Upfront disclosure: I am long GYRO. GYRO is a thinly traded microcap most suitable for limit orders, and the investment thesis discussed here is very sensitive to purchase price. This article is intended for informational purposes only; please do your own research.
Long time readers will know that, above all else, I'm a believer in looking for an edge when making an investment. My theory behind "the edge" is simple: markets are brutally competitive, so in order to outperform, you need to be doing something that most other investors cannot or will not. That search for an edge is the underlying reason why I focus so heavily on microcap stocks: I believe the easiest way to gain an edge is to buy stocks that professional investors simply can't buy due to size limitations.
A simple extension of that strategy is investing in asset classes that are too small for most investors to look at. For example, in You Can Be A Stock Market Genius, Joel Greenblatt makes several arguments for investing in mutual thrifts at a discount. He goes on to explain that the opportunity exists because each individual mutual thrift is much too small to be looked at by a typical analyst, which created an entire industry of mutual thrifts conversions that was overlooked by most funds.
I tend to think liquidations, especially voluntary ones, fall into the same position for several reasons. First, liquidations tend to be the result of a failed business strategy of some sort. It takes a rare management team to admit that shareholders would be better off with all of the company's assets in their hands instead of management's, and it generally takes a setback or two for a management team to admit that. Second, liquidations tend to be for extremely small companies; larger companies tend to be too complex to unwind and are more likely to be taken out by normal M&A. Those three attributes (rarity, small size, failed strategy) mean that most professional investors aren't paying serious attention to liquidations.
But their lack of oversight can lead to serious alpha for those investors willing to pay attention! This letter by Horizon Kinetics argues that discount rates >20% are not uncommon when it comes to liquidations. That's obviously a pretty incredible return! But the return is even more remarkable when considering that liquidations have tight time horizons and limited market risk (i.e. if a company is liquidating and sending $1.00 to shareholders, shareholders get a $1.00 whether the market rises or falls 50%).
Anyway, all of this is just a long way of introducing today's investment idea: Gyrodyne (GYRO). Gyrodyne is liquidating, and it's my belief that today's price presents investors with an opportunity to invest with extremely limited downside and substantial upside in the event of a positive scenario.
Let's start with a very, very quick background, because it's necessary to understand why the liquidation is so interesting at today's prices. For readers looking for more background, I'll point you to all of the VIC write-ups.
The story starts November 2005, when the State University of New York at Stony Brook filed an eminent domain procedure on 245.5 acres of Gyrodyne's undeveloped Flowerfield holdings. New York paid GYRO $26.3m for Flowerfield. Gyrodyne then sued New York for damages, claiming the payment undervalued the land by almost $100m.
Obviously, the $100m difference is huge. Why the value discrepancy? The land was, at the time, zoned for light residential use, and that is what the State argued they should have to pay for it. Gyrodyne argued the land would eventually be zoned residential and thus should be valued on that basis.
Gyrodyne ended up winning the trial and won a huge payment from the state of New York. With all of that cash, they declared a few huge special dividends and eventually, on September 13th, adopted a plan of liquidation.
As part of the liquidation plan, the company will pay out a special dividend of $66.56 to shareholders at the end of this year. Note that this liquidation will be paid in a mix of cash ($45.86 per share) and interest in a liquidating trust contain ownership rights to the properties (Also, please read the press release announcing the dividend! While the ex-dividend date has passed, the release makes very clear the stock continues to trade with the dividend until the end of this year). Post dividend, the company will look to sell those properties and wind up the whole business within two years. As part of the liquidation, GYRO filed this beast of a proxy (100+ pages plus another 100+ appendix pages), which included this very helpful table showing estimated proceeds from a liquidation.
(click to enlarge)
Shares are currently trading in the low $72s, or right in the middle of the distribution range. Seems like the market is fairly valuing the company, and there's nothing to see here, right?
Not so fast. Liquidation analysis like this tend to be conservative for one reason: no one wants to overestimate a liquidation and end up getting sued. And a deeper dive into GYRO's balance sheet seems to confirm that this valuation could be too conservative and presents investors willing to dig a bit deeper the opportunity for significant upside.
The area we want to drill down on is the second line "Gross Real Estate Proceeds." Gyrodyne's real estate basically consists of four properties.
- The remaining 68 acres of Flowerfield that the government did not take
- Port Jefferson, a professional park in New York
- Cortlandt Medical Center in New York
- Fairfax Medical Center in Fairfax, Virginia
Let's see if we can value each of these properties.
First, Port Jefferson. GYRO acquired it for $8.85m in June 2008. Port Jefferson had operating income of $400k in 2012 and $540k in 2011, which should support a valuation of $8.85m (i.e. at cost).
Cortlandt was acquired for $7m in June 2008. In addition, GYRO acquired a house next door for $305k from a distressed seller in August 2008 and some piece of land across the road (Crompond) for $720k in May 2010. The land did $320k in operating income in 2012 and $500k in 2011, so I think a cost valuation at $8m is reasonable.
Fairfax was acquired in March 2009 for $12.891m. Fairfax did about $700k in operating income in 2012 and 2011, which I think (again) supports their cost basis as fair value.
Put them all together and I get a fair value for the non-Flowerfield properties of $30m. Which brings us to Flowerfield. This piece of land is 68 acres that is right next to the acreage that New York took from them in 2005. Remember, New York paid Gyrodyne $26.3m for 245.4 acres right next to this plot. That payment was made under the assumption the acreage would remain zoned industrial light, which most of the rest of Flowerfield currently is. If we apply that same valuation to the remaining 68 acres, we'd come up with a value for this property of ~$7.3m.
Is that right? I don't think so. First, there's an industrial park that takes up 10 acres of property that did $750k in operating income in 2012 and 2011. The industrial park alone is probably worth at least $9 million. If we assume it's worth $9m and the other 58 acres is worth what New York valued them at, then we're looking at a fair value of the land in the $16m range.
Put those two ranges together with the $30m in value we estimated for the other properties, and we come up with an initial value range of $37m - $46m, which corresponds very closely to what the company estimated in its liquidation proxy. But astute readers may have noticed something: all we've been talking about so far is the value under current zoning. Remember, the company's lawsuit said the neighboring acreage should be valued at $125m if zoned residential, and the court agreed that eventually it would be zoned that way and should be valued as such. If the remaining acreage were rezoned, the company's land could see a similar increase in value.
And there's evidence that a zoning change could be on the way. The company's most recent 10-Q states that one of their key business strategies is continuing to pursue the re-zoning of Flowerfield, and their filings are full of hints that they continue to actively work on the rezoning. If successful, the valuation would obviously go much higher. If we applied the valuation from the court case as a first estimate, that would put the value of the land at $35m or so. Add that to the other properties' values, and you're looking at real estate value of $65m. Assuming the same liquidations costs in the proxy and adjusting the selling fee up for the increase in value, we get a liquidation value just under $90.
Obviously that's a decent bit of upside from today's share price in the low $70s. But the beauty of this investment is not in the decent bit of upside; it's actually in how substantial the IRR on the investment is. As I mentioned above, as part of the liquidation, the company has declared a special dividend that shareholders at the end of this year will receive. $45.86 of this dividend will be in cash, meaning shareholders will immediately receive almost two-thirds of their investment back in under one month. We also know that company has to liquidate within two years. The combination of the two leads to a very strong IRR for investors in the low $70s. For example, if you think the liquidation ultimately comes in at $90 and the company completes liquidation by December 2015, the IRR for the investment is over 26%. If it completes by December 2016, the IRR is over 20%. A liquidation in the low $80s would still result in a mid-double digit IRR, which would likely handily outperform the broad equity markets with substantially lower risk.
The other great part of the investment is that the large cash dividend in the next month means that downside risk is extremely limited. If liquidation comes in at $70.86, the low end of what the proxy states (and remember- I believe the proxy was likely too conservative), then IRR is for buyers at $72 is just -2%. I'm happy to risk 2% downside for a good shot at 20-25% annualized returns every day of the week.
I'm including a table below that shows the IRR assuming different levels of purchase price (left column) and liquidation values (top row) and the liquidation finishes by December 2015 (with the $45.86 in cash received at the end of this year). In one sense, the table is pretty obvious: higher liquidation values and lower purchase price lead to stronger returns, but I think it does a good job of showing that it doesn't require a huge Flowerfield sale price for shareholders at today's prices to realize a strong return.
Disclosure: I am long GYRO. GYRO is a thinly traded microcap most suitable for limit orders, and the investment thesis discussed here is very sensitive to purchase price. This article is intended for informational purposes only; please do your own research.
Disclosure: I am long GYRO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
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