Description

JDN is a retail REIT. The company owns about 100 properties and actively develops new properties. The two largest tenants are Wal-Mart and Lowe's which provide about 30% of rental revenue, and about 75% of rental receipts come from national tenants. There is little dispute that the company has among the highest quality properties, evidencecd in part by the high prices it has been receiving in the sale of its properties, with cap rates as as low as 8.5% (cap rate = property cash flow / property cost). The lower the cap rate, the lower the projected return to the purchaser, indicating the property is highly valued. JDN has sold some properties with a cap rate of 8.5% which is at the lowest rate around.

JDN's share price has fallen significantly this year because of a scandal uncovered early in 2000 in which it was found that some managers at its development subsidiary received undisclosed compensation. This caused two problems. First, the fraud put the company into default on bank credit agreements. Second, because contracts signed with Wal-Mart and Lowe's were signed based on inaccurate cost information, there was concern the two companies might challenge their leases and/or development contracts. If funding dried up, especially for the development operations, large losses might be realized.

Ultimately, JDN renegotiated secured debt agreements (at higher interest rates and for shorter terms) and reaffirmed all contracts (leases and development contracts) with Wal-Mart and Lowe's. This allowed the company to proceed with its current development pipeline. Also, the fact that Wal-Mart and Lowe's reaffirmed their deals is a strong indication that the two companies intend to continue working with JDN in the future in developing new properties.

There are two possible scenarios I can envision: 1)JDN resumes it normal operations or 2)JDN sells its assets. In either case, the company seems to be undervalued. I expect a gain of at least 50% from the current level of $11, probably more, within a year or two, with what I perceive to be as very low risk because it is valued on the assumption of current earnings. A summarized valuation for both potential situations follows-

1)Resumes normal operations:
Annual Revenue: $104 million
Operating Costs: 47 million
Income: 57 million
Common Dividend: $1.20/sh
Dividend Yield 11%

(Note: Since REITs own properties which require depreciation under GAAP when in fact the buildings generally rise rather than fall in value, when analyzing REITs it is common to add back building depreciation to net income and subtract instead an amount for regular capital maintenance of the building. The figures above take this into account, and are annualized based on the 6 months through June 30, 2000.)

In 1999, JDN paid a dividend of $1.58 per share. At a current price of $11, that would be a yield of 14%. When the fraud was uncovered, the company slashed its dividend to $1.30 to preserve cash. Eventually, it can be expected the dividend will return to a more normal level. If the dividend returns to $1.58, and the yield falls to a more common 8%, that would imply a share price of $20, in addition to the dividend collected in the interim.

2)Assets are sold:
Assets of roughly $1.3 Billion (figured by adding A, B and C below)
A)Operating Properties--$1 Billion
With operating income of roughly $90 million, found by revenue of $104 million - operating expenses of $14 million (operating expenses include expenses relating specific to the property, and ignore company wide costs) and a cap rate of 9%, the property values come to $1 billion ($90 million / .09) this is what a buyer might pay.
B)Properties In Development--$ 70 Million (book value)
C)Investments In Subsidiary-- 230 Million (book value, primarly of development subsidiary)

Liabilities/Pref Stock of roughly $650 Million (book value of debt and liquidation value of preferred stock)

Liquidation Expenses of $20 Million (a wild, hopefully conservative guess)

Assets - Liabilities = $1.3 Billion - $670 Million = 630 Million, or $19 per share

Catalyst

I began buying shares shortly after the company announced its agreements with Wal-Mart and Lowe's had been reaffirmed, and took it as a sign the company would resume normal operations at some point. I don't see a catalyst here, unless the company's assets are sold. Rather, I see the company continuing strong operations, potentially settling shareholder lawsuits and investors bidding the stock price up as they realize a high, stable dividend is available. I think this is a classic investor overreaction. The fraud uncovered amounted to about $5.5 million over a period of several years, which is not a relatively large amount of money for this company, but knocked over $150 million off common equity market cap.