Description

Maxxam Inc. is an asset rich holding company whose structure and history are as complicated as its shares are cheap. Maxxam, whose shares currently trade for $8.20, has an asset value of approximately $34 per share, conservatively calculated.

Alli718 did a great job of writing up this idea last February, so my note will serve to update recent developments and to identify potential catalysts.

Maxxam has a controversial and litigation prone CEO, Charles Hurwitz -- who controls 73.8% of the vote via common and preferred shares -- and a complicated holding company structure with subsidiaries in the real estate development, forest products, and racing industries. Each of Maxxam's subsidiaries is funded with debt that is non-recourse to the parent company.

Maxxam also owns 62% of an aluminum producer, Kaiser Aluminum Corporation, which was deconsolidated from Maxxam in 2002 when Kaiser filed for Chapter 11. Maxxam has no obligations with respect to its Kaiser holdings in the ongoing bankruptcy proceedings. I have assumed Maxxam’s Kaiser position has no value.

Recent developments:

In October 2002, Maxxam and Hurwitz settled a formal administrative proceeding brought by the Office of Thrift Supervision by paying a small fine and neither admitting nor denying the charges. The OTS proceeding stemmed from a failed S&L subsidiary, United Savings Association of Texas. This settlement removed one of the uncertainties surrounding the Company, since the OTS was seeking $820 mm in damages from the Company and Hurwitz. While the FDIC still has a pending civil action against Maxxam and Hurwitz stemming from the USAT failure, I expect that the FDIC case will also be settled or dismissed without adversely impacting Maxxam. The Company has even announced that it is pursuing reimbursement by the FDIC for its legal expenses in the USAT litigation, but in any case, this six-year old proceeding appears not to be an ongoing liability for Maxxam.

At September 30, 2002, Maxxam had outstanding $43.2 mm of 12% MGHI Notes due 2003, the only debt at the holding company level. The Company had already repurchased most of the issue in the open market at a discount to par through September 30, 2002. Subsequent to Q3, the Company fully retired the MGHI Notes by purchasing in the open market $11.6 million of the Notes at a slight discount to par, and redeeming the remaining $31.6 mm via a call option at par. For simplicity, I have assumed that Maxxam's open market purchases of $11.6 mm between September 30 and the announcement of the MGHI redemption in mid-November were completed at par.

Valuation:

- Total shares outstanding (common and preferred): 7.2 mm
- Current share price: $8.20
- Market value of equity: $59.0 mm
- Unrestricted cash: $146.0 mm ($189.2 mm of unrestricted cash at September 30, 2002, less $43.2 mm spent to repurchase the MGHI Notes)
- Real estate at book value net of all segment debt: $98.5 mm
- Forest product assets: $0
- Racing assets: $0
- Total asset value: $244.5 mm
- Total per share asset value: $ 33.96

Of the $146.0 mm of unrestricted cash, $71.8 mm resides at the parent level and $74.2 mm is split among Maxxam's three subsidiaries: $58.5 mm is at the timber segment, $7.8 is at the real estate segment and $7.9 mm is at the racing segment. All of the $74.2 mm of cash that resides at the subsidiary level is unrestricted and hence, "upstreamable" to the parent.

Maxxam invests in and develops residential and commercial real estate in Arizona, Puerto Rico, California, Texas and New Mexico. As of December 31, 2001, the Company carried real estate with a book value of $278.7 mm and real estate segment debt of $180.2 mm, resulting in $98.5 mm of real estate equity value. Maxxam's book value of real estate net of all segment debt is a fairly conservative valuation benchmark -- Maxxam purchased and began developing the Fountain Hills, Arizona project in 1968 and the Company acquired the Rancho Mirage, California project in 1991.

The Company conducts its forest products operations principally through Pacific Lumber, which owns and manages approximately 218,000 acres of commercial timberlands in northern California. Although Maxxam has struggled with environmental litigation and depressed lumber prices, the Company's timberlands are principally redwood and Douglas-fir -- both high quality species. At a conservative valuation of $4,000 - $5,000 per acre, less $708 mm of net debt, the Company's timber assets could be worth between $164 mm and $382 mm, or $23 to $53 per Maxxam share. But given the significant leverage at the timber segment, I have assumed the timber assets are worth nothing to reflect the financial risk.

Maxxam owns and operates a horse racing facility in Houston, TX, and a greyhound racing facility in Harlingen, TX. The Company's racing operations generated $.2 mm of operating income on $23 mm of revenues in the nine months ended September 30, 2002. I have assumed that the racing assets have no value given their small size relative to Maxxam's other segments.

Assuming Maxxam's real estate operations are worth book value net of all segment debt, placing no value on the Company's timber and racing operations, and adding the unrestricted cash at the parent and subsidiary levels, one can purchase $34 of per share assets for $8.20.

Risks:

- Management could allocate Maxxam's assets uneconomically. For example, at September 30, 2002 Maxxam had $26.1 mm of its unrestricted cash parked in several limited partnerships which invest in diversified portfolios of common stocks. Is this a prudent use of shareholder capital? But paying $.24 on the dollar provides a reasonable margin of safety for all but the worst of management capital allocation mistakes.
- Hurwitz, who is 62, may not care about the trading price of Maxxam shares and will not take advantage of Maxxam's balance sheet liquidity to buy back shares. The Company has, however, bought back shares in the past, and repurchased its debt in the open market at a discount.
- Hurwitz could wait for Maxxam shares to continue to drift lower and make a bid for the Company using its own assets to finance a low-ball takeover. Hurwitz has been involved in enough controversy in the past that an inadequate bid would attract attention and potentially more litigation.
- The shares are very illiquid given the current market value of equity and Hurwitz's 44.9% common position.

Catalyst

Potential share buybacks since the bulk of the OTS and FDIC litigation has been resolved, and there is excess liquidity at the parent level.