Description

Okay, who wants to buy some automotive factories with some hair on them?  Scratch that, A LOT of hair on them.  The company is selling at the very low price of negative $7.50/share!!!  Or at least,  pretty darn close to it!  It’s a long and complex story, but the value is real and there may not be much if any downside (I know, famous last words).

History and Description:
MI Developments (NYSE: MIM) is a 5-year old real estate spin-off from Magna International, (NYSE: MGA) the largest diversified auto parts and vehicle assembly & engineering outsource services provider.  The founder and controlling shareholder of Magna International (via super voting shares), Frank Stronach, decided to pursue his love of the competitive equestrian arts by investing shareholder capital into a horse-racing venture dubbed Magna Entertainment (NYSE: MECA).  Due to poor performance and lack of relevance to auto parts, MGA shareholders pushed Frank to divest the enterprise.   MGA accomplished the separation of both the real estate business (MIM) and the horse racing business (MECA), by placing their 60% interest in MECA onto the balance sheet of MIM, then distributing MIM to their shareholders.  The sole purpose of MIM, in Frank’s own words, is ‘to build factories for Magna International.’  And, naturally, manage this ‘strategic’ investment in the horse racing business.  Frank’s controlling position in MGA carried over to the spun out MIM and MECA.  As such, Frank remains in charge of his stable of companies as a control group.

Just to reit the final structure: the buildings and lots are owned by MIM, and leased to MGA under long-term triple net leases (3N) at fixed rents with annual 2% escalations.  The trouble began when the ‘strategic holding’ (MECA) needed to be recapitalized as early as 2004.  Rather than send the horses to the glue factory, Frank decided to use MIM’s unlevered and stable rental income to subsidize the operating losses and over-indebtedness of MECA. The first proposal was to buy-in the 40% MIM didn’t own in a tender offer.  Shareholders of MIM freaked out, as promises were made at the time of the spin off that MIM would not be used as a backstop for MECA.  It should also be clear that the class of shareholder interested in a stable, tax favored rental income is not the same class of stock holder who is interest in a debt-laded failing horse racing business. MECA was essentially a speculation that a debt-laden, troubled racetrack operator, would successfully lobby the various States for slot-machine gaming licenses, thus converting to ‘racinos’ to save the ailing horse racing industry.   Thankfully, cooler heads prevailed and the deal was called off.  Instead, MIM used its high quality balance sheet to prop up MECA by extending a series of loans against the dodgy collateral of the poorly run speculative firm (similar to THE FED).

MECA’s Failed Debt Elimination Plan:
Last year, MECA announced a ‘Debt-Elimination’ plan, in which it would sell-off ‘non-core’ assets and land to pay off its debt, after which some plan would be put in place to separate the 2 firms.  To show his commitment to plan, Frank purchased a $20 mil follow-on from MECA thru his investment vehicle aptly named “Fair Enterprises Limited”.  Not surprisingly MECA is failing to execute adequate assets sales, which is being exacerbated by the one-two punch of a sharp consumer slowdown and dead credit markets.  MECA has failed to liquidate all that many properties, and what they did sell was either land sold to MIM directly for ‘future development,’ or upon sale the proceeds were subsequently re-borrowed from MIM to keep the firm from filing BK.  MECA is now $300 mil in hock to MIM and the operating losses continue to mount the horses.

Activism and Negotiation:
There are two activist shareholders involved in this situation:  Farallon and Greenlight (who has filed several shareholder oppression lawsuits against MIM which have been dismissed).
In March of 2008, Frank and the board announced a new plan.   This time they would attempt finally separate the two businesses, but for a price.  Under the reorg proposal, as a MIM shareholder this is what you will receive:

A new company: “Rental Co” will be established that will effectively buy MIM common shares for $15.50/share cash money and an 80% residual stake in Rental Co.  I’d like to now point out that MIM is trading for $8/share.  Franks 10% super-voting shares of MIM will become common in Rental Co, and MGA (the tenant) will also take a 10% stake in Rental Co in exchange for a credit guarantee on the $1 bil of debt used to finance the purchase.  Rental Co. will continue to own the rental properties but it will be ‘absolved’ of a bunch of stuff to a partnership, 51% controlled by Frank 49% owned by Rental Co shareholders as a due bill.

Specifically MIM will:

1)    Transfer certain assets to a new partnership 51% owned and controlled by Frank (49% owned my by RentalCo) including:
a.    The $300 mil of obligations MECA owes to MIM (which is probably worth a fraction of face)
b.    $150 mil of cash (which last I checked is worth $150 mil)
2)    Purchase “Credit Insurance” from their sole tenant Magna International (MGA) for the ‘cheap’ price of 10% of Rentla Co.
a.    The Credit Insurance will be a 5 year guarantee for a $1 biil loan from some bank, all due as a bullet maturity
3)    Most importantly Rental Co. shall allow MGA to appoint a majority of her directors, which if you recall is controlled by Frank (surprise).

Important points about the terms of this deal:
This is an absurd deal for MIM to exchange her current 100% ownership of $150 mil in cash and $300 of debts owed by MECA for… 49% interest in the same.  And almost as absurd, Rental Co., which will rely on the credit of its sole tenant MGA to pay its rents, will buy credit insurance from MGA in exchange for 10% ownership of Rental Co. AND BOARD CONTROL. Surely the patients are running the asylum!

But did I fail to mention that MIM is trading for $8/share, and if the deal goes ahead you get paid $15.50/share of cash money and 80% of the shares in a screwed up REIT you can use to wall paper your bathroom?

A Minor Incident:
Subsequent to this deal being proposed back in March, Greenlight and Farallon have filed some 13-D protesting the fairness of this deal.  But then in October, there was this Minor incident.

Halsey Minor, founder of CNET, sent the board special committee of MIM an offer letter, which was ignored, and so he put out a press release:

Halsey Minor today sent a letter to the Special Committee of the Board of Directors of MI Developments (TSX: MIM.A; MIM.B) asking the Board to consider his proposal to acquire the existing intercompany loans made by MI Developments and certain of its affiliates to Magna Entertainment Corp. (NASDAQ: MECA - News; TSX: MEC.A - News).

Mr. Minor first made the offer privately to the Special Committee on October 2, 2008 but has yet to receive a response, necessitating the need to make the offer public so it could receive full consideration from the company’s shareholders.

Commentating on the proposal, Mr. Minor said: “While it is unfortunate that we have to take the unnecessary step of making our proposal public, we believe that MI Developments’ shareholders deserve to know about the opportunity to relieve the company of what has become an increasingly burdensome debt obligation. Magna Entertainment owns some of the world’s premier racetracks, but many of them have fallen into disrepair and are in desperate need of capital to both improve the facilities and attract fans back to the industry. I have long had a passion for the horse racing industry, and believe strongly that this storied, exciting sport can be revitalized. I want to help rebuild this industry, and initiating discussions with MI Developments to explore ways we can solve Magna Entertainment’s liquidity problem and help provide a better strategic direction to these under-capitalized properties is a winning proposition for MI Developments and the horse racing industry overall. I look forward to a response from MI Developments’ Special Committee.”

The full release can be read here: http://www.citybizlist.com/lstg/lstgDetail.aspx?id=41390

In short Mr. Minor is proposing to buy out the MECA loans owed to MIM and use the debt position to foreclose on MECA and then see if he can make a horse race of this horse racing company…  MIM responded (or failed to) by ignoring the letter.  A bunch of directors resigned and were replaced by cronies of Frank as explained by Greenlight’s recent 13-D.

Ok, it should now be clear:  Frank controls MIM.  Frank loves horses. Frank will keep using MIM’s cash flow to continue to subsidize his horse hobby.  Did I mention that MIM is trading for $8/share?  

Lando Calrissian and Darth Vader:
Since March, the credit markets have sunk further into the abyss and MECA continues to run afoul.  While MGA is still rated AA, cash flow positive despite the auto downturn, and has $2 bil+ of cash with little debt, a new $1 bil facility for Rental Co. might not be so easy to swing.   The facility would be secured by $1.7 bil gross book value of occupied industrial and some office space, along with the MGA credit guarantee and aligned 10% equity interest.  As a result, its possible that Frank may just decides to merge MECA into MIM.  (keep in mind they tried this in 2004).  Thus we may just witness a replay of that scene from Star Wars where Darth Vader changes the deal on Lando Calrissian and then instructs him to, “pray I don’t change it again.”

Valuation:
Thus, in order to figure out what price MIM should trade at, lets play bookie by valuing the various potential outcomes and then handicap the horse race between them.

Some Data Points on MIM:

MIM Assets:
Properties:
-105 properties, 98% leased on 3N terms to MGA, Gross Book Value of ~1.7 bil
-$150 mil USD equiv in net annual rents (41% Euro, 30% CAD, 29% USD)
-90% of leases expiring after 2013, average duration 8 years (excluding renewal options)
    Land:
        -$225 mil (2002 cost) of undeveloped land, mostly industrial/residential zoned
            -$30 of it purchased from MECA at “market value”
        -Easily worth $100 mil even today…
    Notes:
-$300 mil of project notes and senior receivables from MECA (not worth much)
    Cash Money:
        -$170 mil

Liabilities:
    -250 mil Senior Notes
    -Future Business dealings with MECA
    -Auto slowdown and big 3 restructuring could affect as much as 25% of MGA’s capacity

Base Case Valuation: DCF Assumptions:
    -15% firm discount rate (note that MGA is an investment grade tenant)
    -MGA closes 25% of their factories when the leases lapse, of which:
        -15% are worth 1/3 gross book (27% gross cap on current lease terms)
        -10% are located in Michigan and are worthless
    -renews 75% of leases indefinitely on same terms
    -$225 mil of land + $170 mil in cash cover the $250 mil of Senior Debt
    -Loans to MECA are worthless

Using the above, I get to a valuation of approximately $19/share.

Lando Calrissian Deal Valuation (same as base case, except):

    -Darth Vader Merges MECA and MIM
    -MECA burns $50mil/year of cash flow into perpetuity (Note: Frank is 76 and can’t live forever.)
    -There are no tax savings on the losses

The MECA losses into perpetuity cost $330 mil or ~$7/share for a valuation of $12/share for MIM.  Did I mention that MIM is trading for $8/share?

For a look at my excel model please visit: http://www.geocities.com/doobadoo1/MIM.xls

Handicapping:
So in either scenario we come to a share price much that $8.   In all fairness it is entirely possible that if merged, Frank finds a way to destroy more than $350 mil of shareholder value.  But in all cases MIM is able to continue the $.60/share dividend, so if she drops another $2/share you will still be paid a relatively stable 10% yield.  I think its more than likely the activist shareholders come to some kind of resolution that results in a much higher share price.

Catalysts:
Successful completion of a transaction to separate the two enterprises resulting in some kind of dividend much greater than the current share price, possibly $15/share.

Catalyst

Catalysts:
Successful completion of a transaction to separate the two enterprises resulting in some kind of dividend much greater than the current share price, possibly $15/share.