Description

PGE and PGE Pfd B

Prime Group Realty Trust, aka The Other Prime, is a beleaguered REIT that owns and operates 24 office properties and 30 industrial properties in the Chicago metropolitan area. The company also owns interests in two office properties through JV’s. The office properties are generally divided into CBD (Central Business District) pptys and suburban office pptys. Most of the CBD, and many of the suburban office pptys are top-tier desirable buildings.

As with Prime Realty, another VIC idea, this Prime was run by a Reschke, namely Mike Reschke. As with Prime Retail, Reschke was way too aggressive in expansion and treated the public company like his own. Through his Primestone Group, he controlled 32% of PGE through Operating Units convertible to stock on a 1:1 basis. As with Prime Retail, Reschke borrowed against the units to lever up his budding empire. When he got into a jam on them, he borrowed money from Blackstone, but also gave them the right to put the stock back to him. When they subsequently did, he was forced to go to Vornado (VNO) and borrow $100MM for which he pledged his Primestone ownership of the PGE operating units. Reschke pursued an aggressive risky policy of developing his own real estate for PGE as opposed to buying already-built and occupied buildings. He started construction on Dearborn Center, a magnificent new office building in Chicago’s Loop, but this ultimately caused a liquidity crunch at PGE. With the stock weakening, he pursued “strategic” alternatives. With the stock down to $14, and the loan to VNO looming, he struck a deal with Cadim, the big Quebec pension fund, to have them fund a $14 buyout of PGE, including the repayment of Reschke’s loan to VNO. However, as the deal progressed, Cadim reportedly got cold feet about their new partner and, coupled with the attacks of 9-11, backed out. This left Reschke unable to pay off his VNO loan and VNO began foreclosure proceedings. Additionally, VNO sold a half interest in their loan to Cadim for $52MM. I think they did this because Cadim had a great inside look at PGE and this was VNO’s way of learning what Cadim knew. To make a long story short, Reschke pretty much adopted a scorched earth policy toward PGE, pursuing any and all legal obstacles in a desperate attempt to keep his units. This had an obvious deleterious effect on the stock, culminating in a cascade of selling in early April that drove the stock to $4.

At this point, the Board of Trustees stepped in and removed Reschke and Curto from running the company. I have met and researched the new mgmt of Nardi, Conforti, and Patterson and gotten very positive impressions and feedback. Nardi owns about 2MM shares of common. Conforti owns several hundred thousand in family trusts. One of the other drivers of the sell-off was a “going concern” clause by the company’s auditors, largely due to a $40MM Pfd A issued to what was then Security Capital that was puttable to PGE with 10 days notice. As disincentive to do this, Reschke had to hike the interest rate paid on this Pfd A. One of new managements first actions was to negotiate a handshake standstill with Sec. Cap., and a suspension of all dividends; They just announced that Sec. Cap. has not only rolled over their $40MM pfd but kicked in another $15MM. The cost is fairly steep, but it has enabled the resumption of the Pfd B dividends and arrears. To further alleviate the liquidity crunch, but preserve the essence of the firm, mgmt has been selling off non-core pptys, particularly the lesser suburban office pptys. Closing of one such sale to Blackstone is imminent. Cadim took their 16% of PGE operating units and converted them to stock; VNO has exercised its right to appoint a Board member, and their nominee will be Mike Fascitelli, VNO’s President.

The three likely outcomes here are 1) PGE gags on their financial leverage. I consider this very unlikely, but given the higher likelihood of exogenous events nowadays, cannot be discounted. 2) VNO or some other buyer emerges. (Pricing to be discussed). 3) PGE right-sizes it finances and prospers as an independent REIT with some terrific Chicago area pptys. The range of values I’ve seen for PGE is anywhere from $10-14.50. Pre Reschke and 9-11 values were in the $16-19 range, so I am inclined toward the $13-14 figures. A preemptive bid in the $11 range might be smart, since the more progress PGE makes at stabilizing itself, the more value will be realized. Am hearing that BankOne is interested in buying Dearborn Center, which would certainly remove all the risk from the common, albeit at the cost of one of the crown jewels.

There are two ways to play PGE: the common and the Pfd B. I am rather agnostic between the two. The common has more risk, but greater leverage if an $11-14 buyout or value realization over time occurs. The Pfd B, which has a $25 lq. pref., has a great yield and more protection, but the percentage upside is less. Additionally, an unlikely scenario could occur where a weaker buyer takes out the common at a premium, but substitutes their own “comparable” preferreds for the B’s. I, therefore, own both.

All in all, I think PGE is in that sweet spot where the worst is behind it, positive developments are occurring, but the stock price does not yet reflect either.

Catalyst

1)Replacement of management
2)VNO and Cadim as new large shareholders; VNO's Fascitelli joins Board.
3)Removal of $40MM putable Pfd, and injection of $15MM more;
4)Resumption of Pfd B dividends.
5)Imminent closing of sale of some suburban pptys to Blackstone.
6)Further non-core asset sales to deleverage the firm.
7)Large insider ownership.
8)High likelihood of buyout of entire company.