For Sale: The Last Fortune of Howard Hughes

“Every man has his price, or a guy like me couldn’t exist.” — Howard Hughes

If you were born after the Eisenhower administration, you may have no idea of who Howard Hughes was or his unique place in American history. Hughes was an aviator, movie producer, casino operator, oil driller, defense contractor, and at one time rumored to be the wealthiest person in the world.

Although he died more than 40 years ago, the mystique behind his name is still powerful enough to spawn the occasional book or movie. Perhaps you’ve seen director Martin Scorsese’s critically acclaimed 2004 film about Hughes, The Aviator.

The Hughes “brand” is so strong, there’s a publicly traded company named for him: The Howard Hughes Corporation (NYSE: HHC).

HHC came into existence after its parent company, General Growth Properties, filed for bankruptcy in 2009. Although not technically a real estate investment trust (REIT), HHC is in the business of owning and managing several real estate properties in the United States.

So why am I discussing Howard Hughes now?

On June 27, shares of HHC jumped more than 30% on news that the company hired a consultant “to explore strategic alternatives that include a sale of the company.” That’s not surprising. Over the past five years, HHC has lost value even after this week’s big jump.

The fundamental problem with HHC is that it in most respects it looks like a REIT, except one: It pays no dividend. That means its shareholders are essentially unsecured lenders, with the company’s assets serving as collateral.

However, there is $3.1 billion of long-term debt outstanding that takes priority over equity in the event of a liquidation of assets. Coincidentally, there also is $3.1 billion of net tangible assets on the books. That leaves HHC’s shareholders holding the bag if the company must be liquidated.

Not the REIT Stuff

That begs the question; why would HHC jump so much on news that it might be sold? Put another way, why would an acquirer pay such a large premium for a stock that has gone nowhere while the S&P 500 has doubled in value?

Certainly, the underlying real estate portfolio generates strong cash flow. For that reason, it may appear the simple solution would be to convert HHC to a REIT. As a REIT, HHC would be required to distribute 90% of its net income as dividends to shareholders.

Last year, HHC earned a little over $57 million in net income. With 43 million shares outstanding, that works out to $1.33 of net income per share. At a 90% payout, that would result in an annual dividend of $1.19. Based on a recent share price of $120, that equates to a dividend yield of roughly 1%.

That low of a yield won’t cut it as a REIT. Most REITs pay an annual dividend yield in the 3% – 6% range, and some considerably more than that. Why settle for a 1% yield when you can get several times that amount from a REIT that is just as safe?

A more likely explanation is that a foreign investor may be interested in acquiring HHC. It’s no secret that many wealthy Chinese citizens have been buying up expensive real estate in America. The type of upscale properties in HHC’s portfolio would be right up their alley.

Another type of buyer that makes sense to me is a pension fund or insurance company. Those portfolio managers take a very long-term approach to managing their assets. They may also be interested in acquiring HHC’s real estate holdings so they can reduce their exposure to stocks.

Fool’s Gold

Regardless of who ends up buying HHC, its dissolution should come as welcome relief to its weary shareholders. After all, the fundamental premise of investing is to earn a return on your money.

If HHC were a tech stock, paying no dividend would be understandable. In that case, reinvesting excess cash flow back into product development could be a wise decision.

However, HHC is a real estate holding company. Unlike a tech stock, its business is not highly scalable. The value of its properties will appreciate over time, probably at a higher rate than inflation but not much more than that.

In that regard, owning shares of HHC is similar to buying gold. It pays no dividend, its value is largely determined by macroeconomic factors beyond its control, and the only way to get any money out of it is to sell it.

That doesn’t sound like a good investment to me, especially if income is what you are after. If Hughes were alive today and HHC wasn’t his namesake company, he’d probably pass on buying the stock.

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