We highly encourage readers to view the PDF version of this writeup. Aside from having a more readable format, it contains crucial data. The link is:

https://docs.google.com/viewer?a=v&pid=explorer&chrome=true&srcid=0B2GVAJDRNXB4NzU0ZjBiZTAtOWFmZS00YzNjLTkwYjEtOTI0YWQzODE5ZjQy&hl=en

Buy the Real Estate / Get the Gold Mine for Free (or vice versa)

Intergroup is a company that owns apartment buildings and the San Francisco Hilton Hotel. Buried deep in the footnotes of the company’s financial statements, however, is an asset  that alone is worth more than the entire company’s market cap.

The asset is preferred shares in a publicly traded Nevada gold miner, Comstock Mining (AMEX:LODE). The footnotes still report these preferred shares at their originally stated value of $13 million. On January 1 of this year, however, these preferred shares became convertible into common stock. At Comstock’s current market price, INTG’s preferreds are worth more than $63 million, i.e., 5x the stated book value.

The market is not aware of this large hidden asset. In 2011, as the gold price rose over 50%, INTG’s stock price has stayed about the same. Luckily, that allows us to capitalize on this tremendous discrepancy and purchase shares in a Nevada gold mine at $0. In short, the per share sum of INTG’s parts is:
 

+ $17.00 : Real estate (primarily apartment complexes)

+ $11.00 : San Francisco Hilton Hotel

+ $2.00 : Other assets, net of liabilities

= $30.00 : TOTAL

+ $25.93 : Current market value of hidden Comstock preferred shares

= $55.93 : INTG’S TOTAL CURRENT VALUE
 

Versus current share price of INTG = $25.00
 

Basically, the value of Comstock preferreds alone is now greater than INTG’s share price.  Investors can argue about whether one should own gold, but none can argue against getting it for free. Even though the above calculation shows this investment to be a no-brainer, we provide a detailed account of values below, in sections a) real estate; b) hotel; c) other assets; and d) Comstock shares.

(2,587,344 shares outstanding are used in the calculations below, which assumes all options are exercised.)
 

A) REAL ESTATE =  $12-$22/share

Intergroup owns real estate throughout the United States, with a concentration in Texas and L.A., California. These properties include eighteen apartment complexes, two single-family homes, two commercial buildings, and two land parcels. See APPENDIX A for the entire list of properties and their related information.

Many of INTG’s properties were bought in the 1970s, so book value is obviously no indicator of true value. INTG’s real estate can be valued on the basis of either i) cap rates, ii) sales comps, iii) mortgage LTVs, and/or iv) replacement value. On all metrics, the properties’ values fall within the range of $12-$22/share.

i) Cap rate valuation

The properties have been producing the following Net Operating Income (NOI), in millions:

Intergroup’s apartment complexes sell at 6% to 7% cap rates. With $6.4m NOI, that puts those properties’ value at $91-$107 million, less the $64 million in mortgages, amounts to equity of $27m-$43m or $10.43-$16.62/share. 

Note that the above does NOT include the Austin, TX property that management recently listed for sale and classified under “Discontinued Operations.” That property adds equity value of $3m-$4m or $1.16-$1.55/share.

In total, the value of the apartment buildings based on cap rates is $30m-$47m or $11.60-$18.17/share.

ii) Sales comps valuation

Aside from a cap rate valuation, we examined sales comps for similar type apartment buildings within a close radius of INTG’s properties. See APPENDIX B for a list and detailed mapping of all comps. The total equity value of INTG’s properties based on sales comps is roughly $56m or $21.83/share.

(As a quick example, across the street from INTG’s Las Colinas, TX property–its gem property that accounts for 1/3 of INTG’s real estate portfolio–an apartment complex of the same size sold in March 2011 for $89k/unit. INTG’s property is more valuable since it has a lake, but assuming the same $89k/unit * 358 units = $32m asset - $18m mortgage = $14 million or $5.41/share–for just that one property.)

iii) LTV valuation

In addition to caps and comps, a quick check based on LTV is warranted. The company has recently refinanced a lot of its properties to take advantage of low interest rates. The CEO of INTG, John Winfield, states that he runs INTG conservatively and seeks to finance real estate at 60% LTVs. Banks in general provide mortgages at LTVs of around 65%. Given that INTG has $71m in outstanding mortgages ($64m on current properties + $7m on properties held for sale), an LTV of 65% implies a market value of $110m. Subtract the $71m in mortgages and total equity value is $39m or $15.08/share.

iv) Replacement cost valuation

Lastly, it is prudent to know what it would cost to build INTG’s residential units, today. As long as the neighborhoods are not deteriorating, purchasing residences below their replacement cost can provide a “competitive moat.” See APPENDIX C for the calculation of replacement values. In total, the rough replacement value of INTG’s properties–and this assumes that land is bought at $0–amounts to $132m. Less $71m in mortgages gets you equity value of $61m or $23.70/share. 

The above four metrics shows that INTG’s real estate is worth $12-$24/share.

Other:

John Winfield sells real estate properties when he determines they have reached their full value. Most recently, in January 2011, the Company sold its 132-unit apartment complex located in San Antonio, Texas for $5.5m and recognized a gain of $3.3m.  The Company received net proceeds of $2.0m after selling costs and the mortgage pay-off of $3.2m.
 

B) HOTEL VALUE = $11/share

Intergroup owns 32% of the 544-room Hilton hotel in San Francisco, CA (known as the “Hilton San Francisco Financial District;” www.sanfranciscohiltonhotel.com), plus the accompanying 5-story garage.

(The math for the 32% is as follows: Justice Investors LP owns the Hilton SF Hotel. Portsmouth Square, a public company (OTCBB: PRSI) owns 50% of Justice and is the general partner. Santa Fe Financial, a public company (OTCBB: SFEF), owns 68.8% of Portsmouth. Intergroup owns 76% of Santa Fe Financial. InterGroup also directly owns 11.7% of Portsmouth. INTG’s CEO John Winfield, by the way, is essentially in charge and owner of all these companies.)

Interestingly, in an INTG SEC filing dated July 21st, 2009, Intergroup discloses the hotel’s appraised value:

“As of June 30, 2008, the most recent appraisal that Justice [the LP that owns the hotel] had for the Hotel was an appraisal for $111,600,000, issued on February 16, 2007...The 404-room W San Francisco hotel is under contract to be sold for $90 million, or approximately $220,000 per key. That sale, which is expected to close on July 30, 2009, is for approximately $15,000 more per room than the February 2007 appraisal of the Justice Hotel. While the W is well located and was built in 1999, it has limited parking. The Justice Hotel [the San Francisco Hilton], on the other hand, has five floors of subterranean parking and can accommodate approximately 500 vehicles. We believe that the parking garage is a unique and valuable asset that differentiates the Justice Hotel from other properties and significantly adds to the value of the Hotel.”

Prior to 2005, INTG’s San Francisco hotel was operated as a Holiday Inn Select, until it was closed for conversion to a full service Hilton. That year-long project included a complete renovation and upgrade of all the hotel's guest rooms, meeting rooms, common areas and restaurant and bar. The total cost of the renovation was $37 million.

Following the rebranding, the hotel has slowly been increasing profits in a cyclically trough environment for the hotel and lodging industry. Since that 2008 appraisal report, it has increased EBITDA by 41%. Management has done a great job of getting average occupancy up to 82%; average daily rate has moved up to $157, resulting in RevPar of $129.

A substantial amount of transaction activity in the San Francisco hotel market has recently taken place, providing a vast amount of sales comps data. See APPENDIX D for the full list. Similar and nearby hotels to INTG’s Hilton sold for around $250k/room, implying a  $136m value for the Hilton (and that does not ascribe any value to its 5-story San Francisco parking garage). $136m less the $45m in mortgages = $91m equity. INTG owns 32% of the hotel, so the value of their stake is $29m or $11.26/share.

(As a side note, since the Hotel recently completed a full-blown renovation, there is no present need for major capital expenditures. However, the hotel will reserve approximately 4% of revenues each year for future capital requirements.)
 

C) OTHER ASSETS & LIABILITIES = $2/share

Accounting for a small portion of Intergroup’s value is other assets and liabilities, which we calculate as follows:

Investment in marketable securities = $21.3m

(Investment portfolio diversified with 75 different equity positions. Portfolio composition: 25% Basic materials; 18% REITs; 17% Investment funds; 14% Services; 7% Financial Services; 19% Other)

Other investments, excluding Comstock = $4.6m

(Private equity hedge fund = $3.2m; Corporate debt & equity instruments = $0.6m; Warrants at fair value = $0.8m)

Other assets = $6.7m

(Accounts receivable; inventory; prepaid expenses; miscellaneous assets)

Cash = $3.3m

  $35.9m TOTAL OF ABOVE OTHER ASSETS

- $30.6m TOTAL OTHER LIABILITIES

= $5.3M NET

Ergo, INTG has net other assets of $5.3m or $2.05/share.
 

D) COMSTOCK (LODE) PREFERRED SHARES = $26-$56/share

i) Value based on current market price of Comstock:

On January 1 of this year, Intergroup’s 13,231 preferred shares in Comstock became convertible into 20.3 million shares of common stock (each preferred share can convert into 1,536 common shares). Intergroup carries these preferred shares on its balance sheet–grouped in with “Other investments” and disclosed only in the footnotes–at their “stated value” of $13.2 million. Clearly, the current market value is 5x that amount.

Current stock price of Comstock (AMEX:LODE) = $3.00

INTG owns 20.3m shares * $3.00 = $61 million or $23.58/share

However, Comstock preferreds are unquestionably worth more than the common. These preferreds are obviously senior to the common, have five times the number of votes per common share, and are entitled to semi-annual dividends of 7.5% per annum. Assuming preferred shares receive just a 10% premium over the common–a conservative assumption–that puts INTG’s Comstock shares at $67m or $25.93/share. 

The value of the preferred shares alone is greater than the current price of INTG.

Surprisingly, though we were ecstatic to find such a large hidden asset, our due diligence on Comstock revealed that it may be severely undervalued at $3/share. Just recently, on June 11th, Comstock began trading on the NYSE Amex and it seems the company is still unknown to many investors.

Management is looking to change that. INTG’s CEO is also the chairman of Comstock. Last year, he brought in Corrado De Gasperis to serve as Comstock’s CEO. Since then, Corrado has done a heck of a job. Comstock is ready to produce and the gold resources it has is tremendous. Now that everything has been put together, Winfield and Corrado intend to get the word out to investors. They begin on September 13th, at the Rodman & Renshaw conference in NY.

Should Comstock soon be unearthed by the investment community and trade at the lower-end range of its peers–which is around $200/oz–its share price would double. That would bring the total value of INTG’s stake in Comstock alone to $134m or $51.80/share. This is as big as free optionality gets. Below is the information that allows us to conclude it is possible.

ii) Value based on potential of Comstock:

For the sake of brevity in what already is a long writeup, we provide two links that give a good history of Comstock and its potential.

February 2011 - Comstock was recently written up on ValueInvestorsClub.com:

http://www.valueinvestorsclub.com/value2/Idea/ViewIdea/43716

October 2010 - Bob Moriarty provides a detailed (bullish) account on Comstock management and his mine visit:

http://www.321gold.com/editorials/moriarty/moriarty102910.html

We think readers would find the above history of Comstock fascinating, but for those who want to get to the gist of the matter: Comstock’s Nevada mine has 1.6 million of gold equivalent ounces. The NI 43-101 technical report conducted by Behre Dolber can be found here:

http://www.comstockmining.com/properties/technical-reports

The above report, however, was compiled in August 2010. The next update of the company's 43-101 is scheduled to be completed in a few weeks and will include 355 new holes, totaling 121,945 feet, drilled since October 2010. This is expected to confirm that Comstock has roughly 2.0 million ounces.

Management is on track with its goal of validating resources (at least measured and indicated) and reserves of 3.25m gold equivalent ounces by 2013. Most of the ounces thus far validated have been done by drilling less than 1,000 feet. Management states that if you drill even farther than that, you have a chance of discovering a great bonanza. Behre Dolber points this out in their August 2010 NI 43-101 report, writing “Exploration opportunities to expand known mineralization....are outstanding and have the potential of doubling the estimated Measured and Indicated Resource.”

3.25 million ounces at $200/oz. puts Comstock’s value at roughly $650 million or $7.22/share. (For Comstock’s shares outstanding, we use the fully diluted count of 90 million.) Given that Intergroup essentially owns 22% of Comstock (20m shares out of 90m), its stake in Comstock could become worth $143m or $55.27/share.

Comstock is almost done with the burdensome red-tape a miner experiences in order to produce in the United States. It has only one permit left to receive–the Air Quality permit from the EPA–and then production can begin. On September 7th, 2011, the EPA granted Comstock its Mercury permit, so this last and final Air Quality permit should be delivered within weeks.

As soon as that is received, everything is set for production to begin at 20k-40k ounces  a year. Cash costs are expected to be $300 to $500/oz. 40k/year production, with $1,800/oz gold and $400/oz costs, would yield $1,400 * 40k = $56m/year. At just a 10x multiple, that would put Comstock’s value at $560m or $6.22. (The current mine equipment can handle production of 100k/year. To get to that production level, it is just a matter of getting additional permits.)

In short, though INTG’s current stake in Comstock is today worth $25.93/share, it has a good possibility of being worth over $50/share.

Unlike Intergroup, whose opaqueness required us to shine a light on it, Comstock provides all the data one needs to judge its value. Therefore, rather than regurgitate all the data here, we provide links to direct sources below. In addition to that, management is very open to calls from investors and/or mine visits. (Their recent annual meeting was a two day event that had thorough presentations by many members of the management team and a full tour of the mining site.) Comstock’s CEO is very detailed and forthcoming with information. The last two conference calls–the September 7th Conference Call Business Update and the 2011 Q2 Conference Call–provide a wealth of data on Comstock.

The latest presentation given by the company can be found here:

http://www.comstockmining.com/files/investor-library/BusinessUpdateCallPresentation_20110907.pdf

Other sources:

http://www.comstockmining.com/investors/investor-library

http://www.comstockmining.com/news/press-releases

http://www.comstockmining.com/corporate/ceo-blog
 

INTG MANAGEMENT

John Winfield, CEO of INTG and also Chairman of Comstock, became involved in Intergroup in the late 1980s. Prior to that time, INTG operated under the name of Mutual Real Estate Investment Trust (M-REIT). In the 1970’s-1980’s, M-REIT suffered because of a challenging economic environment coupled with a heavy debt load. John Winfield stepped in and assumed control of M-REIT in 1984 and eventually renamed it Intergroup. Since that time, Intergroup’s stock price, which at one time traded for pennies, now trades at $25–and that does not count all the dividends.

John Winfield owns 60% of INTG’s stock. (INTG’s management as a total owns 69%.) Winfield has shown good ethics and a knack for capital allocation. He stopped buying real estate right before the bubble–INTG’s last purchase was in 2004. He started buying gold right before everyone else did–started to invest in Comstock in 2004 when gold was around $350/oz. His independent and contrarian thinking has paid off for shareholders, with a 2,500%+ return in INTG’s stock price since he took over.

Winfield also buys back shares. Except for 2009, INTG has repurchased its shares every year. In just the last quarter, INTG repurchased $736k of its shares–a good-size sum given the market cap.
 

CONCLUSION

Though one could argue INTG is worth $35, or $45, or $55, or more, our argument is simpler: INTG is worth substantially more than $25.