Mall the Right Moves

After following a strict diet after the financial crisis, they have, of late, been showing renewed appetites. In the last seven years, mergers and acquisitions had averaged a mere one deal a year among mall REITs. In the last year though, M&A fever is back, and analysts expect the consolidation process in the sector to restart.

While the shareholders of targeted small or medium mall REITs are often more than happy to be absorbed, larger companies are a different story.

Simon and Macerich

Recently, drama unfolded around the missed acquisition of Macerich Co. by Simon Property Group, the largest U.S. shopping mall owner.

It all started in November 2014, when Simon disclosed a 3.6 percent stake in Macerich. Later, Simon proceeded with an initial offer of $91 a share. After being rejected, its “best and final offer” was for $95.50 a share.

Analysts considered the offer extremely compelling—it valued the company at around $23.2 billion, including debt. But it was not enough for Macerich. The company, which is the third-largest U.S. mall owner, fought the acquisition attempt with a so-called poison provision that gave a discount on shares to many shareholders, in order to dilute the would-be acquirer’s stake.

Finally, Simon gave up. In a note released on March 31, the company announced it had withdrawn its offer “in light of the decision by the Macerich board of directors not to engage in discussions with Simon.”
The back-and-forth has left the two companies in uncertain territory.

“Macerich is the only company at the high-end of the [mall companies] spectrum that could be taken out,” said D.J. Busch, an analyst at real estate and REIT research firm Green Street Advisors. At the moment, the main issue for the company, said Mr. Busch, is to prove that its actual value is indeed higher than Simon’s final price tag.

This can be achieved by adding value and improving the operations of the current portfolio. After rejecting Simon’s last offer, Macerich announced it would continue to sell its lower growth properties and set a target to increase operating margins by 4 percent over the next 18 to 24 months.

But not everyone believes in the actual results of this effort.

“We wonder why these initiatives were not adopted prior to Simon Property’s takeover attempt,” Evercore Partners analyst Steve Sakwa told Reuters.

The company’s shares, which reached $94.90 in mid-March, were at $82.90 on May 22. But Macerich’s management seems to believe in a valuation that could be more than $100 a share, according to a letter from Jonathan Litt, founder and chief investment officer of one of the company’s shareholders, Land and Buildings.

“The problem is that the offer looked compelling enough,” said Mr. Busch. He said they’d never know why the deal didn’t work, but that reaching that valuation “doesn’t seem feasible.”

Land and Building, a Stamford, Conn.-based investment manager, and Orange Capital, a New York-based investment manager that is also a shareholder of Macerich, publicly questioned the decisions and offered to help to find an agreement.

In the meantime, Simon is apparently trying to move on. “We put what I felt was an unbelievable, helluva an offer on the table, and I obviously tried very hard to engage,” said the company’s chairman and CEO, David Simon, during an earnings conference call for the first quarter of 2015. Representatives for Macerich and Simon both declined to comment for this story.

Recently, Simon has focused on a joint venture with Sears Holdings Corp., which is launching its new REIT, Seritage Growth Properties, as well as redevelopments and international deals.

“I have really not had the luxury of figuring out what I’m going to do with that [Macerich] stake,” Mr. Simon said during the call.

Targets in Their Sights

Despite frequent, and so far exaggerated, reports of the death of U.S. malls, REITs have been able to perform well in the last reported quarter.

On March 31, Simon Property provided investors with a dividend yield of 3.27 percent, a diluted earnings per share of $4.58 and a return on equity of 27.55 percent. General Growth Properties’ dividend yield was 2.44 percent, diluted EPS was $1.21 and return on equity was 15.81 percent. Macerich’s dividend yield was 3.15 percent, diluted EPS was $10.03 and return on equity was 35.94 percent.

Mall REITs took serious steps to react to the financial crisis, with higher productivity mall REITs actively selling the least productive centers, and redeploying capital into higher-quality centers.

If, among the higher-productivity mall REITs, Macerich remains the only obvious target, other lower-productivity mall owners that have employed the same strategy might now be interesting fish to catch.

In January, Washington Prime Group Inc.—into which Simon spun out its smaller malls and outdoor centers last year—completed the acquisition of Glimcher Realty Trust, for about $2 billion. It paid $10.40 a share in cash and 0.1989 of a share in WPG common stock for each of Glimcher share. The new diversified retail property owner has been named WP Glimcher.

In the short term, the winners of an M&A deal are the shareholders of the acquired company. “If you are an investor in a company that gets taken over, that’s highly profitable,” said John Lutzius, managing director at Green Street Advisors. “Generally [the buyers] have to pay a premium to take over the target company.”
But for shareholders at a company like Simon, in general, buying out numerous companies sounds risky, because the buyer has to pay all those premiums.

“Consolidation in the mall, shopping center, health care and data center sectors” are possibly on the horizon, according to Citi Research’s recent report, “Matchmaker, Matchmaker: Will Simon’s Hostile Bid Spark REIT M&A?”

Greensboro, N.C.-based Tanger Factory Outlet Centers is a “perpetual take-out candidate given the focused portfolio and size,” according to Citi’s report. The $3.4 billion-valued company has a portfolio of 45 outlet centers in 24 states and in Canada.

Its operations are on solid footing, according to a recent Green Street Advisors’ report. “Over the last couple of years [outlets] fell out of favor for the risk of obsolescence that people see in outlets,” said Green Street’s Mr. Busch. Generally located in isolated and large spaces far from cities, outlets are seen as real estate properties that could be converted into other usage, albeit with some difficulty, in the event of troubles. But there are exceptions.

Analysts, though, are generally confident in the quality of Tanger’s portfolio, which at its current value—shares traded at $34 on May 21—“could be bought at a reasonable price,” Mr. Busch said.

Among the low-performing mall REITs, Pennsylvania REIT is often seen as the most likely candidate for a takeover. Citi’s report raised doubts over the possibility of its acquisition for the overall low quality of owned malls.

Lately, though, Pennsylvania REIT “improved the quality of its portfolio,” Mr. Busch pointed out. A couple of years ago, a potential buyer would have faced a complex web of logistics to fix or sell its assets, many of which might look like they aren’t performing on paper.

But now the company “has done a lot of the work, the portfolio is much cleaner and consists of better and more solid assets,” he said. The company’s shares traded at $22.9 on May 21.

The New Entrant

Given the limited number of mall REITs looking to consolidate, some companies might form new mall REITs.
Sears Holding Corporation, which operates 4,000 retail locations under the mastheads of Sears, Kmart and their subsidiaries, has moved on with a plan to raise more than $2.5 billion by selling 254 properties to the new REIT, Seritage Growth Properties. Sears will lease back the properties.

At the same time, Sears has entered into real estate joint ventures with General Growth Properties, Macerich and Simon. In these deals, Sears has contributed with properties located at the three company’s malls, which it will then lease back. General Growth Properties paid $165 million, Macerich paid $150 million in cash and Simon paid $114 million.

Big Guns: Private Equity and International Players

Aside from the ever-present Simon, though, a question is, who can be bold enough to play the buyer’s part?
Most real estate markets have been seeing huge cross-border activity. Much ink has been spilled over how many companies are buying internationally. Private equity firms and sovereign wealth funds are increasingly the most competitive buyers.

The mall sector—in which different sets of skills are required, such as dealing with retail, anchor tenants and often very long-term investments—has generally played under different rules. But that may be changing.

With a €33 billion portfolio of mostly high-productivity malls, Unibail-Rodamco SE, is Europe’s largest mall REIT, and its name often comes up in speculative discussion.

But its targets might be closer to home, rather than on the other side of the pond. “You don’t yet have a large pan-European shopping center company,” said Green Street’s Mr. Lutzius. A logical move would be to cross the Channel and invest in the U.K. market before looking at the U.S. In that market, U.K. retailer Hammerson REIT, with a £8 billion portfolio, is considered a potential candidate for a takeover.

Simon’s acquisition of a 28.7 percent stake in European shopping center operator Klepierre SA, and Westfield’s activity in the U.K. and U.S. show that international deals are possible “but the barrier is high,” said Mr. Lutzius.

Private equity firms and—less likely—sovereign wealth funds, could change the game, but might lack the long-term commitment required in the mall market, analysts note.

In April, Excel Trust Inc., a San Diego-based REIT that primarily targets value-oriented community and power centers, grocery-anchored neighborhood centers and freestanding retail properties, accepted an offer from Blackstone Property Partners, which valued the company at $2 billion, including debt.

With the large amount of capital in the hands of private equity firms, and with pension and sovereign wealth funds on the lookout for both yields and sources of diversification, the mall market is a new frontier, beckoning for exploration.