Description
I’m posting Gyrodyne Company of America (GYRO) because it’s one of the most compelling value stories I’ve found in the market recently.
I own shares. I may buy or sell whenever I like. This is not a recommendation to buy or sell. Etc. and all that.
I'm curious to see what other VIC members think. PLEASE NOTE, GYRO is small and illiquid. If that doesn’t rule it out for you, read on.
Thesis
A two word summary: real estate.
Gyrodyne owns a valuable undeveloped Long Island tract of land called “Flowerfield” that is unencumbered and remains on the books at 1951 prices. Two competing development plans are circulating for the property, and one or the other is quite likely to get underway within 1-2 years.
In addition to Flowerfield, the company owns a stake in a Palm Beach County orange grove. The grove is just miles west of Palm Beach, and is ripe for development.
Although there has been some recent appreciation in Gyrodyne’s stock price, its market capitalization still does not nearly reflect very reasonable valuations of the real estate assets.
A Short History
GYRO had its heyday between 1946 and 1969 as a manufacturer of coaxial helicopters for the military. Now the helicopter business has evaporated, but the company has held onto some significant assets: in 1951 the company fortuitously purchased 500 acres of land, known as “Flowerfield” because of its historic use as a flower nursery, on the north shore of Long Island, just 50 miles east of New York City. Subsequently 180 acres of this land were donated to the State of New York for development as campus for the State University of New York at Stony Brook.
A small portion of the remaining Flowerfield tract has housed some industrial buildings through the years, which were originally used as manufacturing facilities for the helicopter business. GYRO now leases these buildings to outside tenants. The majority of Flowerfield, approximately 314 acres, has remained undeveloped. Today it is one of the largest tracts of undeveloped land on Long Island. GYRO management has been focused on developing Flowerfield to its highest and best use. After several studies and several years of meetings with local authorities and residents, management concluded the highest and best use (and most likely to pass municipal authorities) is to develop the tract as an upscale Landmark National golf community. The company is actively working with municipal authorities to gain approval of this plan, which requires the site to be re-zoned from light industrial to residential. Flowerfield straddles two townships, Smithtown and Brookhaven, which complicates the effort to gain approval for residential zoning.
While Gyrodyne presses ahead with the golf community, the President of Stonybrook is eagerly pursuing plans to annex at least 246 acres of Flowerfield’s undeveloped land. In her 2003 State of the University Address, Stonybrook President Shirley Strum Kenny publicly stated the strong desire of the university to use the land for a planned Center of Excellence in Wireless Technology, and her willingness to pursue eminent domain if necessary. She’s hung her hat on the project. The Stonybrook plan calls for a total $350M investment in developing their new research & development campus. The Stonybrook plan uses about 25% of the land for the Center and the remaining 75% would be used for a mix of school buildings and a sewage treatment facility.
The undeveloped acreage of Flowerfield is carried on the books for just $792K – although the company has capitalized an additional $3.6M of costs relating to recent efforts to develop the property. The small industrial park on the land is carried on the books for just $743K.
Back in 1965 the company made another good land investment by taking a joint venture stake in a 3,500+ acre orange grove in Palm Beach County, Florida – known as “Callery-Judge Grove.” Gyrodyne currently holds a 10.93% interest in the Grove. The property has remained in agricultural use through the decades, but is currently the subject of a mixed-use development plan under review by local authorities. I believe most analysts agree that development in some form is inevitable, given the close proximity to Palm Beach. The recent decision of the Scripps Research Institute to develop a major science center within five miles of Callery-Judge Grove has provided a catalyst for urbanization of the area. However, the future zoning of the Grove property is not yet determined. In July, the Grove began making public overtures to locate the Scripps project on 120 acres of their land, in order to derive higher benefits from the surrounding development.
Due to recurring losses of the Grove’s agricultural operations, Gyrodyne’s joint venture investment is carried on their books for $0. Yes, zero.
The only debt held by the company is a $1.75M line of credit, only partially drawn. Management believes that cash on hand ($1.6M) and cash flow from its Flowerfield rental properties will be sufficient to fund normal operating, administrative, and the remaining predevelopment expenses related to securing entitlements for the golf community at Flowerfield.
Investment Thesis and Valuation
Despite GAAP, it is reasonable to assume that GYRO’s well-located properties are worth considerably more today than book value. But how much are they worth, and how long must we wait to realize the value?
We can now make an educated guess to answer these questions.
Valuation Range for Flowerfield
• Flowerfield Scenario #1 – Development as a Residential Golf Community. Should Gyrodyne succeed in gaining the appropriate entitlements for residential development of the land, home lots on the property ought to be valued in the neighborhood of $300,000 each. The community contemplates 336 residential lots, yielding a gross valuation in the neighborhood of $101M. You can argue a range here of plus or minus 10% taking into account land improvement costs and estimates of local real estate valuations. Regardless, we have a valuation range here of $90-110M for the residential lots. With this kind of project, there is always some risk that municipalities would force the developer to reduce the density of the project to gain approvals. In this case, I believe the proposal has already been designed as a low-density project, through extensive consultations in the community. The plan preserves a relatively high amount of open space (85 acres would remain in a natural state, and a large portion of the parcel would become an attractive golf course). In addition, with only 336 housing units, the project will not require an additional sewage treatment facility on the land, which seems to be a major positive in the eyes of the community. There is also a risk to this valuation range in the possible rise of long-term interest rates, although the buyers of luxury golf community homes are frequently cash buyers that are less sensitive to mortgage pricing. Finally, there is a risk that Long Island simply cannot support a golf community. After all, why would the buyer prefer Long Island to sunny Florida? This risk is quite small. Long Island has a rich golf and country club tradition. A second home or retirement home with close proximity to New York City should have significant appeal for many well-to-do buyers. For whatever it’s worth, management anecdotally reports strong buyer interest in the development.
• Flowerfield Scenario #2 – Annexed by SUNY Stony Brook. The issue here is price. Currently, there is a large spread between what Stony Brook has offered to pay for the land and what Gyrodyne is willing to accept. In initial discussions, Stony Brook made a firm offer to Gyrodyne of $13.4M for the land, an offer management has said “does not even get them into the parking lot of the ballpark…” There is no question Stony Brook intends to try to take the land on the cheap. The University is exploring eminent domain proceedings. However, under New York state law, Gyrodyne would be entitled to the amount specified by an independent appraiser who evaluates the land according to its “highest and best use.” Accordingly, the further along GYRO gets with its golf community project, the more difficult it becomes for SUNY to claim a lower valuation for the land. Let’s say, however, that SUNY could argue successfully that the highest and best use of the land is represented by its current zoning, light industrial. GYRO could build 6.8M square feet of light industrial and office space. I believe SUNY would be very hard pressed to make any argument that the land is worth less than $100,000 an acre, or $24.6M for the 246 acres SUNY intends to acquire. $100,000 an acre is the price that is being offered to SUNY for an alternate, much less desirable site on the former Grumman property in Calverton.
Another data point: it is interesting to note that GYRO has on its books a recent transaction that provides a benchmark in valuing Flowerfield. On August 8, 2002 Gyrodyne sold 12 acres and certain buildings of Flowerfield (held on GYRO’s books for $559K) to an existing tenant for $5.4M. The appraised value used for eminent domain proceedings would certainly be open for contest unless it aligned approximately with the value implied by this recent transaction. Based on rental revenue lost after the transaction, I estimate the company sold 64K sq ft of buildings in addition to the 12 acres of land. The value of the buildings alone is capped by their average age of about 44 years, so I can’t imagine it could exceed $30/sq ft cost of a decent quality new build. That caps the value of the building at a maximum of $1.9M. That leaves a conservative estimate of $3.5M value allocated to the 12 acres of land, or a minimum of $292,000 per acre.
So my range for SUNY eminent domain scenarios spans from a worst case $100,000 an acre up to $292,000 or more per acre. Assuming Gyrodyne may only develop 85% of its 314 acres, this gives us a range of $26.7M - $77.9M. Yes, I do realize this is a wide range. My personal belief is that the likely outcome is towards the high end of this range. You can arrive at your own conclusions. Regardless, we’ll see later how this tallies up in terms of dollars per share of stock value. I will note that some haircut may need to be taken in the eminent domain scenario due to the possibility of acrimonious legal battles, the time value of money, and a relatively small termination fee on the Landmark project.
For either scenario, I’d expect the beginning of development to be no more distant than two years from now. There is a catalyst in that Stony Brook's aggressiveness in grabbing the property is pushing the municipalities into rapid approval of Gyrodyne's plans, which appear to be greatly preferred by the local communities. However, there are no guarantees. (You can read on below and decide if these valuations provide you with sufficient compensation for your patience.)
Valuation Range for Callery-Judge Grove
There are a range of possible outcomes for the Callery-Judge Grove property. The property may ultimately be deemed an area for agricultural preservation, in which case the county could acquire lands for approximately $15,000 per acre based on an October 2001 study (which would value the GYRO property at $6M in 2001.) This valuation was confirmed in the latest 10-K which states that in June 2003 the property was more recently appraised at a value of $6.7M. Management has confirmed that this appraisal assumes *agricultural* zoning for the land.
However, depending on how development deliberations proceed, the land could be re-zoned for commercial and/or residential use. We can observe that a comparable residential property of 70 acres in the Loxahatchee area is selling for $53,000 an acre, implying a potential value of up to $20M for Gyrodyne’s stake in the Grove.
Recently, the Scripps Research Institute confirmed its plan to establish a major science center within five miles of the Callery-Judge Grove. This helps to create demand for additional residential development in the master-planned community and supports real estate prices at the community.
The exact timing of any transaction involving the Callery-Judge Grove is difficult to predict, but the demographic forces in Palm Beach County (and the fact that county-level planning has already been going on for a number of years) make it reasonable to assume that a development plan will take shape within the not-so-distant future.
Bearing these considerations in mind, the following table provides a range of valuation estimates:
Summary of Valuation Analysis ($M)
Worst Best
Flowerfield Undeveloped Land $27 $101
Flowerfield Rental Properties $3 $6
Callery-Judge Grove Stake $7 $20
Other Assets $5 $5
Total Asset Value $42 $132
Total Liabilities $4 $4
Fair Value of Equity $38 $128
Fair Value Per Share (1.16M shares) $32.76 $110.35
OK, so this is a range you could drive a truck through. I won't downplay the uncertainty here, while eminent domain proceedings are being plotted against the company. However, with the stock at $35.00, and the bargain meter dreadfully weak, this looks to me like a pretty good place to park some cash with a small downside and a very nice "free call option" (I've always wanted to say that!) Based on what I know today, I'd put my bets at the middle to high end of the range. The "worst case" scenario is pretty pessimistic.
Note: There are 164,650 options outstanding at the end of the year at an average $16.30 per share price. There are no more options remaining for future issuance under approved plans.
Some Other Considerations
Some analysts may gripe about whether the management group being sufficiently skilled to pull off such a large scale development effort. Alas, the jury is out. However, I really have no specific issues with their current strategy or actions in pursuit of lucrative residential development while holding out against low-ball Stony Brook bids. The more imminent the possibility of residential development appears, the higher valuation any appraiser will need to give the land.
I’m not too pleased with the level of stock compensation (which has run at about 30,000 options granted per year.) However, if the valuation ultimately comes in towards the high end of the range discussed above, the dilution is not a deciding factor.
The timing of both development projects is uncertain. Capital could be tied up in the stock for many years while local authorities wrangle over the development plans. However, I believe the real assets are high quality and more likely to appreciate than to decline in value over time. In addition, there are external catalysts to development that have not been present in prior years (Stony Brook and Scripps.)
See the 8-K dated April 29, 2004 for an “other event” impacting the company: in April, one of GYRO’s directors was convicted of knowingly and willfully put material false information on tax Form 1065 for a client. I hate to see this kind of stuff by anyone close to the company. Read the 8-K, draw your own conclusions.
To end on a positive note, there is some good company amongst the major holders of the stock. The 13-G/A filed 2/17/2004 shows Bruce Sherman of Private Capital Management fame as personal owner of 123,402 shares (10.8%). Private Capital Management owns 77,105 shares. Recently two groups who I know little about, Everest Special Situations Fund L.P. and Kellogg Capital Group, LLC, filed a 13-D announcing their 8% ownership and intent to “explore with management and other third parties ways to maximize shareholder value.”
Catalyst
Stony Brook expansion plan is speeding "highest and best use" development plans for Flowerfield; demographics and the Scripps facility are speeding development and raising value of Callery-Judge Grove.