The Rude Awakening
Baltimore, Maryland
Friday, October 27, 2006 ---------------------------- - Where one bubble bursts, another begins – hunting real estate growth abroad,
- A seasoned crisis investing specialist guides you through the "Paris of South
America,"
- The painful cost of lost opportunities…rolling in like perfect, unsurfed waves…
---------------------------- Eric Fry, reporting from a destination in the East… Two days ago your editors – both senior and junior –boarded a jet from
Orange County, California to a distant locale in the East. Five hours later we landed in Newark, New Jersey. We might have
preferred a destination further east, like Paris or Prague…or maybe further
east still like Phuket or Papeete. But our travel itinerary featured business, not pleasure. We are en route to
Baltimore for the monthly "editorial meeting" – the forum in which we
present, discuss and debate investment ideas. The list of attendees will include names that most Rude readers will
recognize, like Chris Mayer, editor of Capital and Crisis and Addison
Wiggin, co-editor of the daily Reckoning. These guys, along with the rest
of the crew, rarely fail to present terrific investment ideas – most of which
appear shortly thereafter as recommendations in their respective
investment letters. Often, these meetings feel a little bitter-sweet. They're sweet because of
the investment ideas they yield for our clients. But the slightly bitter taste
derives of the fact that your editor and his colleagues cannot own any of
the recommendations until 48 hours after an editor publishes them. During the meetings, therefore, your editor often feels like he's visiting his
favorite restaurant with his jaw wired shut. He can smell the enticing
aromas and see the preparations arriving at nearby tables, be he can taste
none of it…until 48 hours later. Or perhaps these meetings feel like watching set after set of flawless 6-
foot waves while sitting on the beach without a surfboard. Isn't that right, Joel? A few days ago, your surf-crazed junior editor slumped glumly on a beach
towel as he watched gorgeous waves rolling in. Since Joel did not have a
surfboard in his possession, he simply watched. "Doesn't it bother you to just sit here and watch those waves?" your senior
editor insensitively inquired. "Yep." Came the response. "I know it would drive me crazy to just sit and watch a volleyball game
without playing in it," your senior editor persisted. "Yeah, well, it's driving my crazy to watch these waves." Joel replied. "Why don't you rent a board tomorrow and go out?" "I think I will," he said… But he never did. Joel missed his opportunity. There will be other waves on other days, but those beautiful waves on
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By Chris Mayer What we have here is an asset story — another case in which you can buy
a bundle of attractive, cheap, hard-to-replicate assets all in one stock.
Unusual, in this case, is that these assets also come with a high-growth
kicker. The company is Inversiones y Representaciones SA (NYSE: IRS), which
means Investments and Representations in Spanish. In either language,
that's a mouthful. So investors simply call it IRSA. The IRSA story begins with Eduardo Elsztain, IRSA's current chairman, a
crisis-tested Argentine with a nose for the best in Argentine real estate. I
say "crisis-tested," but perhaps that is redundant. Any Argentine
businessman operating since 2001 and still in business today is, by
definition, crisis-tested. But Elsztain has been navigating Argentina's
serial crises for 25 years. 
A college dropout, Eduardo went to work for his grandfather's business in
Buenos Aires in 1981. Here, he got his first bloody nose in the rough-and-
tumble world of an Argentine crisis. The decade would prove disastrous
and ultimately bankrupt the family business. Elsztain nursed his wounds in
the relative calm of New York, heading there in 1990. He was determined
to return, though, convinced of the opportunities in Argentina in the wake
of that crisis. Then, the story takes an amazing turn. While in New York, Elsztain got
the ear of billionaire superinvestor George Soros. Elsztain made the case
that Argentine stocks were super cheap. Convinced, Soros gave Elsztain
$10 million to buy beaten-down Argentine stocks. Elsztain headed back to Argentina and bought IRSA for $120,000. It was
not much more than a shell company, but it had one valuable commodity
— a listing on the Buenos Aires Stock Exchange. Then Elsztain began his
buying spree in earnest. When the stock market soared over the next two
years, Elsztain took the profits and reinvested them in cheap real estate.
The properties were throwing off 20% in cash-on-cash returns. Elsztain
kept reinvesting and Soros kept backing him. Soon, IRSA had amassed an
impressive portfolio of real estate. But Elsztain didn't just sit tight. He had the foresight to sell a lot of those
properties in the late '90s as things were heating up in the country. So by
the time the 2001 crisis rolled around, IRSA was sitting on a fair amount
of cash. Still, the severity of that crisis left no company unscathed. IRSA generated
losses in 2000, 2001 and 2002. Yet the company survived, and it was in
good position to resume development activities once the economy
improved. In its darkest days, in the summer of 2002, IRSA shares changed hands at
$3.95 — down from about $30 at its peak. Today, even though the stock
has tripled from its all-time low, it still sells for less than half its all-time
peak. As the nearby chart illustrates, IRSA's share price has been trailing
well behind the Argentine Merval Index. But we expect a reversal of
fortunes! 
IRSA owns a diverse portfolio of real estate in Argentina. It owns a
portfolio of office property in and around Buenos Aires. The crisis had a
big impact on these rental properties. As the peso lost value, so did
IRSA's rental leases. Elsztain reports in his latest quarterly missive on the
improvements in this market since the crisis: "During fiscal year 2006, our offices showed a significant recovery in
occupancy rates, with rising rental prices… While in 2000, our premium
offices rented at US$28 per square meter, during the crisis, these values
plummeted to US$7 per square meter per month. At present, we are
entering contracts at a rate of US$21 per square meter per month for the
'class A' segment." Basic translation: "Our buildings are full and we are charging more to rent
them." Also, financial crises have a way of stopping the creation of new
supply. No one built much of anything for more than three years in
Argentina. As a result, the quality "class A" sort of space IRSA specializes
in is in short supply. Occupancy rates are 94%. That's good. And Elsztain
reports, the future looks still brighter: "The future of this sector is highly
promising, as the new agreements are expected to reach values close to
US$30 per square meter for 2008." Real estate is a business with a lag effect. IRSA's leases are for 36-month
terms and numbers don't show the full effect of the Argentine recovery —
yet. As old leases expire and new ones come on at the higher rates, cash
flow should rise. IRSA also has a portfolio of shopping centers it owns through a publicly
traded subsidiary, Alto Palermo. These properties enjoy occupancy rates
of 99% — nary any empty space at all. There are also three luxury hotels,
consisting of nearly 700 rooms. Occupancy rates are about 78% and
rising. Hotel rates increased 18% year over year. Tourism returning to
Argentina boosted the hotel business. As cheap as Argentina is as a place
to visit, this trend should continue. Along with these properties, IRSA maintains a healthy development
pipeline of apartments and residential communities available for sale.
In this mix, IRSA also owns a considerable stockpile of land — about
2,500 acres. Some of this land lies in choice locations in Buenos Aires.
For example, about 7.2 million developable square feet is located in a
parcel called Santa Maria del Plata, which is adjacent to Puerto Madero.
Recall from above, The Wall Street Journal reports property in Puerto
Madero going for $280 per square foot. If you use the $280 on 7.2 million
square feet, you get a rather absurd number of $2 billion — which is more
than 3 times the enterprise value of the whole company! (Think of
enterprise value as the price to buy the whole company outright — market
cap plus debt less cash.) OK, so Santa Maria del Plata is not Puerto Madero — and there is nothing
built on it at the moment, nor does IRSA have permits to do so. Discount
for all that — say the land is worth only $100 per square foot. Even at this
price, the land alone is worth what the whole company is trading for in the
market. If you were to go through and value each of IRSA's real estate properties
and sum them all up — you'd get some high numbers. Certainly, you'd
get a number some multiple of book value. Currently, IRSA trades for
little more than book value. Book value is an accounting convention that
reflects the cost of these properties. So it dramatically understates the
value of its real estate. The Santa Maria parcel alone, for example, is on
the books at a mere $39 million. By this measure, IRSA is about as cheap a real estate stock as you'll find
— especially in an economy of Argentina's size. And IRSA has put up growth numbers that need little translation. Sales
were up 56% in fiscal 2006 (ending June 30). That follows a 41% increase
in 2005. Shares change hands in today's market for around 16 times 2006
earnings. Again, you've got more upside as leases roll over. It's an asset
play with a growing cash stream plugged into it. IRSA is also in good financial shape, with little debt and ample cash.
Ratings agency Fitch recently upped IRSA to the coveted status of
"investment grade." The risks here are as obvious as they are unavoidable. In IRSA, you
assume some of the risks of investing in a volatile emerging market. Less
obvious, perhaps, is a murky corporate governance issue. IRSA and
Cresud (an Argentine agribusiness) and the Elsztain family interests
intersect in ways that open the possibility of deals made at the expense of
one for the benefit of the other. However, the cheapness of the shares and the pile of assets backing the
stock make up for these warts, in my view. Plus, we are investing in a
market still recovering from one of the worst financial meltdowns the
Western world has seen in the last quarter century. So it seems likely that
such a youthful recovery has legs yet. IRSA has many things I like: tangible assets that sweat (or that throw off
cash and increase in value over time), a strong financial condition and a
cheap share price. What we have here is an asset story…with a high-growth kicker. ---- International Investment Special ---- A one-time opportunity to turn every $2,600 you invest into
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