Tejon Ranch Co. (TRC) is a real estate company whose main asset is 270,000 acres of contiguous, mostly undeveloped land 60 miles north of Los Angeles. TRC's cash flows are currently negative, and they will not turn meaningfully positive in the near future. This is not your usual cash-throwing VIC value idea, but then neither is gold and renowned value gurus are buying into it these days. We believe TRC allows investors to buy good property 30% below real estate market prices.
TRC's current revenues are derived from royalties, leases, and farming within its lands. However, the company's value mostly resides in undeveloped land that the company has only recently started to develop. The entitlement and development process has historically been bogged down by litigation with environmental groups and a slow permitting process.
A major breakthrough for TRC took place in May 2008, when the company reached a Conservation Agreement with five major environmental groups (including the Sierra Club) that permanently preserved 178,000 acres out of the total 270,000 that TRC owns. In exchange, the environmental groups agree not to litigate against development in 30,000 acres.
The 30,000 acres comprise the tracts where the company has planned 3 major developments (Tejon Industrial Park - "TIC", Tejon Mountain Village - "TMV", and Centennial). While any development within the 30,000 acres still has to go through standard environmental and administrative permitting (and potential litigation from environmental groups non-party to the Agreement), the Agreement succeeded in persuading local authorities to grant permitting in these areas. TIC is already under development, and TMV was granted entitlement approval by Kern County in Oct 2009 and should start development in 2011. The company completed a rights offering in June at $23/share in which it raised $60mm to fund development of the projects.
The Conservation Agreement also granted the environmental groups the option to purchase the development rights to the remaining 62,000 acres at a "fair market value" price appraised by the State of California. This option expires at the end of 2011. While we have no news of negotiations taking place yet regarding exercise of the option, we believe this clause constitutes a major potential catalyst, either in the way of a substantial cash inflow if the option is exercised (hard catalyst) or by way of the 62,000 acres reverting to TRC for full or partial development (softer catalyst).
We value TRC's land holdings by sum-of-the parts. We assess no value to the 178,000 acres preserved in the Conservation Agreement. We value each acre within the 30,000 acre developable area at $10,000-12,000/acre, based on current market value in the Bakersfield area. The trickiest tract to value is the 62,000 acres subject to the purchase option by the environmental groups. Note that if the options are not exercised before the end of 2011, TRC and the Groups ambiguously commit to "meet and confer to discuss alternatives for purchasing conservation easements covering these areas". We value these acres at $3,000-5,000/acre, which would imply that 36% of the 62,000 acres would eventually be deemed developable.
178,000 preserved acres @ $0/acre = $0
30,000 acres @ $11,000/acre = $330mm
62,000 acres @ $4,000/acre = $248mm
Total 270,000 acres land value = $578mm
Current TRC EV: $405mm (20.2mm diluted shares out.)
Based on our valuation above, TRC should be worth $30/share, vs $21.77 today (39% upside).
While the value of the 62,000 acres under option is uncertain, we are encouraged by the fact that 81% of TRC's enterprise value is derived from the 30,000 developable acres. As a consequence, all of the upside for TRC depends on what value we assign to its 62,000 acres under option. Given that we only need to rely on a $1,200/acre value for each of those 62,000 acres to justify the current $21.77/share valuation, we are confident that there is ample margin of safety and plenty of upside to the stock.
An obvious concern for a company like TRC is the potential for mismanagement of the property and/or unwise investment of cash. We feel comfortable with the company's cost structure, and like the fact that Third Avenue owns 26% of the company and holds a Board seat.
The key risk to the story is obviously further weakness in the CA real estate market. We are not oblivious to the dire state of this market (residential and commercial), and we don't necessarily believe it will recover anytime soon. However, we believe TRC offers a meaningful margin of safety given the implied discount to the value of its land holdings.