MAC Development Corporation – HBS Case Study Essay
The McCaffreys are in a sticky situation as they have tied up land for a development project and everything seems to be falling apart. They have deadlines to meet and so many moving pieces that I had to read the Case Study several times to wrap my head around it all. At the start of the Phoenix project, there were basically three main puzzle pieces the McCaffreys had to juggle. The first one was the Village of Woodland, where the land was located, had verbally agreed to give $4. 1 Million in subsidies to the property for improving a community eyesore.
This was a huge upside for the project initially, but the project and this $4. 1 Million still had to be approved by the board to be official. It was not guaranteed money yet. The second puzzle piece was with their loan. After a lower than expected appraisal on the project, Bank One lowered their loan offer to $2 Million and said MACD had to get a $500,000 line of credit from another source for them to issue the loan. In addition, the loan would not be approved until MACD had a signed purchase and sale agreement for one of the buildings. The last puzzle piece was regarding the purchase of the land itself.
The land owner was a tough negotiator, and after 9 months of haggling, the two parties were still $75,000 apart in the purchase price. Colleen acknowledges at this time that the risks were high but so were the rewards. It was crucial that they didn’t make a mistake. By the end of the case the odds start stacking up against MAC Development. In addition to the initial risks, more complications begin. Harwich Bank and Trust backed out of their agreement last minute for a $500,000 line of credit claiming Bank One had already claimed all the collateral. Then MACD found a client to buy the first building but the Village turned them down.
Then the broker they hired to find new buyers wasn’t finding anything or working very hard, as development deals take more work and time to get paid a commission. They were feeling understaffed and contemplated hiring Jim, the youngest McCaffrey to work on the deal. The September 11, 2001 terrorist attacks shook the country and would undoubtedly start a recession. The company had invested two years of their time and energy as well as $311,500 of theirs and investors’ money they risk losing should they choose to scrap the project. Their risks were interrelated and with a recession coming, there wasn’t room for error.
Dick has been overly optimistic about the project in my opinion, giving most of these factors the benefit of the doubt. The $4. 1 Million subsidy package was verbal which in business is good for nothing. He and his team saw dollar signs when they found cheap land with free government TIF money on the table and started putting in more time and money until they found themselves here. He has different risks contingent upon other risks such as the Bank One loan requiring a purchase and sale agreement but the Village of Woodland having power to deny the purchase and sale agreement of any potential buyers.
With that said he has done a decent job managing what he could, and no one can see when market crashes come. Sometimes developers are left sitting with a project like this and in a tough spot. Perhaps they should have had other deals in the pipeline they could choose instead of having all the team’s time and his investors’ money in one deal. Though he has past experience dealing with such issues, he should not have let his team become so invested. He needs to decide if he should jump ship or go full-speed ahead. What’s worse, to lose 300K or lose a multimillion dollar vacant business park to the bank because you can’t make the payments?
His comments at the end sound desperate and emotional rather than logical: “When you don’t have any money and you find yourself ensnared, it’s either win or go bankrupt. We often wonder, if we were wealthy people, would we have risked all that time and money? Sometimes it starts to feel like the only option is to move forward. ” The project has an overall IRR of 47. 7% under the given assumptions. And the investors may not know just how unsure these assumptions are. The odds that the project will go as planned and the cash flows are as projected are pretty close to zero in my view, especially with all that can go wrong.
The total return is divided up into 3 classes of investors: A, B, and C. The A Class investors take on the least risk by taking a guaranteed return of 25%. They are the first to be paid from the cash flows, and once they are paid their 25% they are considered paid in full and withdrawn from the investment. Each group that allows their cash to be used as working capital gets a bonus return. After the bonus, class A receives an overall IRR of 30. 63% return. Class B is guaranteed a return of 20% and splits some of the development risk with MAC Development by taking 32. 4% of the future cash flows.
After 12 years when the government tax refunds expire, the Class B investors make a 36. 95% on their money. The third class of investment is Class C which is the McCaffreys. Their position is unique because not only their equity investment is considered, but all of the time the team spent on the project. With all of this valued in, Class C was structured to take an 18% guaranteed return, getting paid last but getting 67. 6% of all future cash flows. Because of all their time and energy put into the deal, as well as bearing the brunt of the development risk, the McCaffreys pull in an IRR of 88. 9% for their money contributed. Over 12 years they will make $2,651,499. These are obviously great returns for everyone if the project goes according to plan. The purchase price of the land affects the return, but not significantly. This will be discussed further below. With time running out and so much to do, there is little room for error and the McCaffreys must act fast. The most effective ways to spend their time with the Village will be to try to persuade them to allow the current buyer they have lined up. They really need to sell them on his trustworthiness, quality of business, jobs, etc.
Dick must also explain to the Village that due to the September 11 attacks, the economy is sure to face a recession and they will need to be flexible or they won’t be able to move forward with the project at all and the site will remain blighted. As far as finalizing the loan with Bank One goes, they need to get to work finding a $500,000 revolving line of credit as soon as possible. In the meantime they can negotiate to get that number down to perhaps $250,000 with Bank One. A recession has potential to bring down interest rates which could be one upside to the current events.
They could begin exploring other banks’ offers for the project. Perhaps find a 75% LTV loan? As far as the final purchase price, Dick needs to be careful because in the grand scheme of things, $75,000 is not going to kill the deal. Dick needs to be prepared to pay the seller’s asking price so they can cross that off the to-do list and focus on bigger things. I would recommend accepting the current price, but contingent on the seller contesting and fixing the current land valuation issue they’re facing. This affects the subsidies which are a huge part of the cash flows. Finally, the McCaffreys need to get to work finding another otential buyer of one of the buildings just in case their current buyer is rejected again. Even if they get the first buyer approved, it can only help the investment if they have multiple buildings sold. This will also help affirm the projections and help everyone feel more settled. The McCaffreys can still save this. They need to focus their efforts, be confident and fast-acting. However, if they fail, they face a far greater loss than the $311,500 currently invested. They need to think realistically and logically. Not emotionally. Either way I think Dick McCAffrey is right, under the current circumstances, it’s either win or go bankrupt.