Gyrodyne Company GYRO
December 09, 2005 - 8:26pm EST by
sag301
2005 2006
Price: 41.90 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 52 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

Gyrodyne Company of America Inc. – December 8, 2005

Business Description

Brief History
Gyrodyne Company of America was originally incorporated in 1946 and was engaged in the design, testing, development and production of coaxial helicopters primarily for the US Navy. After the elimination of this business in 1975, the Company began converting its vacant manufacturing facilities and established its rental property operations. There are no hidden liabilities remaining from the helicopter business.

Since there is effectively no business, what we are left with is a pure asset play. The Company owns primarily two assets: 1) the “Flowerfield” property a 314 acre parcel of land 50 miles east of Manhattan, which management believes is one of the largest undeveloped tracts of light industrial zoned land on Long Island and 2) a 10.93% stake in a 3,698 acre orange grove in Palm Beach County, Florida.

Asset #1: Flowerfield Property / ”Situation”
The 314 acre site, primarily zoned for light industry, is located approximately 50 miles east of the city on the north shore of Long Island. Of the 314 acres, approximately 30 acres are utilized by some small industrial buildings which generate approximately $1.15 million in free cash flow per year.

The remaining site, after years of study and management’s desire to maximize value of the property, was to be used to develop an 18-hole championship golf course along with 336 residential lots for luxury homes. The Company completed the design phase for the golf course and residential community and filed for applications to change the zoning from light industrial to residential in late 2002 and 2003. Unfortunately, at the same time, The State University of New York at Stony Brook (“SUNY”) decided that 245.4 acres of the land owned by the Company would be an ideal location to add a research center. SUNY subsequently offered $13.4 million, or $55k per acre, for the land, which management refused.

On October 31, 2005 the Company announced that it had received a written offer, in accordance with New York’s Eminent Domain Law from SUNY, for a blended average of $107,000 per acre for the 245.4 acres. SUNY subsequently took title of the property and the Company should have received this cash ($26.3 million). Gyrodyne will now appeal to the Court of Claims to determine fair value of the tract according to the ‘highest and best use’ of the land. This process can take anywhere from 12 to 18 months.

Asset #2: 10.93% Equity Interest in the Callery-Judge Orange Grove
In 1965, the Company made an original limited partnership investment into the 3,698 acre orange grove in Palm Beach County, Florida for $1.1 million. Over the years, because of non-participation in capital calls, the stake has been effectively diluted down to 10.93%. From the most recent press release regarding the appraisal that the Callery-Judge Partnership has done each year would imply there are $14.7 million of liabilities at this entity.

The orange grove makes no money, and as such, has been written down over the years to $0 on the balance sheet. While it has been used for agricultural purposes for decades, its position vis-à-vis Palm Beach would suggest development of the land could not be too far down the road.

In late 2003, the Scripps Research Institute headquartered in La Jolla, California announced plants to develop a major east coast center on property located approximately 4.5 miles north of the Callery-Judge Grove. While efforts to move the center to the Grove’s land didn’t prove entirely fruitful, the grove land is now subject to a master plan of its own to develop a community on the land. The plan is currently stalled in the approval process, however they have formed a Callery-Judge Neighbor Advisory Committee to include the public on the decisions of the community in efforts to ease pain of the process.

Valuation

The short answer here is that nobody knows what either of these two assets is actually worth. Placing any sort of probabilities on an upside scenario would require predicting the outcome of a court judgment (never a good idea) as well as the future actions of various local and state officials. And so I think it’s best to focus on the reasonable worst case scenario, take the conservative case in each of the multiple variations with respect to each asset, and consider everything else as upside.

Asset #1 – The Flowerfield Property

We are actually going to break this 314 acre asset into two assets: 1) the rental property and 2) everything else.

1) The rental property generates approximately $1.15 million in free cash flow per year assuming maintenance capex approximates depreciation and amortization. I have attributed no s,g&a to this number as a third party buyer could easily fold these rental income generating buildings into their current property business with little incremental costs. Real estate transactions are generally valued based on “capitalization rates” which is effectively the inverse of the multiple of free cash flow paid or a back-of-the-envelope DCF (i.e. a transaction done at a 10% cap rate is a purchase price of 10x fcf). Years ago, cap rates on real estate transactions hovered in the 7%-9% range depending on the underlying asset. As interest rates plummeted, the capitalization rates investors demanded fell as well and actually dipped into the 5%-6% range.
2)
In any event, these are old buildings, so I do not feel comfortable attributing a 5% cap rate when the current 10-year Treasury yield is 4.46%. I am comfortable with the high-end, or economically worst from a valuation perspective, of an 8% cap rate. I think 350 basis points over treasuries is a conservative yield for these assets or about the 15 year average of the BB spread to treasuries. At an 8% cap rate, the pretax value of the rental property is about $14.3 million. I am also comfortable that this is conservative because in late 2002, 12 acres of rental property were sold for approximately $5.37 million. This implies a valuation of $13.4 million for 30 acres, 3 years ago. Again to be conservative, I attribute a 38% tax and expense rate to the proceeds of this liquidation value though my contention currently is that the Company should be able to realize full value without paying corporate level taxes on any of the assets we are going to discuss through some creative structuring. I cannot imagine the Company actually paying more than the current 15% long term capital gains tax plus transaction expenses on such a sale, but again to be conservative and to highlight the lack of any real downside relative to the current share price, I will use the corporate income tax rate of 38%. The post-tax value of the rental property then, sold at a range of 6-8% cap rates is $8.9 million to $11.8 million or $6.79 to $9.05 per fully diluted share.

3) The remaining asset at Flowerfield is 284 acres of partially developed land because the Company kept throwing good cash after bad in order to 1) keep up the golf course community plan to the extent SUNY backed down and 2) have a stronger fight in the ‘highest and best use’ argument for residential land which would command a premium of $100k to $200k per acre over light industrial zoned land. Empty land does not generate cash flow and so, to value this property, we can only use the asset replacement methodology. I spoke to two brokers on Long Island in 2004, neither of whom could produce a comp in that area for the last few years of below $200k per acre for light industrial zoned land. The $200k per acre was to acquire development rights only and not the underlying asset. Most of the comps hovered in the $250k - $300k per acre range as of 2004.

The real issue is that there is no ‘comp’ given the size of the parcel of land. But to be conservative, I took a discount to the average comp of $250k-$300k. And for these reasons and the ones contained in the following “Current Events” section, I am completely comfortable that as an absolute, worst-case scenario, the remaining acreage is worth at least $200k per acre. Again, though this value, either through a 1031 exchange or another alternate corporate structure, should be realized without paying corporate level taxes, I assume a conservative 38% tax and expense rate on the realization of these proceeds. At a range of $200k - $400k per acre, the net after-tax value of the 284 acres is $35.2 million to $70.4 million or $26.88 to $53.76 per fully diluted share.

Asset #2 – 10.93% Equity Stake in the Callery-Judge Grove

Again, this land currently produces no cash flow as a citrus grove, so any attempts to discount the future earnings power of this asset to determine its value would be nearly meaningless. So much like the Long Island property, we must use the replacement cost methodology. But with this asset, we can also factor in the appraisal of Pinel Appraisal Services, the independent third party appraisal firm that performs an annual appraisal on the Grove for the Callery Judge Partnership.

The two sources of information for my downside scenario for this property were i) a broker at CB Richard Ellis and 2) Nat Roberts, the General Manager of the Grove. CB Richard Ellis was hired by the county of Palm Beach to assist in determining the location for the research center. When we spoke a year and a half ago, the real estate market had yet to reach the ‘bubble’ status. When asked what he could liquidate it for if I had given it to him the next day, he mentioned that a discount to the comps (and the appropriate size discount for this land which, unlike the Long Island property, is surrounded by similarly large tracts of undeveloped land) would suggest that $40,000 to $50,000 per acre was the low end and could easily be realized in a fire sale. The ‘correct’ valuation based on comparable transactions and given a few months to market was closer to $75,000 to $85,000. Because, at that time, the Scripps Center location had not been finalized and there was some slight possibility that the Callery-Judge Grove became the site, he quoted the upside at $100,000 to $150,000. Since then, the Scripps Center deal has begun to come to fruition and from my conversation in Oct. 2005, the price will be in the $130k per acre range on the site that was chosen.

My conversations with Nat Roberts yielded similar results. Nat seems to be well connected to local, county and state politicians, which should be helpful in the development of the community on the site. Nat mentioned the appraisal report, which has recently been updated for June 2005 and implies a price per acre of about $45,000. So, though difficult to value considering the size of the parcel and the illiquidity of the units, I am comfortable with a worst case scenario of $45,000 (the June 2005 appraisal) with upside at $95,000 per acre. Again, though very unlikely, I assume a conservative 38% tax and expense rate on the proceeds of these units. These valuations imply the 10.93% equity stake, after $14.7 million of liabilities, would yield $10.3 million to $22.8 million in net, after tax proceeds, or $7.85 to $17.41 per fully diluted share.

After adding in the holding company assets that could be turned into cash in a liquidation and backing out all liabilities ($3.0 million), I get to an after-tax, net equity value for Gyrodyne Company of America Inc. of $42.11 to $80.92 per fully diluted share.

Current Events/ Major Shareholders/ Management/ Valuation Update

Major Shareholders
In order to understand why this situation is not simply similar to a closed-end fund trading at a discount to NAV or a complicated, but common, European holding company with a stub that often trades at a negative valuation but value never gets realized, it is important to consider the major shareholders and their actions.

The first set is the original 13D filers of Everest Special Situations Fund and Kellogg Capital. These guys paid in the $20s and $30s for their shares and were effectively looking to get cashed out with an asset sale much like K Capital Partners did years ago. Neither of them have the capital (unless they combined funds and put 100% of their money into it) to buy the whole company. In addition, Bruce Sherman of Private Capital Management is the largest holder and, while passive, appears to understand the value of the land near his home in Naples, Florida. Everest/Kellogg did, however, attract enough attention to the situation for two more filers who I believe to be more important.

Phillip Goldstein, who runs a small $100mm fund, and Andrew Dakos have accumulated an 11% position as well, paying a higher price than Everest and Kellogg. Goldstein has a history of shareholder activism and has successfully attacked closed end funds, not surprisingly, trading at a discount to NAV.

After many letters and meetings, the Company finally agreed to hire investment bankers in June of 2005 to ‘explore strategic alternatives’ to unlock shareholder value. The firm of Coady Diemar Partners, which is a couple of old senior bankers from more recognizable wall street firms, has been tasked with presenting the board with its options. I think this is important for two reasons: 1) we will finally get a professional opinion with respect to the taxation/corporate structure and 2) providing a review of “strategic alternatives” does not generate revenue for the firm, transaction fees do. Mr. Coady confirmed that he has been retained only to provide alternatives currently. I would be greatly surprised if their alternatives did not include an extended engagement to liquidate part or all of the assets of the Company, providing a catalyst to unlock value. While this report has been completed, management has not yet decided how this information will be disseminated to the shareholders.

Current Events
Two recent events are important to note from a valuation perspective. One is the sale in July of 2005 of 6.4 acres of the Callery Judge property to the County of Palm Beach. The County needed the six acres for the widening of a road in front of a school. Instead of a protracted condemnation proceeding during which the land values would be skyrocketing because of the development nearby of the Scripps center, the County chose instead to settle for $1.28 million plus $300k in legal fees or $200,000 per acre and 5.0x my downside scenario price per acre. I do not believe this is useful to comp all 3698 acres. But, it should be noted that a government agency typically does not pay the high end of a valuation range either.

Upon another conversation with CB Richard Ellis in October, their ‘firesale’ liquidation price is now $75,000 to $85,000 per acre with fair value in the $100,000 to $150,000; upside is now splitting the parcel into 5 or 6 pieces and taking one to two years to sell them all at $200,000+ per acre. Additionally, they are begging for the listing with a laundry list of developers who are losing the bids on the Scripps Center but trying to find land around it for sale. So while only one comp at $132,000 is available, I am pretty comfortable that it is worth at least $45,000 per acre.

The second event relates to Long Island light industrial property, which our downside scenario contemplates a price, per-acre, of $200,000. I have not been able to confirm as of yet, but am told that a few acres 3 miles east (effectively further from the city, so ‘worse’ from a location perspective) sold in July for an implied $500,000 per acre or 2.5x my downside scenario. In my attempts to confirm, I have spoken with two more commercial/industrial real estate brokers who are very familiar with our particular tract of land. They both indicated again that there are no comps in the area that are meaningful as most of the land is residential in the area. But both quoted $300,000 as the absolute worst-case scenario for a liquidation price and fair value at $500,000 to $800,000 per acre.

Summary
At the end of the day, the current share price of $43.00 represents slightly above a liquidation of the two assets at $45,000 per acre for the Grove and $200,000 per acre for the Long Island property at the full corporate tax rate along with generous transaction fees. Given the extremely conservative nature of the per-acre prices and the attribution of an almost unreasonable tax and expense rate, it is very difficult to see how you lose any money at the current price.

The upside scenario of no corporate taxation, utilizing a 6% cap rate on the income and $200,000 and $500,000 per acre for the Long Island property and the Grove, respectively, yields $183.71 per fully diluted share or roughly 4.2x your money, which I apply very low probability of having everything work out in our favor (and realizing the proceeds tax free).

To get to my fair value estimate, I am utilizing $70,000 per acre for the grove, a 7% cap rate on the income, 15% for long term capital gains tax and 3% for transaction fees, and finally $300,000 per acre for the Long Island property which gets me to about $80.55 per share.

With limited downside and an upside of 2-4x your money with a 1 to 2 year time horizon, I would recommend for purchase any and all shares available of the Company at the current price.

Catalyst

Sale/condemnation process
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