Portfolio manager’s Letter May 2011
This story begins last October when David Einhorn of Greenlight Capital recommended the short of St Joe Company at the Value Investing Congress in New York. While conceding that the stock might go up in value if the St Joe Company’s property development plans proceeded smoothly, he used 119 slides to show that both sales and development had slowed to a crawl based on the current and foreseeable future.
Einhorn’s presentation was very detailed and appeared well done. It contained all of the obvious things like the fact that lots that were selling for $350,000 in 2007 were selling for $125,000 in 2010 and with sales volume is a fraction of that in 2006.
None of this would appear particularly startling in view of what we already know about real estate in Florida. However, his main contention that St Joe Company should give up the real estate development business and return to being a timber company would seem to border on being a bad joke. His contention is that it costs more to develop the real estate into buildable lots than the lots are worth flies in the face of the fact that the state has grown from nothing to 18 million people in the last sixty years.
Granted the panhandle is not South Florida, and the winters get cold; but South Florida is full, and people still like to live near the beach. St Joe Company owns 574,000 acres of the Florida Panhandle, 70% of which is within 10 miles of the beach, Einhorn dredges up a lot of numbers to support his contention, but the notion that growing pine trees that can be turned into pulp and 2X4s is the highest and best use of all of St Joe Company’s land seems to me to be nonsense.
Actually, the story starts in 2007 when Bruce Berkowitz started buying St Joe Company for his Fairholme Fund. Fairholme Fund now owns 30% of St Joe Company and Berkowitz has taken over as Chairman of the board of St Joe Company. The Real Estate is St Joe Company’s only significant asset. At today’s prices Mr. Market is saying the St Joe Company’s Real estate is worth about $3,500 an acre. Einhorn says it’s only good for growing pine trees and is only worth $1100 an acre.
Berkowitz is traditional value investor and bought his position at prices higher than today’s. As a value investor, he would have bought with a margin of safety so he must feel that the land is worth considerably more than $3,400 per acre. So, we have two very smart guys but they cannot both be right. St Joe Company is either undervalued or overvalued; it cannot be both.
While the St Joe Company has shown an operating loss for the last three years, it has been able to build its cash position from $24 million at the end of 2007 to $216 million at the end of 1st quarter of 2011. At the same time, it decreased debt from $541 million to $29 million even as its annual revenue has dropped by 73%.
In 2010, St Joe Company’s total revenue was about $100 million, granted a significant decline from $500 million in 2006. Still, it seems to me that St Joe Company would have been a better short at $85 in 2005 than it is today at $25. With a positive cash flow and a strong balance sheet in the face of a terrible real estate market, it seems like it would be easy to find a weaker company to short.
Of 2010’s $100 million in revenue only about 39% is from real estate sales with most of the rest coming from resort club revenues which have been fairly stable over the last three years, and timber sales which actually showed a small increase last year.
In the face of this, at his Value Investing Congress in early May, Whitney Tilson joined Einhorn and announced that his biggest short position was St Joe Company. As a rationale for this position, he regurgitated some of Einhorn’s presentation from last fall’s Congress, outlining problems at WindMark Beach. This residential subdivision is one of fifteen subdivisions that St Joe Company has developed in which they are currently selling lots.
The company’s figures indicate that total revenue to St Joe Company from WindMark Beach last year was something less than $150,000 or about two tenths of one percent of the company’s 2010 revenue – not something that I would want to base any kind of investment decision on. It would like basing a decision to short Berkshire Hathaway solely on that fact that See’s Candies was having a bad year.
In addition to these active subdivisions, St Joe Company has approval from state and local authorities for thirty more subdivisions in Florida. All told St Joe Company has received approval for the development of 36,257 residential units and 900 + acres of commercial property. Conveniently, in this context, the Florida Legislature recently repealed Florida’s Growth Management Law.
This regulation was restrictive and expensive in that it required that all Florida development plans be reviewed in Tallahassee. This repeal should have a positive impact on the intrinsic value of Florida Real Estate by making it easier and cheaper to start new developments.
While it is not clear that any of its projects is likely to generate strong cash flow in the next few years, it is clear that David Einhorn and Bruce Berkowitz have very different opinions on the Value of St Joe Company’s Real Estate.
On May 5th, the company reported first quarter results which included the sale of 22 residential lots for an average of $95,000, a 1.2 acre commercial lot for $192,000 per acre, and 98 acres of rural land for $28,000 per acre. While the St Joe Company’s revenue from lot sales was a fraction of what it was three years ago, it did manage its first quarterly profit in a while. The sale of the rural land for $28,000 per acre would seem to place into question Einhorn’s $1100 per acre valuation for St Joe Company’s real estate.
In addition, St Joe Company sold timber rights in the first quarter to 40,975 acres for $1,365 per acre. For its $56 million, the purchaser gets to harvest the trees that are on the land, but once the timber is cut, the land reverts to St. Joe. While this transaction helps to establish the value of the timber on St Joe Company’s property, it certainly also makes Einhorn’s estimates look silly.
St Joe Company’s first quarter profit was largely the result of this onetime timber sale. As a result of the sale, the Company’s revenue for the quarter was $73.4 Million, against $13.3 million for the first quarter of last year, and $100 million for all of last year. Earnings for the quarter were $0.15 per share compared to a loss of $0.13 last year, and this marks the first quarterly profit for the St Joe Company in three years.
I attended the St Joe Company’s annual meeting on May 17th at Watercolor Florida. While there was no new news at the meeting, Berkowitz did indicate that trying to value St Joe Company on the basis of what was happening in one subdivision was not a proper way to value the whole company. He was generally very upbeat of the St Joe Company’s prospects, and said that sales at Watercolor for the first week of May where the best in the history of the development.
I took this to mean that he was referring to resort revenues, and it did appear that area was very busy. Watercolor is a very upscale beach front resort on the Gulf of Mexico between Destin and Panama City. The resort is very nice and the beaches along the gulf in this area are among the nicest in Florida.
I spent a good deal of time driving the area and it is obvious that a lot of St Joe Company’s land is very rural, and some of this has very little development potential. On the other hand, their beach front property is extremely valuable and their 70,000 acres around the new Panama City Airport has potential for commercial and industrial development. While the airport is in the country now, it is only a few miles from West Bay, a large body of water that opens to the Gulf and includes the Port of Panama City. Most of the land between the airport and the bay is owned by St Joe Company.
In addition to beach front property, St Joe Company appears to own quite a bit of waterfront property on this bay and around Port St. Joe. They also own lakefront and river front property throughout this area of the state. Currently they have developments open in Tallahassee and in Jacksonville.
St Joe Company owns a lot of land, but there is a large difference in the value of different pieces of their land based on the land’s eventual highest and best use. I don’t see that Einhorn’s estimates are of any real value as they considerably understate the worst case estimates. If I had to guess I would say that Mr. Market is valuing the land at a sizable discount.
From his recent comments and action, it appears the Berkowitz is more interested in the potential for development around the new Panama City Airport than in the resort property (This may in part explain the recent changes to the board of directors). Attached is a map that shows St Joe Company’s property in 2003. The airport is located in the West Bay Sector Plan, and it appears that St Joe Company not only owns all the property around the airport, but most of the land between the airport and Watercolor.
The State of Florida has plans to build a four lane high way to connect the airport to I 10 and the port of Panama City. The State has also spent money on converting the port of Panama City to handle container shipping.
What we can say with reasonable certainty is that the St Joe Company is at the mercy of the real estate market in Florida and so their revenue is not likely to return the level of 2005 anytime soon. But their balance sheet is solid, something that probably is not true for a good deal of their competition. Management has done a very good job of reducing the St Joe Company’s debt and cutting overhead and the company seems to be in good shape to weather a prolonged slump.
Real estate will recover, thought it may take longer this time. With Berkowitz in charge of St Joe Company’s very valuable assets the long term prospects for this company would appear to be good.