McIntyre Partnerships' commentary for the third quarter ended September 30, 2024.
Dear Partners,
McIntyre Partnerships Quarterly Returns
Performance and Positioning Review – Q3 2024
Through Q3 2024, McIntyre Partnerships returned approx. 8% gross and 6% net. This compares to the Russell 2000 Value’s return including dividends of 9%. In the winners column, SHC, Stock A, SPHR, CC, OSW, and MDRX contributed 100-500bps. In the losers column, LESL, GTX, and STHO lost 100-500bps.
Our Q3 returns were strong with a 15% gain compared to our benchmark, the Russell 2000 Value, which rallied roughly 10%. However, YTD we are still lagging our index slightly on both a gross and net basis. The largest contributor to our Q3 outperformance was the ~40% rally in SHC, which turned from our largest loser to our largest gainer. In our Q2 letter, I highlighted my thesis arguing that Sterigenics’ volumes were poised to improve. When the company reported Q2 results, Sterigenics volumes accelerated for the first time in four quarters, and the shares reacted favorably. As volumes continue to recover and SHC’s legal issues are resolved, I believe SHC has considerable room to rally, and we maintain a large position.
Beyond SHC, the fund had modest gains in OSW, STHO, and Stock A. I attribute our gains here largely to the overall rally in small cap value stocks as well as strong earnings, particularly at OSW and Stock A. Even in a concentrated portfolio like ours, when the overall market has a strong move in either direction, like the 10% rally in Q3, our portfolio’s beta will be a significant driver of our results. However, that does not negate my job as a stock picker, and I was pleased with the results of our underlying investments even if the overall market rally was the bigger Q3 story. Stock A is the only significant new holding as of Q3 end and I will discuss it once we have built a full position. Subsequent to quarter’s end, we have built a large position in SEG, discussed below. We had no significant losers in the quarter.
Portfolio Review – Exposures and Concentration
At quarter end, our exposures are 102% long, 5% short, and 97% net. Our five largest positions are SHC, GTX, OSW, Stock A, and STHO, and account for roughly 68% of assets.
Portfolio Review – New Positions
Seaport Entertainment Group (NYSEAMERICAN:SEG)
SEG is a recent spinoff from Howard Hughes Holdings (HHH), a developer of real estate and master-planned communities. SEG is what I have previously called a “bad bank” spin, where a company that is otherwise doing well spins off its troubled and/or non-core assets to highlight the value of the remaining parent company. I am generally very interested in bank bad spins, as this type of spin implies that shareholders of the parent company do not want what is being spun, thus we might find indiscriminate selling and a bargain valuation. However, my enthusiasm is highly contingent upon how “bad” these assets truly are.
In the case of SEG, I believe the spin contains one large, troubled asset, the Seaport in Lower Manhattan, that I think is redeemable or at least priced at an excessive discount to a reasonable outcome. In addition, SEG contains a handful of non-core yet marketable assets and a lot of cash. At present, I believe SEG’s cash and other assets are worth more than its current market cap, thus unless the Seaport turnaround eats considerably into the value of these assets, we should expect to do quite well on our investment over time. For perspective, I estimate SEG has cash per share of $16 and other assets of $25/sh., which compares to the current SEG price of $28. While the Seaport development has thus far been a failure, I estimate its construction costs were over $70/sh., implying significant upside potential if the new management team has even modest success.
Before walking through SEG’s assets, I want to flesh out the spin dynamics to explain why I think we have been able to buy shares at a large discount to fair value. SEG was spun with a nine-to-one ratio. At the time, HHH was valued at $70 and SEG was trading at $25, so the spinoff represented less than 5% of the overall value of existing shareholders’ investment. I believe many HHH investors sold their SEG shares due to sloth, lack of mandate to own lower market cap companies, and a dislike of the Seaport investment after years of issues. Further, after the spin, SEG commenced a rights offering whereby for every one share already owned, SEG shareholders could buy an additional 1.25 shares of SEG at a $25 price. I believe the rights offering had a four-fold effect. First, it made holding onto the shares even less compelling for existing HHH shareholders. Second, the rights offering pinned SEG’s price around $25 until it was completed, a typical dynamic seen in large rights offerings. Third, the rights offering limited SEG management’s ability to discuss their business plans, limiting new investor interest. Finally, both HHH and SEG have a large shareholder, Bill Ackman’s Pershing Square fund, who agreed to backstop the SEG rights offering. As Pershing Square already owns ~40% of each company, had the fund completely backstopped the rights offering, they would have owned almost 75% of the company. I do not know Ackman, and I will not pontificate on his motives. What I will say is that if McIntyre Partnerships ever agrees to backstop a rights offering and essentially take a company private, you can be sure I will demand a significant discount to take that risk. I believe a similar dynamic played out here.
Regarding SEG’s assets, I divide them into cash, other assets, and the Seaport. SEG has roughly $200MM in cash and 12.5MM shares outstanding, yielding $16/sh. at the hold co level. While there are two small pieces of non-recourse debt and some cash will be spent repositioning the Seaport, unless management’s capital allocation is atrocious, I believe unencumbered cash representing over 50% of the market cap provides strong downside support.
Regarding the other assets, the largest ones are a Las Vegas minor league baseball team and its stadium, air rights to build a casino in Las Vegas, and the 250 Water Street property in New York City. The baseball team and property were acquired for roughly $10/sh., net of debt, and are operating well. The air rights are difficult to value, but they sit on top of roughly 60 acres of prime Las Vegas Strip real estate, where recent land transactions have taken place in the $30-$50MM per acre range. As a rule of thumb, air rights are worth about a third of the overall land value, thus one could argue the LV air rights are worth $40-$65/sh., net of the 20% owned by their JV partner. However, there is no guarantee development will take place, and I value them at $4/sh. for conservatism. 250 Water Street is located adjacent to the Seaport, has sunk development costs of ~$240MM, and has been zoned to build a ~550,000 square foot building, implying costs of $440 PSF. While the Seaport has been underwhelming relative to original expectations, in a Manhattan real estate development, land costs typically range between $250-$400 PSF, and the 250 Water Street property is significantly further along in its entitlement process than most land deals. I conservatively value it at $300 PSF, or $8/sh. net of debt. SEG also has a handful of smaller JVs and assets that I value at $3/sh.
Regarding the Seaport, there are several different assets, but the primary driver of value are several newly constructed buildings with a combined ~500,000 SF of rentable space. A full examination of the Seaport's troubles is beyond the scope of this letter, but suffice to say, execution has not been as envisioned when HHH sank close to $1B into these assets. Significant space remains unleased, and the properties are losing a modest amount of money at present. With negative cash flow and a bad track record, I am sympathetic to the previous HHH shareholders who sold and said “good riddance” upon the spin. However, there is a price for almost anything, and I believe we are buying at an unrealistically low valuation. First, I believe the cash burn concerns are real but exaggerated, and I do not anticipate SEG generating significant losses beyond tenant improvement expenses. As is the case with most spinoffs, GAAP accounting of SEG’s historical operations is not necessarily reflective of the company’s post-spin expenses, something management was restricted from fully explaining during the rights offering period. As the space is only approximately 60% leased, I am not surprised by a modest cash burn. Once leasing is completed, I believe the asset will be solidly cash flow positive, which I expect to occur in the next two years. Second, I estimate the replacement cost for these assets at $1,000 PSF at a minimum, and likely closer to $1,300, yielding $40-$50/sh. While replacement costs are not necessarily indicative of current value, I believe Lower Manhattan will remain a growing destination and I expect the cost to develop and the Seaport’s rent PSF to converge over time. Finally, there is an active rental market in the area that provides comparable transactions for what the full lease out of the Seaport will look like. On the low end, old Class B office space in the area rents for $40 PSF. In a more optimistic scenario, street-level retail rents in Lower Manhattan average $200-$300 PSF, Manhattan restaurant rents average $150-$400 PSF, and new office space across the river in Brooklyn currently rents for $70-$90 PSF. Further, several Seaport assets are already fully leased at rents over $100 PSF. I conservatively estimate the Seaport will achieve rents of $75 PSF net of overhead, which yields $40MM in NOI. A 6% cap rate would yield $50/sh. in value.
Adding it all up and then applying a modest hold co discount, I believe a conservative price target for SEG is $70/sh., with significant catalysts from management providing clarity and the lease out of the Seaport. If the new management team successfully turns around the Seaport, I believe a significantly higher price is possible over time.
As always, please feel free to contact me with any questions.
Sincerely,
Chris McIntyre
McIntyre Partnerships
