April 14, 2011 - 5:14pm EST by
2011 2012
Price: 6.57 EPS $0.34 $0.34
Shares Out. (in M): 105 P/E 19.3x 19.3x
Market Cap (in $M): 692 P/FCF 13.6x 12.9x
Net Debt (in $M): 353 EBIT 47 52
TEV ($): 1,045 TEV/EBIT 19.9x 19.0x

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     Mission West Properties is an REIT which owns a portfolio of triple net leased research and development properties in the Silicon Valley of California. It was a great business until the internet bubble burst. In 2000, the vacancy rate for R & D properties in the Silicon Valley was 3.3%. In 2001, the vacancy rate in the Silicon Valley market was 14.8%. Some stabilization of the market occured mid-decade with an improvement in 2008's 16.3% vacancy rate over 2007's rate of 16.6%. However, this improvement was overwhelmed by the effects of the recession, and the vacancy rate climbed to 19.3% by year-end 2009. It improved slightly to 18.7% by the end of 2010 and is at 18.2% at the end of this year's first quarter.
     MSW focuses on single tenant long-term triple net leases in the Silicon Valley. They believe that their strategy provides them with efficiencies and cost-savings. The Company employs only 6 people although it owns 111 buildings with 8,011,026 rentable square feet. They have only 71 tenants. The largest tenant is Microsoft which provides 15.6% of total annual rents and the second largest is Apple which provides about 11% of total annual rents. When the rental market is strong, MSW is able to produce very high returns. However, when the market is troubled, every tenant loss is a large loss, and the leverage is to the downside. In 2000, MSW's properties were 99% leased at a rate of $1.36 per square foot. In 2001, their properties were 97% leased at $1.59 per square foot. By 2007 MSW's vacancy rate was 38% and average monthly rental income per square foot had declined to $1.42. In 2008 the vacancy rate improved to 34%, but average rental income per square foot declined to $1.25. 2009's vacancy rate stayed at 34% but the average rental income per square foot improved to $1.30. In 2010, the vacancy rate improved to 70% while rental income per square foot remained at $1.30. During the 1st quarter, their vacancy rate increased slightly to 31.5%. Consequently, the trend seems to have stabilized and might even be going in the right direction for MSW.  2011 maybe a challenge for the Company as leases on 640,671 rentable square feet of space expire. These leases provide MSW with 8.9% of its total annual base rents. On today's earnings call, management indicated that so far all but 175,000 square feet of space has been spoken for. When this hurdle is cleared, MSW has several years of clear sailing as most of the tenants with leases expiring in 2012 have indicated a desire to stay put.
     At year-end 2010, MSW had 2,397,707 square feet of unrented space. Of those, 777,000 square feet are for sale. The largest piece is the McCandless Technology Park which is 628,061 square feet spread over 13 buildings on 52.5 acres of land. The land has been rezoned for residential use and is estimated to be worth $2 million an acre. The buildings and land have an historic cost of $71.3 million and are carried on the books, net of depreciation, at $52.4 million, but generated only $603,308 of rental income in 2010. In the 4th quarter of 2009, the first of the McCandless buildings was sold for $14.1 million which represented a gain of $6.2 million or 78.5% over net cost. Management stated that they have indications of interest of over $100,000,000 for the properties. Even if the 13 buildings still on the books bring no premium to net cost, the proceeds from the sale can easily reinvested for a better return. Net of the McCandless properties, MSW's vacancy rate will improve to 24%. The other properties for sale are 3 small holdings carried at $15.1 million net. As with the McCandless properties, the land has been rezoned for residential use.  Again, the proceeds from sales can be reinvested for a better return than 0%.
     MSW has $345.8 million of mortgage debt and $7.7 million of related party debt. Scheduled maturities over the next 5 years are: $15.2 million, $16.1 million, $82.5 million, $12.2 million, and $12.9 million. The 2013 maturity bulge is on the Company's $73 million loan from Northwestern Mutual Life. The loan carries an interest rate of 5.64% and is secured by properties with a net value of $119 million which produce $9.6 million of cash flow. $108 million is due in 2018 on a loan to Hartford Life at 6.21% and another $39.7 million is due to Hartford Life in 2030. $124.4 million is due to Allianz Life in 2025. Accordingly, liquidity is not a concern. 
     At year-end 2010, MSW had $457.9 million of unencumbered properties which produced $30.6 million of annual rents. These unencumbered properties include the facilities leased to Microsoft and some of the Apple facilities. Of the unencumbered properties, 1,537,633 rentable square feet, carried at $170.8 million, are vacant and produce no income. This figure includes the 777,000 square feet that are for sale. Over time, perhaps over a very long time, these vacant properties will be released or the assets redeployed. This is the upside to MSW.
     In the meantime, the Company generates rental revenues of $99.4 million a year. Operating expenses, excluding depreciation, run $28.6 million a year and interest runs $20.1 million a year giving the company $0.48 of cash flow per share. Management estimates that 2011 funds from operations will be about $0.50 - 0.51 per share. With $50 - $100 million of proceeds from assets sales, either income will increase or a special dividend will be paid out to shareholders.
     The Company has 22,370,770 shares outstanding and 82,915,265 operating partnership units for a total common stock equivalent of 105,286,035. 73.9% of the total outstanding is controlled by Carl E. Berg, his family, and his investors. Carl Berg is a venture capitalist who helped found Sun Microsystems, Amdahl and other technology companies. He started his real estate ventures to provide facilities to technology companies. As long as he owns 25% or more of the capitalization, he cannot acquire or develop any real property zoned for office, industrial, or research & development in California, Oregon, or Washington without first disclosing and making the opportunity available to MSW. With 73.9% of the Company, worth $511.2 million, management has some real skin in the game.
     While waiting for wonderful things to happen, investors are paid an annual dividend of $0.52 for a yield of 7.9%. The Company has been good about protecting its balance sheet and has not pushed its dividend. Over the years it has been cut from $0.96 to $0.64 to $0.60 and now to its present level. Management believes that the current level of dividend payout is secure.
     This idea will not make anyone rich. It may, however, make someone happy.


     The redeployment of non-earning assets.
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