Simon Property Group Inc.'s planned merger with Taubman Centers Inc. will generate near-term earnings accretion for Simon and give it an even sharper competitive edge in the class A mall arena, but questions linger about the pricing and the risks it is assuming with the combination.
Equity research analysts disagree about whether the deal — management has called it both a joint venture and an acquisition — better favors the assumed buyer or seller. However, they appear to agree that the $3.6 billion price tag, representing a 6.2% capitalization rate, deviates from historical precedent in the asset class, and potentially resets the marketplace for high-quality malls. Before the "retail apocalypse" of the last couple of years, class A malls priced at cap rates in the low 4% range.
"Everyone's underwriting some form of distress, including declining cash flows," Mizuho analyst Haendel St. Juste said in an interview. "That means higher cap rates."
The merger, announced Feb. 10, sent Taubman's shares soaring more than 50%, and the stock, as of Feb. 11, is trading higher than the $52.50 purchase price in anticipation of a possible, if unlikely, higher bid. St. Juste deemed the pricing a win for Taubman, even if it is below the company's net asset value, in view of the company's high leverage and "tenant-related headwinds."
BTIG analyst James Sullivan said Simon is getting a deal acquiring highly productive malls that only rarely trade hands at a 6.2% capitalization rate. "That's a very attractive yield on a portfolio of such high quality. ... The price is good by reference to historical valuations for these kinds of assets," the analyst told S&P Global Market Intelligence.
Others had a less favorable take. BMO Capital Markets analyst Jeremy Metz said the deal values Taubman below NAV — his estimate is $56 using a 5.9% cap rate. It also disappoints from Simon's vantage point, Metz said, insofar as Simon is the dominant acquirer in the space and yet near-term earnings accretion from the deal is "limited" at 3%, and much free cash flow will be effectively tied up.
Simon has historically been an "astute deal maker," the analyst wrote. "At a 6.2% cap rate for a portfolio producing $972 [per square foot] in tenant sales, this clearly confirms the significant resetting of mall valuations."
Some analysts, including Metz and BMO's St. Juste, see incremental risk with the increased leverage, even though Simon's balance sheet is among the cleanest in REIT-land and management expects no change to the company's corporate credit rating.
"Given significant and growing capex needs for releasing, redeveloping, and defending assets, [Simon] is taking on added capital needs away from its core portfolio as it looks to support [Taubman's] efforts, while now also needing to delever along the way," Metz said.
Both Simon and Taubman posted same-store net operating income growth — or decline, in Taubman's case — at a multiyear low in 2019, as the companies continued to battle retailer tenant store closures and bankruptcies.
The planned combination will significantly boost Simon's exposure to Florida, Michigan, Connecticut, Virginia, Missouri and Colorado, and increase its total square footage by roughly 13.2%, according to S&P Global Market Intelligence data. Internationally, Simon will enter China and nearly double its exposure to Korea. Taubman's malls are more highly productive, tenant sales-wise, which BTIG's Sullivan said is a function of their location in high-growth markets with high average household incomes.
Sullivan overall was positive on the deal, which he said will yield more benefits in time. Simon will boost the earnings accretion by refinancing Taubman's balance sheet, and will be able to create more synergies by slimming down the payroll below the C-suite level.
"Simon runs their business at the highest operating margin in the industry, and they've done a very good job historically of moving up operating margins of companies they've acquired," he said.
Jefferies' REIT team saw a silver lining in the deal's pricing, saying it would effectively set a floor on weakened mall valuations. And they said the deal could bring Forever 21 Inc.'s troubles to a quicker resolution, given that Simon will control around 114 locations when the Taubman deal closes.
The Jefferies team wrote favorably of Simon's "unmatched capabilities" — namely, its ability to deploy, via the back-to-back Taubman and Forever 21 acquisitions, roughly $7 billion of liquidity against a difficult retail backdrop.
"These deals are complementary, given a difficult retail backdrop, showcasing [Simon's] capacity to execute," the team said.