Inland Western remains highly levered and operating earnings continue to be depressed. In a sign of just how unhealthy its fundamentals are, Inland Western slashed its dividend by 90% and suspended its share repurchase program indefinitely. Consequently, the only current means for shareholders to get their cash out is through an extremely thinly traded secondary market, or to accept one of two tenders that offer $1.50/share (CMG Acquisition) or $2.30/share (REITCo). Given these tenders, why does Inland Western's letter claim the shares are worth $6.85? And if they're not worth $6.85, what are they really worth?
The best way to objectively value Inland Western shares is to use Inland Western's own financial results. Using their own reported results and a few simple mathematical excercises, it's clear that the shares are not worth anything close to $6.85. In fact, Inland Western's reported book value, based on their September 30th 2009 10Q (attached below), is only $5.19/share. One can easily arrive at this number by dividing total equity ($2,501,384) by total shares outstanding (481,164). Both of these numbers can be found at the bottom of the consolidated balance sheet on page 1 of the attached 10Q. It's certainly possible that a REIT could trade above book value, but that's not likely in Inland's case.
Nevertheless, book value is an imperfect measure because it ignores prospective earnings ability. So what would the share price be if one were to account for the cash flows generated by Inland's huge portfolio? It's possible to quickly calculate a very close and very accurate estimate by using Inland Western's reported Funds From Operations ("FFO"), which is reported on the bottom of page 49 of the 10Q, and then applying a market-based FFO multiple. In terms of calculating FFO, it's simple. Inland Western is reporting annualized FFO of .34/share as of September 30th 2009. The math is: (($122,696/9)x12)/481,164.
Determining the appropriate FFO multiple is more art than science, but that isn't difficult either. The trick is to compare Inland to its peer group, and I have done just that in the below chart. The chart shows the closing price and FFO multiples (far right column) of 36 publicly-traded REITs as of January 21st, which is conveniently the same date as the Inland Western shareholder letter.
Based on the average 2010 FFO multiple of these 36 publicly traded REITs (14.3x), Inland Western could be worth $4.86/share. However, using the average 2010 FFO multiple of 36 publicly traded REITs is far too generous; this multiple actually needs to be discounted, and that means Inland Western is worth much less.
- REIT FFO Multiples
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There are several reasons to discount the multiple. First, Inland Western is completely illiquid. You could not sell it without great effort, assuming you could manage to sell it at all. Second, Inland Western offers a paltry divided yield of 1.3%, which is 70% below the average dividend yield of these 36 REITs. Furthermore, Inland has a portfolio concentration in retail assets, so it does not deserve the benefit of the higher FFO multiples given to public REITs with better performing assets in stronger markets. Moreover, based on the silly valuation included in the January 21st letter, the veracity of management is, shall we say, subject to scrutiny.
So Inland Western clearly warrants a discounted FFO multiple, and one that is much more closely aligned with highly levered REITs with large portfolios stuffed full of retail properties. Based on this logic, a much more applicable FFO multiple would likely range from a low of 5.3x (GGP, a large mall owner, highlighted in red) to a high of 10.6x (MAC, a large owner and manager of retail properties).
This would translate into a value of $1.80 to $3.60 per share at most, which is far from management's ridiculous estimate of $6.85, but much closer to the real value of the shares based on actual earnings and current market multiples. An even more accurate estimate can be derived by using the forward FFO multiple of Developers Diversified Realty (DDR). DDR bought Inland Retail Real Estate Trust, a very close cousin of Inland Western, for $6.2 billion in February 2007. DDR now trades at an 8.0x forward multiple, which indicates that Inland Western is worth no more than $2.72 per share.
Non-Traded REITs have never been known as hallmarks of transparency, but Inland Western is leading the race to the bottom with its January 21st letter. Worse, if you are participating in Inland Western's Dividend Reinvestment Program, you are being sold shares at $6.85 per share. This is at least twice what the shares appear to be worth.
January_Letter_to_Shareholders.pdf- January 21st shareholder letter
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