One of the highest-flying office REITs has fallen to earth. Los Angeles-based Maguire Properties [NYSE: MPG] announced on December 11 that it formed a special committee of its board to pursue strategic alternatives to its business. But a new report by Citigroup analyst Jonathan Litt casts a long shadow over the timing of the firm’s moves.

In the days following the announcement, Citigroup conducted a detailed sensitivity analysis of the company’s net asset value (NAV). The conclusion — “In our best case scenario there is not enough upside in the shares to warrant changing our rating (Sell). Furthermore, the analysis reinforced our Sell rating on the shares.”

According to Litt, an inhospitable capital market, deteriorating fundamentals and downward pressure on real estate valuations are all negative factors. While another REIT might make a worthy suitor, Litt doubts that an existing public company would want to sustain the dilution to earnings that would come given the large chunk of McGuire Properties valuation that is tied up in non-income producing assets — land, development and vacant space.

“Our NAV analysis shows that even under an optimistic scenario, investors would only achieve pricing at the current stock price in a takeout, with considerable downside in the event a deal does not go through,” says Litt.

Over the past year, McGuire’s stock has traded in a wide range, from $21.95 to $44.69. The day after the Dec. 11 announcement, trading volume doubled and the stock jumped more than $3 a share.

“Shareholder value is at the heart of our responsibility as board members,” says Walter Weisman, chairman of Maguire’s special committee. “We intend to look at all reasonable strategic alternatives which serve that goal. At the same time, we are prepared to wait if the time and opportunity are not right.”

Litt compares Maguire’s pursuit of strategic alternatives to a similar strategy undertaken by Fort Worth-based Crescent Real Estate Equities. That analysis also resulted in a “sell” rating. After a five-month restructuring period, Crescent was purchased by Morgan Stanley Real Estate in August for $6.5 billion, the equivalent of $22.80 a share. The purchase price was 12% higher than Crescent's prior 30-day average closing share price.

Citigroup’s recent analysis factored Maguire’s income at the start of 2008, the value of its vacant space, construction in progress, value creation for the in-process developments, and value for the lone hotel asset and management company. The end result was an NAV of $16 to $30 per share. That’s not good news when the midpoint of that range is well below Maguire’s most recent closing price — $28.67 on December 18.

Maguire is also highly leveraged with 80% debt, and the report recommends cutting the dividend immediately to conserve capital in a liquidity-strained market.

“Overall, a management-led buyout or private equity deal may prove difficult in the current environment given the inability to secure the debt financing to take it private,” says Litt. “While a hostile M&A transaction is not out of the question, practically speaking, it is very difficult to accomplish, given [CEO Maguire’s] 16.6% stake in the company, and his tax protections limiting the ability of many of the assets to be sold.”

There are several caveats to Citigroup’s analysis. A buyer could accept a lower initial return, and even a 25 basis point lower cap rate (5.25% vs. 5.50%) would equate to a $4 per share change in NAV. Also, market fundamentals in Orange County and downtown Los Angeles could improve faster than Citigroup’s expectations, driving better leasing activity and leading to higher cash flow, earnings growth and asset value.

We’ll keep you posted as this story develops.