St. Joe Company Update

Investment Manager's Letter November – December 2013

St. Joe Company has announced the sale of about two thirds of its land holdings in the Florida Panhandle. The sale is for 387,000 acres for $565 million which works out to about $1500 per acre. This sale is essentially a disposal of the St. Joe Company’s timber business. The land involved has no development potential within the next twenty to thirty years. St Joe is left with 184,000 acres that do have developmental potential although it will take a good many years for all of that potential to be realized.

The remaining 184,000 acres is not timberland, even though there may be trees on some it. It is land that management feels has developmental potential. Included within these 184,000 acres the company currently has land use entitlements for 30,000 acres of residential property, 200 plus acres of commercial property and 1000 acres of industrial entitlements for land around the new Panama City Airport. In November, the company began the process of obtaining entitlements for 110,000 acres in western Bay county and eastern Walton County. Under a new Florida law it is now possible to lock in rezoning for this very large parcel.

The property includes most of the land not already rezoned in these two counties. St. Joe Company has not disclosed requested entitlements for specific areas, but has discussed plans for a large adult-oriented community that would probably be a part of this plan. The company has scheduled five public hearings in the next two weeks to get public input.

In 2011 and 2012, St Joe has sold commercial land in this area for $227,000 per acre to $363,000 per acre (there have been no commercial land sales so far in 2013). It is currently selling quarter acre residential lots mostly in Breakfast Point and Watersound for $67,000 (up from $52,500 in 2012). Residential lots in beach area sold for $175,000 so far in 2013 (up from $129,000 in 2012). Most of the beach area lots sold would have been in Windmark Beach, which is Gulf County near the Port of St. Joe Company, and not on this Map. Since it will take number years to sell the property, the present value of the land would be at a substantial discount to the above prices. The present value will depend on the amount of high value entitlements received, but clearly would be worth a good deal more than the $1500 per acre that they realized from the sale of the timber land.

The timber operation generated operating income of $13.5 million which would represent a return of 2.4% on the $565 million sale price. Short term upside for the stock comes from the fact that the stock is down on what is basically good news (assuming Management can do better than 2% with the $565 million). The stock initially jumped on the announcement, but dropped after David Einhorn basically told the press "I told you so". He had said the market was overvaluing the property when he shorted the stock in 2010. He went on to the plainly ludicrous inference that St. Joe Company’s remained property may also be worth $1500 per acre. With property fronting on 20 miles of the intracoastal waterway, plus over 30 miles of frontage on West Bay, plus 15 miles of both sides State Road 79, plus 20 miles on the proposed West Bay Parkway, the potential for commercial, industrial, and high value residential property is many times the $565 million they will receive from the timber land.

I, as investment manager, assumed that, by now, Einhorn would have taken his profit and was long gone, but one would wonder why he would need to talk the stock down if he were out. There are still 13.3 million shares of the stock held by short sellers. This represents about 20 days trading in the stock at the average volume in recent trading. This representspotential buying when the shorts decide to buy the stock to cover their shorts, and can move the stock if the shorts decide to all cover in a short period of time. But will have less effect if the covering takes place over several years.

On completion of the sale of the timberland, the company will have $700 million in cash, $10 million net debt, and it has been cash flow positive for the last 3 years, so if I was short maybe I’d, as investment manager, be talking the stock down, too. At a current price of $17 per share, and with $7 per share in cash when the deal is completed, the market is valuing their remaining 184, 000 acres at around $5,000 per acre. With the retail value of the land north of $200,000 per acre, even a huge discount for present value is not likely to get you down to $5,000 per acre. Clearly, the people holding those shorts do not believe that the company will ever be able to realize the retail price, but having lived in Florida for forty years and having driven most of the land in question, it would not surprise me that, if St Joe is willing to wait (with all that cash there is no reason they could not wait), they will eventually get whatever price they want. When we get 10 years down the road, no matter how much of the land has been sold, that which is left will be worth a good deal more than it is today.

Perhaps the most interesting question about St. Joe Company is what Bruce Berkowitz (his Fairholme Fund owns 27% of the stock and Berkowitz is chairman of the board) might have in mind for the company’s $700 million in cash. Bruce has beaten the S&P 500 by 10% a year for the last fourteen years at Fairholme, so he is not going to have to work very hard to find something that will beat the 2.4% return the company is now getting from their $565 million. On their 3rd quarter conference call, management repeatedly refused to discuss how they planned to use the proceeds of the sale of the timber land, so we will just have to wait and see what happens to the cash once the sale is closed in the first half of 2014.

Currently, the company has very little in the way of revenue and earnings from the bits and pieces of real estate they sell each year and from their resort operations. Probably it is this apparent inactivity that keeps the shorts interested, valuing the company on the basis of its earnings only.

St. Joe Company has started to develop some recurring earnings from commercial rental property. Currently under Construction is a $60 million 360,000-square-foot shopping center located across from Pier Park Lifestyle Center on US-98 east of the State Road 79 intersection. The Pier Park North shopping center’s anticipated opening is Spring of 2014. Tenants will include Bed Bath & Beyond, Rooms to Go, Shoe Carnival, Men's Wearhouse, Mattress Firm, Dick's Sporting Goods, Michaels, Pier 1 Imports, and Kirkland's. The property is being developed by a joint venture in which St. Joe will hold a 75% interest.

Market Comment

So far in the fourth Quarter we are having trouble keeping up with the market averages. This is mostly because Berkshire Hathaway topped out in July and has not been participating in the rally since then. The good news is that Buffett’s buyback price is currently about $103, so there is not much downside risk in the stock.

The market has moved on to more speculative stocks. The Russell 2000 (small Companies) and the NASDAQ have both outperformed the S&P 500 in the third and fourth Quarter. This shift to small stocks is typical of the late stage of a bull market, as Managers with a 12 month horizon (about the length of time it takes their customer’s money to grow feet and get ready to leave) begin to play catch up. This activity sends the money invested higher and higher up the risk scale, and means that what they do catch up now they will lose quickly in the next correction.

Timing that correction is difficult because it depends largely on when the FED starts to tighten and interest rates start to increase. Even though the FED has delayed the end of QE three, long term interest rates bottomed in July and have begun to creep back up. So, the end of the easy money may not be as far off as the FED would like to believe.

With 30% cash in our accounts we will continue to under-perform the market as long as the rally continues, but we expect to get that underperformance back as soon as the market corrects.

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