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Real Estate Inv. Trusts: REITs
Maguire Properties (MPG)

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By 782gear
February 3, 2005

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Maguire Properties (MPG) announced last week that it is purchasing a 5 million SF portfolio of 10 properties, primarily in Southern California, but also in Phoenix, Denver, an Austin, along with 4 adjacent development parcels from a CalPERS partnership, Commonwealth Partners for a purchase price of $1.5 billion. I listened in on the conference call and have digested a few reports on the transaction.

Like a drunk caught in the crosswalk, I remain baffled by the traffic and the reactions of the drivers in this transaction. Both sides have appropriate arguments.

On one side, you have a major player in the Southern California markets purchasing some properties that provide an excellent fit to their current business plan. MPG is one of the obvious choices to own and manage these assets. Other REIT bidders were Arden (ARI), Equity Office (EOP), and Trizac (TRZ). The market, anticipating such an event, has sold the stock down from $28 to around $24, apparently assuming they would have to overpay to play. I think it safe to say the auction process pretty much assures MPG at best got an NAV neutral transaction.

The traffic going in the other direction is looking at all the debt (100%) MPG is putting on the right side of the balance sheet, basically a slightly over burdened balance sheet (59% debt) is growing to 72%. The Fixed charge coverage ratio is declining from 2+ to, according to the company, 1.6.

The company, however, announces it intends to raise equity in the form of JVs over the course of 2005 to get the balance sheet back in order. It also intends to sell off the Phoenix, Denver, and Austin properties, where it has no other properties and to concentrate on the Southern California properties, expanding its Orange County and LA portfolios and initiating a presence in San Diego with three major properties totaling roughly 800,000 SF.

But, its detractors say, "With 72% debt and a fixed charge coverage ratio of 1.6, MPG needs equity worse than its potential JV partners need MPG's properties and, to mark the point, the potential equity partners are not in the bidding war that MPG found itself winning (?).

If MPG is not able to get in tomorrow's market what they paid for Commonwealth's properties in today's market, getting the balance sheet back to a reasonable, say 50%, number is likely to come at a cost to MPG's shareholders. Raising equity in the stock market may also cost MPG's shareholders since the cost of equity capital is presumably higher than the debt being retired by the stock offering. By the way, there was no talk of going to the stock market for more equity. Yet, depending on the cost of the debt, particularly the bridge loan provided by CSFB, MPG's financial advisor on the transaction, which was not offered on the conference call, that may be an alternative if the other methods outlined on the call do not work out, mainly a wish list of several property sales and potential JVs.

MPG's management points out the transaction makes obvious sense for the long term, providing a portfolio of Class A, particularly the La Jolla, LA, and Costa Mesa addresses, office properties in its primary market, where it views itself as a local sharpshooter. MPG obviously sees value where Commonwealth and the losing bidders did not.

Gear's view, the drunk in the crosswalk:

When MPG came public in 2003, it was able to refinance most all of its debt at very attractive rates, making the relatively high 59% of debt still easily manageable. This transaction puts MPG's debt load and cost of debt, at least in the short run, over the reasonable limit. Solving that problem requires outside, third party providers of equity capital. Internally, only property sales and stock issuance can solve the problem. Granted, MPG has many institutional quality properties; but it is unknown what institutional providers of capital will extract from MPG's shareholders.

Since coming public, MPG has come close but has not yet covered its dividend with AFFO. I'm not sure that distributing equity in excess of AFFO makes sense any longer. At a sub 6% (?) cap rate the new properties, with debt service likely to exceed the cap rate, could further contribute to the problem. It would have been nice for MPG to have grown into its dividend before swinging for the fences. If BXP, with its record of acquisitions, maintaining debt coverage, and payout ratios, had announced this acquisition, I wouldn't worry as much. But, in my opinion, MPG has not yet earned its wings in the public markets. A few more years of straight and level flight would have been preferable before trying to take its shareholders through wingovers, barrel rolls, and loops.

With properties that are clearly blue chip, it would have been preferable in my opinion for MPG to have moved its management team toward blue chip status as well. When the value of its stock fell below MPG's estimated value of its assets, one of the Jim Sullivans on the call, asked why management didn't take that opportunity to purchase some of their own shares. Yeah, why not?

One final thought and I'll await your brickbats:

If a company's estimated NAV is $24+/- and its stock price is also $24 at 59% leverage, I feel confident in saying that an NAV neutral transaction that also increases leverage to 72% makes owning that stock a bit more risky than the day before the transaction. All business plans, workout plans, wish lists, hopes, and dreams can have little effect on too much current debt.

Your comments, critiques, editing, ridicule, and opinions are very much welcomed.

Best Regards,
Gear


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