67 per diluted share)
A “low case” might resemble:
$28 million net current assets
$0 million State claim proceeds
$16 million Flowerfield sale
$11 million net Grove proceeds
$3 million interest income
$1 million from stock option exercises
($5 million) approximated G&A expense
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$54 million ($41 per diluted share)
And a “high case” could approximate the following:
$28 million net current assets
$47 million State claim proceeds at $300,000 per acre overall
$27 million Flowerfield sale at $400,000 per acre overall
$22 million net Grove proceeds from sale at $100,000 per acre
$3 million interest income
$1 million from stock option exercises
($5 million) approximated G&A expense
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$123 million ($94 per diluted share)
The base case indicates an IRR of 13% from now to a $67 value at 12/31/08. Not stunning, but a very respectable unleveraged return, especially if the downside is limited and the upside potential is meaningful.
I hope this hasn't been too repetitive. I've tried to focus on the key issues and new developments. I encourage Sag, Tickles, and others to weigh in with comments and additions. Meantime, I'm hoping GYRO makes good progress toward this future - and toward a successful liquidity event!
Catalyst
1. Increasing valuation of the Grove
2. Progress toward settlement with SUNY
3. Finalized plans for development of remaining Flowerfield acreage