Tuesday 9 March 2010

Running on empty, how bad are things in the Glazer empire?

[Breaking news: Someone has kindly pointed out that one of the Glazers' shopping centers went into foreclosure in February.  Details here.]

Isn’t it strange that the “billionaire” Glazer family have never paid down a penny of the spiralling Payment In Kind (“PIK”) loans that David Gill tells us are the “family’s responsibility”? Even if the successfully concluded bond issue now allows the PIKs to be repaid from Manchester United’s cash flow, it would still make financial sense to pay them down themselves and then pocket United’s dividends. A loan that is increasing by a compound rate of 14.25% pa (soon to rise to 16.25%) is some of the most expensive financing imaginable. You would always pay it down if you could.

What could be going on inside the Glazer empire that has prevented them from doing so?

Now I don’t intend to embarrass myself by commentating on NFL matters, a subject about which I know virtually nothing, but a quick trawl through the US media and various fans’ sites suggest that despite an appalling 2009 season (winning 3 and losing 13, the worse season for the Bucs since 1991), the Glazers are in no mood to spend money on their team. It is often suggested that the Buccaneers were operating $30m below the salary cap last season (an NFL record) and there has so far been little activity during the “free agent” process that started a few days ago. Inevitably, Bucs fans and the local media have questioned whether all is well with owners financially. Attendances were down over 10% last season and season ticket prices have been cut aggressively (we wish).

It is worth remembering that the Glazers’ purchase of United was met with some surprise in Florida. Whilst rich, the family did not appear to have the sort of means required to finance such a large purchase. Indeed, even the publically declared equity element (£272m or $495m at the time) was so large that one local paper (the St Petersburg Times) suggested the family would need to make asset sales to raise the money.  During the run up to the family’s bid for United, there were very strong market rumours that at least some of the £272m “equity” had itself been borrowed.  I have it on very good authority that Commerzbank lent the family £100m+ to buy United shares on the market.  Whatever the truth of the matter, such loans were definitely repaid immediately before the bid, because otherwise the family would not have been able to issue the original “prefs” (the precursors to the PIKs) secured on their equity in the club.  It is my strong suspicion (although I should stress it is speculation) that the family’s property business, First Allied Corporation, repaid the Commerzbank loan using debt raised against its US property interests.  First Allied was a party to the pref agreements with the three original hedge funds, suggesting it was involved in the initial financing of the bid.

Sadly for curious observers like me, there is very little public information on the “intensely private” Glazer family. Their ownership of United and the Tampa Bay Buccaneers couldn’t be more high profile of course, but any other details of their business affairs remain very hard to find. The 2005 Offer Document and the 2006 Refinancing Investment Memorandum both name two major business owned by the family in addition to United and the Buccaneers, these were Zapata Corporation (listed on the New York Stock Exchange) and First Allied Corporation (their private US real estate business).

Selling: Zapata Corporation
The Glazers took a majority stake in Zapata in 1992 (the business had been founded by George H Bush in 1966 as an oil drilling contractor). The Glazers used Zapata as a vehicle for various ventures in the 1990s, including abortive attempts to become a dotcom business during the internet boom (Zapata launched an unsuccessful hostile bid for excite.com). By the time of the acquisition of United, Zapata’s main investments were a 77.5% stake in air bag fabric manufacturer Safety Components International and a 58.1% stake in Omega Protein Corporation, a business producing fish oil and fish meal from the Menhaden fish found off the eastern seaboard of the United States. Having attempted to take full control of Safety Components in 2003 and 2004, Zapata sold its stake in the business in September 2005 to private equity investor Wilbur Ross for $51.2m. The disposal of the stake in Safety Components was followed swiftly by an exit from Omega Protein Corporation, in a series of transactions in 2006. At this point, it appeared that Zapata intended to reinvest its c. $160m cash pile in other businesses. The credit crunch seems to have put pay to this plan, and in June 2009, SEC fillings showed that the Glazers had sold their 51% stake in Zapata (which was by this stage effectively a cash shell) to veteran investor Philip Falcone for $74m (£46m).

Selling: La Bellucia
Zapata Corporation wasn’t the only asset the Glazer family cashed in during 2009. In 2000, one of the Glazers’ companies, First Allied Jacksonville Corporation paid $14m for the historic Palm beach mansion La Bellucia (“Beautiful Lucy”) designed by Addison Mizner and built in 1920 (see photo). Despite its historic status, the Glazer family initially sought planning permission to demolish the property (such respecters of tradition). When this was turned down, a refurbishment was apparently planned, but then in late 2009, the property suddenly went on the market for $27.5m and was sold swiftly to Jeff Greene (a man who made a fortune betting the against sub-prime mortgages) for a very reasonable $24m.

So within six months, the Glazers raised almost a $100m (before tax). We know they didn’t use any of the proceeds to pay down the PIKs, and indeed we also know that in December 2008, the Glazers felt it necessary to borrow £10m ($16m) from Manchester United. These loans were on top of £10m paid since the takeover in “management and administration fees”, and a £2.9m “consultancy agreement” between United and a Glazer company signed in June 2009. The sudden rush for cash by the Glazers in 2009 suggests that things were not going well at the heart of the family business, First Allied Corporation.

Voids and debt: First Allied Corporation
Unlike in the UK, a private US company like First Allied does not have to file any public accounts. Sadly, there is no US equivalent of Companies House. The company’s website does however allow us to look at what assets it owns. The company say it “specializes in the ownership, management and leasing of over 6,700,000 square feet of community and neighborhood shopping centers located throughout the United States.” This 6.7m sq ft doesn’t tally with the list of properties on the company’s website (perhaps there have been disposals), the properties listed total, by my calculation, 5.27m square feet.   This makes First Allied a medium sized player in the shopping center market in the US.  Thankfully, most of First Allied’s peers are quoted companies and this allows us to draw some tentative conclusions about the state of the business.

Looking at the company’s quoted peer group of shopping center Real Estate Investment Trusts (“REITs”), we can see that on average, rent per square foot is $12-13 for shopping centers. So assuming a rental value of $13 per square foot (including vacant lots), this would suggest First Allied generates annual rental income of around $68m. At a typical “cap rate” (the % yield used to value the portfolio) of 7.5% (again derived from the REIT peer group), this suggests a gross property value (before debt) around $900m.

The term “shopping center” in the US doesn’t refer to indoor malls, but rather to out of town “strip malls”, generally a row (or rows) of shops running alongside a huge car parking area. These shopping centers are generally located by freeways in the sprawling suburbs of the US. US shopping centers frequently have an “anchor tenant”, one very large retailer accounting for a third or more of the square footage of a center. The anchor acts as a draw for the center and this gives it significant power in negotiating with the landlord. The anchor would expect to pay less “base rent” than the other tenants, and may be able to negotiate “percentage rent”, rent based on turnover. The success or failure of the center will be closely linked to the success of the anchor, a good quality anchor (such as a Wal Mart) can make a center, whilst a poor quality anchor will make a center unattractive to potential tenants. The photo and diagram below show a typical First Allied owned center (this one is in Greenbelt, Maryland with a total retail area of c.140k sq ft and is anchored by a K-Mart).

An analysis of the sixty five shopping centers First Allied lists on its website show some interesting facts about the business. Only twenty of the centers have anchor tenants, but these account for 55% of the company’s total square footage. Of those that do have anchor tenants, K-Mart is by the far the largest, with seven stores accounting for 14% of the total portfolio (and 44% of anchor space). K-Mart is not a high quality tenant, a discount retailer founded in 1951 (the same year as Wal Mart), K-Mart’s story is one of years of failure and decline. K-Mart (which is now part of Sears) hasn’t reported a year of “same-store” (that is comparable stores excluding openings and closings) sales growth since 2002. First Allied’s over exposure to K-Mart and under exposure to its competitors Wal Mart (only anchoring one of First Allied’s centers) and Target (anchoring two centers) will not have helped during the sharp consumer downturn of the last two years.

The First Allied website shows which of its properties are currently unlet (what are called “voids” in the property sector). First Allied’s overall void rate is just under 9%, which is fairly standard for US strip malls at the moment (again using the REITS peer group as a benchmark). The headline 9% figure disguises a more worrying trend in the 45% of the portfolio that is not anchored by one retailer. The non-anchored centers have a void rate of over 14%, which is very poor by industry standards. Of the 44 non-anchored centers, 14 have 20% of more of their space empty. Void rates around 20% are normally considered to the tipping point at which a center may enter a downward spiral as shoppers are put off by all the empty lots, and more retailers elect to leave the center in the search for better locations.

On the positive side, First Allied’s shopping centers tend to be located in above average income areas of the US. The company does not have huge exposure to California or the south west where the residential property crash has had most impact. The biggest geographical exposure by state is to Texas (around a third of total space). Texas has proved relatively resilient during the US recession, and First Allied’s two largest centers in the state are well anchored by Target stores and have low void rates.

On balance however, the First Allied portfolio shows signs of significant operational weakness. All US retail real estate companies have found themselves under huge pressure since 2007, but First Allied’s weak anchor mix and very high void rate across its non anchored portfolio suggests that income will have fallen more sharply than the industry average over the last two to three years. What does all this mean for the Glazer family’s finances? Well like all real estate businesses, it is certain that First Allied will be significantly leveraged, both at the corporate level and at the level of individual shopping centers. All First Allied’s quoted peer group have suffered balance sheet problems in the last few years as rents have fallen, capital values have fallen and companies have found debt harder to roll over. In the quoted sector, the REITS have responded to these pressures by raising significant amounts of new equity during 2008 and 2009. The table below shows typical debt to equity ratios in the quoted peer group and the scale of the equity fundraising undertaken.

Quoted peer group

December 2009 $m

09 equity issued
% 09 equity
Developers Diversified
Equity One
Federal Realty
In total, the six REITS have raised $3bn in new equity in the last year, equivalent to around 30% of their existing shareholders’ equity. The vast majority of this new capital has been used to repay existing borrowings.

As a private company, the option of issuing new equity to the market is not open to First Allied. Obviously we have no insight into the shape of the company’s balance sheet, but it would not be unreasonable to assume that First Allied has a “typical” real estate capital structure, with debt representing at least half of gross assets. On the $900m of gross assets estimated above, it is therefore likely that First Allied would have at least $450m financed through debt. Given the high void rate experienced by the company and the weak anchors in many centers, cash flow has probably been well below plan for the last two years or more. Whilst purely guesswork, in these circumstances and (unlike the quoted peer group) without having access to external sources of equity, it seems very likely that the Glazers will have had to put capital into First Allied.

The need to recapitalise First Allied fits entirely with the family’s management of its other businesses. The Buccaneers have been starved of investment on the playing side, at United no attempt has been made to repay any of the PIK debt (and indeed Red Football has been purposely refinanced in such a way to allow the club’s cash to be used to pay the PIKs). The family’s only quoted investment has been sold, as has a high profile property asset, together bringing in almost $100m. Has this money gone to shore up First Allied’s balance sheet? And what of the loans the family took from United? Are they a reflection of the fact that First Allied no longer has the capacity to pay the family dividends to which no doubt they were accustomed during the property boom years?

What does all this mean for United? Well this quick glance at the Glazers’ other interests suggest the family are overstretched and in retrenchment mode. That doesn’t tally with the assertion that the club is “not for sale”….  Perhaps someone should make them an offer.