As part of our ongoing “Cash is a Liability” series (available here), we’ll present a fairly well-known investor and billionaire who appears to actually agree with us (that cash is not a liability even in the current no-return-on-cash-reserves-environment and, in reality, it provides tremendous future investment optionality).

Sam Zell, whose net worth approaches $5 billion, and who is the Chairman of many publicly-traded real estate companies, has had what some may contend is a rather remarkable investment career – if his amassment of several billion dollars of net worth is not convincing enough. He has achieved much of his financial success acquiring distressed assets, even earning the self-proclaimed nickname “Grave Dancer”. Not all of his conquests were in real estate. He purchased a number of distressed bonds in various industries following the collapse of the Tech Bubble in 20001.

He also partnered with Marty Whitman (of Third Avenue) in the takeover of Danielson Holding Company in 2003. That shell company, which owned substantial net operating loss carryforwards, eventually acquired, out of bankruptcy, the waste renewal/energy business of Covanta – leading to the formation of Covanta Holding Company. When he took control, along with Third Avenue, of Danielson in 2003, this former insurance company traded for not more than $1.50/share. Covanta, in which Mr. Zell is still the Independent Chairman, now trades for $14.68/share, a 19% annualized return over this 13-year period. Not bad.

These days, Mr. Zell is still most widely recognized for his various real estate investments. One such is Equity Lifestyle Properties (ELS). This company owns and operates recreational properties, such as recreational vehicle campsites. Over the last five years, Equity Lifestyle Properties has compounded its earnings per share at a rate of 48.1% annually. Compare this to a few of the largest real estate investment trusts, Boston Properties and Simon Property Group, which are otherwise well-managed companies that own high quality properties. As demonstrated in this table, Mr. Zell is certainly not embarrassed of his recent track record, even though the others have also performed well during this period.

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These qualifying remarks about Mr. Zell are important for the following reason. He assumed the Chairman role of Equity Commonwealth (EQC) in 2014. While this is not an owner operated company in the purest sense, as Mr. Zell and his family own only 2% of the shares, he undoubtedly has tight managerial control by virtue of his Chairmanship position. Equity Commonwealth owns a number of office properties in several states. It currently owns 45 properties comprising 20.7 million square feet, 90.3% of which is leased.

Since he assumed management, his actions, in the current environment, are truly extraordinary. Equity Commonwealth has been selling assets, and building cash reserves. In 2015, the company sold 91 properties, or 18.9 million of square feet. Through the first six months of this year, the company sold 16 properties, or 2 million square feet. In less than two years’ time, Equity Commonwealth has shrunk its property portfolio by more than 50%. Based on Mr. Zell’s public comments, the company is not done selling either.

Why is Sam Zell selling while most everyone else is buying? REITs in particular have benefited perhaps more than any other industry in the last five years from low interest rates. Cheap debt and high equity valuations have enabled this industry to expand at a more than brisk pace. Yet, Mr. Zell is retrenching.

As of June 30, 2016, Equity Commonwealth had $1.8 billion of cash and $4.9 billion of total assets – cash is now 36% of total assets. Debt is less than 50% of shareholders’ equity. This is a most unusual corporate posture. Using the aforementioned examples – Boston Properties and Simon Property Group – as a benchmark, this high level of cash and modest debt load is certainly unconventional by a very wide margin.

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Notice the valuation divergence – who can ignore it? Equity Commonwealth trades barely above book value, while the others – well, it’s obvious. Clearly, today’s investor punishes a company that avoids high valuation acquisitions and, instead, is building cash for future opportunities – even though it earns little income from it in the interim. As the title of this series indicates, cash is indeed a liability in the minds of most investors. And, those companies that remain fully invested, even though the investments made today at large premiums to book value could erode long term shareholders’ equity, are rewarded with a high multiple.

This is not a recommendation to buy Equity Commonwealth. But there is a reason Mr. Zell is not investing his company’s cash. In a recent Bloomberg interview, he explained that the cost of holding cash has never been lower, and the optionality of that cash, by extension, has never been higher. If he is correct, and the cavalier purchase of assets by the real estate industry at these valuations ultimately produces distressed opportunities (and they almost always do), the optionality afforded to him vis-a-vis ample liquidity will serve his investors well. The others? Perhaps not so pretty.

-Published September 29th, 2016


Also Read “Cash as Liability” Commentary

1http://www.wsj.com/articles/SB1009142765484601320


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