Description

MI Development

Summary
Magna International (“Magna”) the world’s 3rd largest auto parts manufacturer (S&P rated A, $7.3 billion market capitalization) recently spun-out MI Development (“MIM” or the “Company”). MIM is comprised of two separate assets (i) approximately $1.1 billion of real estate triple net leased to Magna and Magna related entities and (ii) shares of publicly traded Magna Entertainment (“MECA”) which currently trade at a valuation of almost $280 million. At the current stock price of $26.30 approximately 78% of the Company’s value is in Magna related real estate and 22% is in the shares of MECA. The Company has virtually no debt.

All of the Magna entities are effectively controlled by Frank Stronach and the Stronach Trust (“Stronach”). Stronach owns less than 10% of the stock of MIM but has nearly 100% voting control due to the 500:1 voting ratio on his “B” shares. Wall Street has a love/hate relationship with Stronach. On one hand, he is viewed as a successful entrepreneur who built an industry leading auto parts company from nothing. On the other hand, he has appointed offspring in executive positions, he ahs disproportionate voting control in all his companies, and has invested $800 million of Magna shareholders funds in a horseracing business largely because he likes horses. The spin-off of the MECA shares has been very positively received by the shareholders of MGA.

Real Estate
The Company’s real estate can be further broken down into two separate categories (i) slightly over $1.0 billion of book value in 106 income producing properties and (ii) $117 million of book value in 6 assets currently under development. The majority of these assets are manufacturing facilities with a few R&D facilities and office buildings. The assets are located in Austria (31%), Canada (31%), the U.S. (19%), Germany (8%), and Mexico (8%). Lease expirations are low with a weighted average lease term of 12 years and no material expirations until 2008 (6.5% in that year assuming no extensions). All of this real estate has Magna, or one of its sister companies or subsidiaries, as a sole tenant. Although Magna the parent company itself guarantees only 16.5% of the leases, with most leases recourse only to a subsidiary, it is reasonable to believe that there will not be material defaults under these leases. A summary of significant lease terms is provided in Appendix A.

Note that the properties above were “donated” into MIM at an 11.2% cap rate or $42 p.s.f. Management has indicated that there are approximately 100 additional properties within Magna and its related companies which represent a pipeline for acquisitions at cap rates ranging between 9.5% (for European assets) and 10.5% (for U.S. assets). In addition, the Company has developed $70 million per year of assets on average for Magna during the last couple years when the Company was an internal division of Manga. Given the growth expectations for Magna (10%+) it is reasonable to assume that there will be similar opportunities to continue to develop new plants in the future.

Currently, the Company’s real estate produces a pre-tax unlevered income stream of approximately $105 million and will produce approximately $116 million of unlevered pre-tax income once in-development properties are completed. Backing out the value of the MECA shares at the market price and discounting the in-development properties to 80% of book (for no reason except conservatism) the result is that the income producing real estate is being valued at a 12.0% capitalization rate, 86% of book value, and slightly more than $42 p.s.f. I believe this compares very favorably to other specialty triple net lessors (NNN, CARS, USV, etc) which trade at dividend yields in between 5% and 8% and also compares favorably to traditional real estate equities which are, almost across the board, trading at premiums to NAV and at an weighted average yield of 5.8%. In fact, were MIM to convert to REIT and simply pay-out its current income to shareholders it would be the highest yielding REIT in the SSB REIT Index. An investment in MIM, if MECA could be excluded, would also compare very favorably on a risk return basis to Magna parent bonds and preferreds which trade at yield to worst around 4%.

Magna Entertainment
MECA is the second largest horse-racing business in North America which owns and operates 14 tracks. While I have not included a separate analysis of MECA, this business is arguably far less attractive and certainly less consistent business than the triple net lease business discussed above. MECA has a different management team and is, as much as a Stronach company can be, a separate company. That said, there is an understanding that MIM will be involved with the development of MECA tracks in some unspecified way. In the best case this means that MIM has a “first look” at MECA development opportunities but has no implicit or explicit obligation to use its capital to support MECA The worst case, and the case I would argue is currently “in” the stock price, is that MIM provides an inherent guarantee of capital for any project that MECA wants to pursue and would even buy MECA if there were any risk of it going under. Due to these facts it is difficult to short the MECA out of MIM.

The Best Case Scenario
It is completely plausible for the Company, over the next 2 years, to acquire or develop $500 to $600 million of additional real estate which would be triple net leased to Magna funded by internally generated cash flow and by leveraging the existing stabilized real estate a moderate amount (30% to 40% LTV). If this scenario were to take place (i.e. free cash and proceeds from debt are applied to increasing the triple net lease portfolio with little “leakage” to the horseracing business) the pro forma company may look like the following:

Today Pro Forma
NOI 105,456 157,329
Book Value 1,025,057 1,543,787
Cap Rate 11.99% 10.00%
Debt 8,059 350,000
Cost of Debt N/A 7.0%
Lev. CF Share $2.23 $2.81
Div. Coverage N/A 1.25x
Div. Per Share N/A $2.25
Dividend Rate N/A 7.0%
Stock Price $26.30 $39.97

What the above analysis illustrates is that if proceeds are reinvested at a 10% return in triple net real estate, and not squandered on the horseracing business, you could see significant price appreciation. Note that in this scenario it would be sensible for the Company to adopt a REIT structure and to begin to dividend the majority of its cash flow to shareholders in a tax efficient manner. Given the scenario above, assuming that the Company can raise debt at 7%, the Company could pay a $2.25 dividend yielding 7.0% with 1.25x coverage. Note that this assumes no increase or decrease in the value of the MECA holdings.


The Worst Case Scenario
There are two worst case scenarios (i) the more likely is that cash flow generated by the real estate business as well as cash raised through leverage is squandered on the horseracing business, (ii) the second, but less likely, case is that Magna’s auto business, or one of its subsidiaries, is forced to contract to a point where it does not renew its leases. The second scenario does not seem very likely to me given Magna’s position in the industry, its formidable credit profile, and overall trends towards out sourcing. Therefore, below is more detail on the first and more imminent risk.

It is concerning that MECA has recently announced its intention to build a $100 million paddock and training facility in Florida. While I am not an expert on horseracing, I cannot believe that this is a good use of capital. While it is not clear where the $100 million will come from, it would be disturbing if the financing for this very expensive barn for Stronach horses was funded by MECA and ultimately MIM shareholders. On the other hand, it may be proved out that the relationship between MIM and MECA has some strategic value. For example, should one of MECA’s tracks be allowed to install slot machines it would be completely acceptable for MIM to aid in the build out of a track to support the additional interest which slots bring. Unfortunately, MIM’s management has not made clear how, when, and how much it will be investing in MECA.

Catalyst