Dreamland in Rio Rancho

**lzhang** Fri Jul 20, 2007 1:36 am

Dreamland in Rio Rancho
Dreamland in Rio Rancho

Introduction

AMREP Corp. (AXR) came to our attention from a message board (mitbbs.com). The price of its stock collapsed from an all time high of about $150 early this year to below $50 recently. Is AXR just another inflated bubble worth nothing? Is the dramatic valuation change justified? Just this Monday (July 16th), its board announced a special cash dividend of $1 per share payable on Aug. 24 to shareholders of record at the close of business on Aug. 10. Its ttm PE is about 6.7 and ttm earning is $7.4. All of these simple facts are very intriguing and it sounds like something worthy of studying.

Overview

AXR was founded in 1961 and it has primarily three business segments: the Real Estate business operated by AMREP Southwest, Magazine Fulfillment Services and Magazine Newsstand Distribution Services (through Kable Media Services, and its subsidiaries, etc.)

Most of its Real Estate business activities are conducted in the City of Rio Rancho and certain adjoining areas of Sandoval County, New Mexico. The company purchased 91,000 acres of lands in Rio Rancho (which is essentially the whole city) more than 40 years ago. Its current land inventory is about 17,000 acres. Rio Rancho is the third largest city in New Mexico with a population of approximately 76,000.

Through Kable, the Company (i) performs fulfillment and related services for publishers and other customers and (ii) distributes periodicals nationally and in Canada and, to a small degree, in other foreign countries. Currently it is the second largest provider of subscription fulfillment services to magazine publishers in the US.

Current problems in the housing market cast pessimism and the pessimism is one of the reasons for the recent price depression. Its magazine fulfillment and distribution services are not particularly interesting to investment public, if you think about the information distribution channels are shifting to internet. But this kind of pessimism might be the place you can find values.

First of all, we see the company is in very good shape. Its debts are about $32M and its lease obligations about $24M, a total of $56M obligations. As of April 30, 2007, it has $42M cash, $12M investment assets, $40M other Real Estate Properties (excluding those in Rio Rancho), $30M PPE, etc. In fact, its real estate properties in Rio Rancho were purchased so long ago that their value does not show much on the balance sheet.

Rio Rancho

As of fiscal year 2007, the company sold a total of 1,051 acres of lands, of which 194 were developed and 857 undeveloped. The average revenues are about $91K/acre with $284K/acre for developed and $48K/acre for undeveloped. It is hard to project its future revenues for land sale, but we can have some kind of rough estimation. Usually the undeveloped lands require very few further investment and we can take the sale price as close to its profit (net of tax). The per acre revenues for fiscal year 2007, 2006, and 2005 are $48K, $26K, and $15K, respectively. With the housing market is cooling down in the area, it is hard to project if the sale price is going up and for how much. But as the city and its population are still growing, it is hard to project the sale price is going down too much, either. For now, if we assume the operating profit is about $48K/acre, and 30% tax rate, we have about $34K/acre net profit (or net value here). For the about 17,000 acres lands the company current owns, 6,500 acres are either contiguous large blocks or with high percentage ownership of individual lots, so those lands can be easily sold or developed without much capital investment and we give them full valuation. The remaining 10,500 acres of lands are in scattered lots, which the company owns less than 50% of the lots in the area. So we want to give those lands lower valuation. If the sale price is about $35K/acre, the net worth is about $24.5K/acre. Now we have $(34×6500+24.5×10500)K=$478M. The current EV of the company is about $300M, which is about 37% undervalued, just for this part of the whole company.

We should realize that there are many assumptions in this estimation. The future prosperity of the city of Rio Rancho, the ability the management to make reasonable land sales, etc., are very key issues here. If the lands the company owns are not under fire sale, they should appreciate with time. As we think the company is healthy financially, they should have the ability to sell the lands with reasonable price from time to time.

Fulfillment and Newsstand Distribution Services

The business sounds dull, and no growth, but it might be the right business to make lots of money. The magazine subscription fulfillment services and newsstand distribution services should be considered together, as they are correlated businesses. If one subscribes to some magazines, he is unlikely to buy many from retailers; if he do not subscribes to any magazine, he is more likely to buy some issues he is interested in at newsstands. Even now people can get most information from internet, magazines are still part of people's life style. In some cases, people prefer to read magazines, which is part of their leisure time to enjoy.

In the spreadsheet, we have listed its fulfillment and distribution services operation results. Its revenues have been growing steadily from 1992 to 2007. Currently it earns about $1 per share per year from this operation. The company acquired Palm Coast Data Holdco, Inc., a major provider of fulfillment services for magazine publishers and others, for about $95M, with its cash from operation and borrowings, as of November 2006. The deal was done in January 2007. The earnings in fiscal year 2007 were distorted by this M&A. If we added back the amortization and depreciation, $6M, the earnings were just above $1.

Considering the recent M&A, it is reasonable to value this whole part of the company at > $95M, or just 100M to be conservative. If we use PE=10 for current earning, we will have $66M as its market cap for this part of the company.

Value Estimation

Sum all the components up, $42M cash, $12M investment assets, $40M other assets, $478M Rio Rancho lands, $100M magazine fulfillment and distribution business, we will have a valuation of $672M, minus $32M debts, and we should have about $640M left for shareholders, which translates into about $96 per share value. Compared to its current price, about $48 per share as of July 19 2007, we have got a 50% off offer. Nice price.

Uncertainty Evaluation

There are more detailed discussions on various risk factors of the company operations in its recent annual report. Here we mainly focus on the uncertainty of our own value estimation. As we believe, our valuation is very conservative and the fair value we have estimated, $96, is on the low side of many possible outcomes. It might turn out that our estimation is still considerably lower than its true value, if some experts were to give such an estimation, however, we do not think our valuation is without any uncertainty, even if it is more likely to fluctuate upwards than downwards.

For its media services, we would like to give an uncertainty of $40M on the $100M valuation, as different valuation methods give such big difference. The $100M valuation based on recent M&A is extremely low; the PE valuation might be very misleading, given the facts that PE=10 is just an arbitrary number, and that the earning itself might be distorted. Just for simplicity, we use those two methods to estimate the minimum value of that part of the company.

For the valuation of the Rio Rancho lands, we use the average undeveloped land sale price (in its recent annual report) as reference to value its land assets. As we have discussed, there are many assumptions in this estimation. Even we have divided the lands into different types and given some part of the lands a considerably lower valuation, we may still have overestimated its valuation. So for this part, we would like to assign $100M, or about 20%, as the uncertainty of our $478M Rio Rancho land valuation. To view the land valuation downside risk from another perspective, let's look at its land composites at Rio Rancho. As the founder of the city, the company's land portfolios include all kind of lots for commercial, industrial, and residential purposes. Housing market problems can be partly offset by business market. Even facing the housing slowdown, given the fact that the house permits are just about 60% in 2007 compared to the same periods of 2006, its average land sale prices go up compared to last year. The new house prices are stable compared to last year, and the existing SFH prices within Rio Rancho are keeping going up from year 2001 to 2007. (See housing information spreadsheet). Based on these information, we believe our estimation is on its low side of possible ranges.

The $40M other assets are book value of its other real estate properties, etc., mainly at Colorado. Due to smaller valuation, we ignore the uncertainty on this part, even we believe its current valuation is more likely to be higher than its book value.

Adding those uncertainties in quadrature (ignoring correlation between different businesses, which is quite reasonable between media services and real estate in Rio Rancho), we have the overall uncertainty of our estimation as $√(40^2+100^2)M=$108M, or $16/share.

Conclusion and Discussion

By our estimation, we give AXR a valuation of $(96±16)/share. At about $48/share, the price of AXR is about 50% discounted to its value, even we believe this $96/share valuation is still on its low side of business value.

FD and Disclaimer

The author has a long position in AXR, established as of July 18 2007. The position can be changed without further notice.

This is not an investment recommendation to buy or sell any of the securities mentioned therein. All materials presented here are for information purposes only.

References

http://www.sec.gov/Archives/edgar/data/6207/000000620707000013/axr10k07.htm

http://www.amrepcorp.com/

http://www.amrepsouthwest.com/

http://www.kable.com/

http://www.ci.rio-rancho.nm.us/

http://mitbbs.com/article_t/Stock/23346349.html

http://spreadsheets.google.com/pub?key=pBWqCNQoWBZpp7uNOmivXIg

Housing information:

http://spreadsheets.google.com/pub?key=pBWqCNQoWBZruMnQQoCPEdQ

More information:

http://en.wikipedia.org/wiki/Rio_Rancho%2C_New_Mexico

http://www.rredc.org/documents/RR_Overview_January07.pdf

http://www.rredc.org/FullPresentation12_08_06.pdf.pdf

http://en.wikipedia.org/wiki/Albuquerque%2C_New_Mexico

**xxyygorich** Fri Jul 20, 2007 10:17 am

Nice analysis.

What's the reason for the collapse?

In a year the stock changed from 4x -> 150 -> 4x.

**lzhang** Fri Jul 20, 2007 1:09 pm

Hi,

I do not have a clear idea.

Some people claimed `naked shorts' to be the reason to bring it down. In any case, softening housing market is the main reason, imho.

xxyygorich wrote: Nice analysis.

What's the reason for the collapse?

In a year the stock changed from 4x -> 150 -> 4x.

**blast_investor** Sun Jul 22, 2007 11:23 pm

Hi lzhang:

Excellent write up on this stock pick.

Do you have any idea whether the owned land acreage is entitled for sale for zoning purposes?

As I understood, in most cities or towns in USA, any land to be sold to developers (or builders) must be zoned and approved by local governments. To get higher prices, the land must be approved before hand for commercial or residential purposes.

As I uderstood, land zoned for farming purpose has very low value, probably significantly lower value than $35k/acre in your estimate.

In that sense, land zoning or entitlement breakdown is my major piece of concern on your valuation estimation.

**lzhang** Mon Jul 23, 2007 1:40 am

Hi blast,

To my understanding, when the company purchased the lands and made long-term development plan for the city, all the lands dedicated to future home or commercial purposes, 73,725 acres out of the total ~91000 acres, were divided into 114,500 home sites or commercial lots, while the remaining are either for public facilities or unplatted. All the acreages mentioned for valuation are for home or commercial usage.

Even so, it is still quite possible that with the further development of the city, the company or other developers may face more and more difficulties in getting final approvals, utilities, etc., as residents or other political groups may oppose some particular projects, and resources, especially water supplies, are getting more and more scarce.

In any case, this is a main risk factor for those 10,500 acres of scattered lots, because if it wants to sell them for better prices, it might need to purchase some of the adjacent lots, which are at market prices. Once the projects are delayed due to those problems, it may suffer from substantial losses.

blast_investor wrote:
Do you have any idea whether the owned land acreage is entitled for sale for zoning purposes?

As I understood, in most cities or towns in USA, any land to be sold to developers (or builders) must be zoned and approved by local governments. To get higher prices, the land must be approved before hand for commercial or residential purposes.

As I understood, land zoned for farming purpose has very low value, probably significantly lower value than $35k/acre in your estimate.

In that sense, land zoning or entitlement breakdown is my major piece of concern on your valuation estimation.

**blast_investor** Mon Jul 23, 2007 10:27 am

Rio Rancho is suburb of Albuquerque (about 20 miles). Albuquerque is biggest city of New Mexico.

Therefore, Rio Rancho real estate can be considered part of bigger Albuquerque area.

This is extra information for those who are not familiar with New Mexico state.

**lzhang** Mon Jul 23, 2007 1:46 pm

Hi blast,

Thanks for the reminder. I have added more info just for references.

blast_investor wrote: Rio Rancho is suburb of Albuquerque (about 20 miles). Albuquerque is biggest city of New Mexico.

Therefore, Rio Rancho real estate can be considered part of bigger Albuquerque area.

This is extra information for those who are not familiar with New Mexico state.

**blast_investor** Mon Jul 23, 2007 7:19 pm

Value Investor CLub recommendation of short on AXR at $70 in November of 2006:

http://www.valueinvestorsclub.com/value2/VIC/guests/view-thread.aspx?delay=45&id=2530&more=dtrue

It is worth reading from other side of opinion.

**lzhang** Mon Jul 23, 2007 11:07 pm

Hi blast,

Thanks for the link. Let me try to understand what are the points. In any case, it is not hard to find negative comments these days (much newer than this one).

blast_investor wrote: Value Investor CLub recommendation of short on AXR at $70 in November of 2006:

http://www.valueinvestorsclub.com/value2/VIC/guests/view-thread.aspx?delay=45&id=2530&more=dtrue

It is worth reading from other side of opinion.

heffer504 wrote:
Amrep owns a lot of land in New Mexico. Much like California Coastal (CALC)...

I did not study CALC, so I do not want to comment on this too much. But a quick look at CALC, I have two points:

1. It has relatively large amount of debts
2. Its officers/directors are buying these days.

I won't short CALC even as of now.

For the cash and media services part, I do not have much to say. His $70Mcash+$50M media valuation is in line with our $42M cash+$100M media valuation, within my estimation uncertainty ±$40M.

For house starts information, I have a much more updated spreadsheet in my analysis, and house prices as well.

heffer504 wrote:
My basic calculation is as follows: 18,000 acres, 65k/acre, 75% gross margin (has ranged from 40-65% historically), 3% sales commission, 5m overhead/year, 40% tax rate, and a 60% discount factor (assuming they sell the land over the next 12 years, though they’ve said they’ll do it over 20). This gets me to 275m of value, as compared with the 330m ascribed to it.

The catches for his analysis here are:

1. The net profits for fiscal year 2007 were much higher, about $41K/acre net profit as of AXR's latest 10-K. Its 4th quarter profits from land sales were higher compared to these of 2006 on per acre basis.
2. where does the 60% discount factor come from? Do you discount your net worth from your own house that way? The real estate properties will appreciate with time, they will compound by themselves for you! If we took this ridiculous discount factor out, his valuation was in line with ours.

OK, I won't short based on this analysis.

About the softening housing market

I think real estate market is really segmented and localized. From the spreadsheet I have, I do not see the SFH prices in the area are too soft. The price is still cheap for a typical SFH there, compared to average household income, about $70K/year. The population of the city is expected to increase 60% in 3 years from now, to about 125K in 2010.

**lzhang** Tue Jul 24, 2007 1:06 am

I updated the spreadsheet to include revenues from land sales.