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DDR will be shinier after spinoff, but deal has an underside, analysts say

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DDR will be shinier after spinoff, but deal has an underside, analysts say

DDR Corp.'s planned spinoff surprised to the upside and substantially closed the company's perceived valuation gap, but analysts identified lingering risks and uncertainty in the DDR story.

The real estate investment trust's shares surged more than 10% in Friday trading after the company said it would spin off 50 of its lower-growth assets, including the 12 Puerto Rico properties that were serving as an overhang on the stock, into a new REIT dubbed Retail Value Trust.

On a Dec. 14 conference call, CEO David Lukes said the deal bookends the company's ongoing disposition program and portfolio transformation. Cash flow growth will be the focus of the "New DDR," he said.

Talk of a possible spinoff had circulated for months, but few thought a final plan would emerge so soon, or that continental U.S. assets would be included, Evercore ISI's REIT team said in a research note. The team estimated Retail Value Trust to be a $2.4 billion company with $220 million of net operating income at an estimated 9% blended cap rate.

The equity research community deemed the spinoff a short-term positive for shareholders, but Baird analyst RJ Milligan said a discount is still warranted in DDR's case. The spinoff will cost $50 million in fees and an additional $50 million in debt extinguishment costs and will result in an effective dividend cut, which will dismay income-oriented investors attracted to DDR's dividend yield.

Moreover, although the spinoff will give DDR's legacy portfolio a new polish — lower leverage, better demographics, higher rents, renewed internal growth potential it is still "middle of the pack."

"We continue to recommend the shopping center names with better internal growth ... or the deeply discounted shopping center names with minimal execution risk heading into 2018," Milligan said, singling out Regency Centers Corp. and Retail Opportunity Investments Corp. for praise, and Retail Properties of America Inc. as a "top pick."

Analysts also took issue with the fact that Retail Value Trust will be externally managed by DDR.

"[T]he examples we've seen in the REIT marketplace, typically those entities also hive off some form of management because part of the difficulty in some of these assets is it sucks away a lot of management time in just dealing with issues because there are more challenged situations," an analyst said during the Q&A segment of the Dec. 14 conference call, according to a transcript.

DDR expects to close its spinoff of Retail Value Trust in the summer of 2018.