June 22, 2017 - 1:10pm EST by
2017 2018
Price: 93.60 EPS 0 0
Shares Out. (in M): 189 P/E 0 0
Market Cap (in $M): 17,722 P/FCF 0 0
Net Debt (in $M): 12,434 EBIT 0 0
TEV (in $M): 30,056 TEV/EBIT 0 0

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Investment Thesis:


By any standard Vornado is a blue chip REIT.  Three factors now make it a compelling buy:


1.  It trades at an historically wide spread to NAV (over 25% based on Green Street numbers.)


2.  The upcoming merger/spinoff of its Washington DC properties into a new entity (JBG Smith Properties) should be attractive to investors who want focused companies and should highlight the underlying value of both.


3.  With the spinoff,  Vornado is at the end of a simplification process that started in 2012.  CEO Steve Roth is justifiably proud of his actions in both  selling non-core assets well (in general) and focusing on distinctive holdings.  Roth is 75 and very driven by the stock price, and, I believe, will consider even bolder steps (selling all or part of the company) if the gap with NAV does not begin to close.  


Corporate History:


Steve Roth started to invest in real estate in the 1960’s. In the late 1970’s, he started to accumulate stock in Two Guys (corporate name Vornado), a struggling discounter, for its real estate value.  Ultimately, he took control of the company and proceeded to buy back over 60% of the stock at a time when buybacks were a rarity.  In the late 1980’s, he bought a large position in another discount chain, Alexander’s, for its real estate value.  He competed for control with Donald Trump, ultimately prevailing in the early 1990’s when Trump had serious financial issues.  (Today, Alexander’s is a public company; VNO owns about one-third.)  


In 1996, Roth hired Mike Fascitelli, the head real estate banker at Goldman, to be President.  Soon thereafter, VNO began to acquire Manhattan office buildings—most notably a Midtown portfolio from Bernard Mendik.  That deal brought along with it David Mandelbaum, who now runs the New York business.  


In 2002, VNO acquired Charles E. Smith, then the largest office landlord in DC.  At the same time, it was building the Bloomberg building (offices and, even more importantly, condos) on the site of the former Alexander’s store between 58th and 59th and Lexington.  The company continued to be acquisitive before the financial crisis although lost its biggest deal: Blackstone outbid VNO in 2007 for Sam Zell’s Equity Office Properties.  (Roth to Zell:  Roses are red, violets are blue.  I love you Sam, our bid is $52.)  Also in this period, VNO bought 33% of Toys R Us in a failed LBO.  


The 2008-12 period was a trying one—partially due to the financial crisis and partially due to self-inflicted wounds—the most notable being an investment (9.9%) with Bill Ackman in JC Penney.  As noted above, in 2012 Roth began a major simplification program of a company then characterized by complexity and opacity.  At the same time, he began quarterly investor calls.  Fascitelli, who had been named CEO in 2009, left in early 2013.  Today, Roth is still Chairman and CEO and has not announced a succession plan, which frustrates many investors.  


Vornado today is much more straightforward after a tremendous amount of corporate activity over the last 5 years—spinning off over $9 billion (including DC), exiting $6 billion in non-core assets (some through 1231 exchanges, and buying $4 billion of high-quality buildings in New York.  This even included a spinoff of Urban Edge (ticker UE),a NYC area shopping center REIT that was the foundation of the company (VNO still owns 5.4%).  RemainCo (new VNO) is a NYC focused company (offices and street retail) with two additional major assets:  The Merchandise Mart in Chicago and 555 California St, the largest single office building in downtown San Francisco.  JBG Smith.which should begin trading next month under the symbol JBGS, is primarily offices and multifamily in metropolitan Washington DC.  


New VNO:


(Good presentation from the Citi Global Property CEO Conference in March available on the corporate website)


Two figures summarizes the quality of this business:  Over the last 10 years FFO/share has compounded at 8.7%/year and same store NOI of 5.2%/year.  New York (almost all of which is Manhattan) will be almost 90% of EBITDA of the new company; the Chicago and San Francisco properties mentioned above make up the balance.  Within New York, the business splits 2/3 office and 1/3 street retail.  Importantly, while VNO has been very acquisitive over time, the company has a long history of successfully upgrading and repositioning buildings to create substantial value.  One such building which I know well is 330 Madison (42/43).  Ten years ago this was a tired, Class B property.  After a $120MM investment 5 years ago, it is an award winning property with a prestigious tenant roster and commensurate rents.   


Given the controversy swirling around all things retail today and the importance of this segment to VNO, we should examine its business more closely.  Roth does this in his letter in the 2016 Annual Report (pp.15-17).

Without restating his arguments I would add the following thoughts.  There is no doubt that rents have decreased and asset values are off their highs in many parts of Manhattan.  But half of the company’s retail cash flow (and this percentage should rise over the next few years) come from Fifth Avenue in the 50s and Times Square.  In both submarkets, VNO has a very strong position and long term leases with highly credit worthy tenants.  These properties can and should command very low cap rates.  


The most important opportunity in New York is the Penn Plaza District, where VNO owns 6.8MM of office space, the 1700 room Hotel Pennsylvania (right across the street from Penn Station), and a JV with Related Companies to redevelop the Farley Post Office on 8th Avenue into the new Moynihan Train Station with 750K sf of unique office space and 100K sf of retail.  Roth terms the redevelopment opportunity here “the Big Kahuna”  Clearly, many investors are worn out by management’s hyping of the tremendous opportunity embedded in Penn Plaza for many years and a lack of action to date (outside of the recently signed contract with the state for Moynihan).  But there is now no doubt, as Roth has argued for years, that Manhattan is tilting south and west and there is a good argument that Hudson Yards will both accelerate this trend and give a renovated Penn Plaza, which has always had very low vacancies, the opportunity to raise rents meaningfully.  Roth in his latest shareholder letter:  “We have transformed almost all of our fleet; Penn Plaza is on deck.”


One more thought about New York:  It is as deep and liquid a real estate market as any. As Vornado CIO Michael Franco observed last fall, “Investors from around the world want to be in the best cities.  New York is 1st 2nd and 3rd on their list.”



Washington DC:


(See 6/17 Investor Presentation on the JBG Smith Properties website).


“The deal is the big fix for Washington.  And the math works.  At its simplest, New York unburdened by Washington has to trade much better.

And Washington with JBG management has to perform and trade much better.  Simply stated, that’s what this deal is all about.”—Steve Roth in 2016 Annual.


As noted above, VNO entered DC 15 years ago with the acquisition of Charles E Smith.  Some overbuilding, sequestration, and the military BRAC program which severely impacted selected assets have combined to pressure income in recent years.  Roth, already convinced that the company was overly complex and pained by the drag that DC had on overall results, has sought an exit strategy.  The discussion in the Form 10 reveals that talks with JBG, a private local firm with a stellar reputation that had raised a series of very successful partnerships, began in 2013.  Note that Yale was JBG’s first institutional investor almost 20 years ago and a senior person in the Yale Investment office will be on the JBGS Board.


Current shareholders, who will own 73% of the new company, will shortly receive 1 share in JBGS for every two shares in VNO.  I think there is a good case that DC is poised for an upturn over the next several years.  One of the most notable features of JBGS is the development (and redevelopment, especially Crystal City) potential within the current portfolio.

This stock could become especially interesting given the lack of natural sponsorship for the spinoff.




While clearly debatable, I favor NAV over FFO multiples as a primary valuation technique for REITs.  Roth favors it also and last year, for the first time, the company calculated an NAV for itself in its year-end supplement.

I don’t see much sell-side research but here are three recent estimates/share:


Green Street:  $126

Morgan Stanley:  $144

Vornado:  $135


For those who don’t know, Green Street Research is a boutique firm focused on real estate companies.  I don’t have access to their research currently but I have had it in the past and believe they are very good and, without banking conflicts, objective as well.


There is a very interesting chart on p. 18 of the 2016 annual which compares Vornado's stock price to the Green Street NAV since 1998, but I can't seem to insert it here. 


As can be seen, VNO has traded near its NAV most of the time.  It now trades at its widest discount since its earliest days as a company.









Going Private:


As noted above, Vornado and Blackstone were in a bidding war for Equity Office Properties in 2007.  It was probably fortuitous for VNO that Blackstone won, even though the latter wound up doing well on the deal.

Few other than REIT specialists (I’m not, as must be clear) would remember that there were a wave of firms that went private in the 2005-07 period; 14 significant deals in 2007 alone.  While recent months have been quiet on this front, there were 7 $2 billion+ deals in 2015, three of which were Blackstone acquisitions.  The largest of these, BioMed Realty, took a page from the EOP playbook:  Very shortly after the deal closed Blackstone sold a significant group of assets to another company. Jon Grey, Blackstone’s Real Estate head, has been very public recently about looking at public companies as a source of deals.  And while Blackstone is usual suspect #1, there are other firms, both domestic and foreign, that could well be interested in all or parts of Vornado.


Steve Roth:


Brilliant, stubborn, egomaniacal are all fair descriptions of Steve Roth. He will be 76 this year.  I have no idea when he will retire, but I am confident that he wants to go out on top.  He is hyper focused on his stock price. Not only does he believe that it is woefully inadequate, but from his perspective he just spent 5 years working very hard to streamline the company so that investors would reward him by according it full value.  At the same time, he believes that sellers of truly irreplaceable real estate are almost always proven wrong over time; so he will not sell at any price.  And, like all real estate moguls, he is very interested in tax minimization.  In the end, I think these comments from the May, 2017 investor call sum up his thinking:


“We will continue to leave no stone unturned to accomplish our objective, which is to get a stock price that we believe reflects the value of our business.  We are unbelievably frustrated by the discount.”





I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


See above:  Pending spinoff of JBG Smith Properties should call attention to the value in both companies.

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