Simon’s $10 billion bid for bankrupt General Growth roils retailing

Simon Property Group Inc. already is known for playing hardball with mall tenants over rent.

So national retailers like The Gap Inc. and Limited Brands Inc. will be bracing for future lease negotiations if the nation’s largest mall owner succeeds in a $10 billion bid to take over its nearest rival, the bankrupt General Growth Properties Inc.

A successful deal would give Indianapolis-based Simon ownership of about 40 percent of the nation’s shopping malls and more than 60 percent of the most-sought-after centers.

And it could turn back a trend that had been friendly to some retailers’ balance sheets: Many had managed to extract better deals from General Growth of late by using the Chicago-based company’s April bankruptcy filing—coupled with weak consumer spending and a dismal retail real estate market—as a bargaining chip.

simonSimon, meanwhile, managed to raise rents at its 382 malls even in the recession. It also managed to quadruple its cash and reduce leverage in anticipation of a General Growth bid.

“We can only imagine the calls in opposition being made today to Washington from national retailers such as Gap, Abercrombie and Limited,” Stifel Nicolaus analyst and former mall-industry executive David M. Fick wrote in a Feb. 16 note to investors.

King of malls

The fear is that Simon will use its growing control over the industry to raise rents and force retailers to take space in less desirable malls if they want stores in the Class A malls—the roughly 40 percent of the portfolio that generates 80 percent of revenue.

Simon officials and many of the analysts that follow the company say the fear is unfounded. They say Simon runs efficient, well-located malls that attract throngs of customers—precisely the sort of properties retailers are wise to pay a premium to join. And with a Simon-General Growth marriage, tenants could negotiate more of their deals at once.

Retailers have plenty of options—no one is forcing retailers to do deals that don’t make financial sense, said John A. Kite, chairman and CEO of locally based Kite Realty Group Trust.

“It doesn’t make sense to me that tenants would make the decision to invest capital in deals they didn’t want just to do ones that they want,” he said. “Tenants make deals in properties where they think they’ll have good sales.”

Indeed, large mall tenants have some leverage over Simon. The company could scarcely afford to lose Gap or its sister brands Banana Republic and Old Navy, although the impact of such a loss on Simon’s bottom line would be far from catastrophic.

Gap, which is Simon’s largest tenant with 4 million square feet in 374 stores, pays just 2.9 percent of the total base minimum rent Simon collects. The San Francisco-based chain also is the largest tenant for General Growth, paying about 3 percent of that firm’s total.

Columbus, Ohio-based Limited Brands Inc. comes in a close second, generating 2.1 percent of Simon’s base rent and 2.6 percent of General Growth’s.

On the other hand, the two retailers rely on locations at Simon and General Growth malls for about 40 percent of their business, Fick estimates.

Blank check

Simon Simon

Total domination of the U.S. shopping mall business has been CEO David Simon’s goal since he took over the company in 1995. He’s used acquisitions of rivals such as DeBartolo, Rodamco, Kravco and Chelsea to transform what had been a regional mall owner into a worldwide powerhouse.

In each of its deals, Simon raised equity and didn’t over-leverage its balance sheet, said Fick, the Stifel Nicolaus analyst.

General Growth wasn’t as cautious with its $11.4 billion deal for Rouse Co. in 2004. Simon’s discipline in avoiding a bidding war for the high-end Rouse portfolio means it could now acquire both Rouse and General Growth for less than General Growth paid for Rouse.

Fick figures Simon’s first offer—which earmarks $7 billion for General Growth’s unsecured debt holders, $3 billion for shareholders, and for Simon to take on $21 billion in secured debt—is merely an opening salvo.

“They have almost an unlimited check-writing capability,” he said. “There’s no question Simon has the capital and platform to buy GGP. We think they’re the single logical buyer for this company.”

Fick thinks General Growth is worth $12 to $14 per share. He said he could make a case up to $19 per share, but he expects David Simon won’t pay that much.

Activist investor Bill Ackman, whose Pershing Square Capital Management owns about 25 percent of General Growth, has said he believes the shares are worth a minimum of $24 apiece.

After Simon announced its bid, GGP shares rocketed to more than $12. The shares fell as low as 32 cents last year after the company filed for the biggest real-estate bankruptcy in U.S. history.

General Growth said Feb. 16 that Simon’s bid was “not sufficient to pre-empt the process we are undertaking to explore all avenues to emerge from Chapter 11.”

Another potential bidder is Canada-based Brookfield Asset Management Inc., which has offered to invest capital so General Growth can emerge from bankruptcy.

Antitrust questions

The combination of Simon and GGP would own almost 600 malls with more than 500 million square feet of retail space, including high-performing properties such as Fashion Show in Las Vegas, Water Tower Place in Chicago, South Street Seaport in New York and Ala Moana Center in Hawaii.

The potential concentration in ownership by Simon has led to concerns about regulatory hurdles. Most observers say a federal antitrust challenge is unlikely since malls make up only a small portion, less than 10 percent, of the nation’s retail real estate. They also point to the growth in online retailing.

Pushback from attorney generals is possible, said Fick, citing state-level challenges to acquisitions by what is now Macy’s in 1994 and 2005.

But in those cases, the locals worried about mass closures of overlapping department stores. Simon’s business model relies on filling its malls with tenants and shoppers—an interest more closely aligned with that of local government officials.

Simon is the most natural fit for General Growth and has plenty of cash to close on a deal, said Gene Zink, founder of Chicago-based Strategic Capital Partners LLC and a former longtime executive at locally based Duke Realty Corp.

“David [Simon] is so much bigger, so much better capitalized, so much better positioned. I don’t think he has a peer,” Zink said. “It clearly means that if he gets it done, he has huge leverage over his tenants.”

For other retail property owners, the deal won’t have much of an effect other than as a stabilizing force in the commercial real estate market, Kite said.

“Them becoming bigger and stronger is primarily good for Indianapolis,” he said. “We also have a lot of shopping centers near their malls, so the stronger they are, the better for us.”

Size matters

Simon over the years has proven that, in the mall business—unlike every other category of commercial real estate—the size of the portfolio matters.

And it’s not just about squeezing more rent out of tenants. Simon has saved millions on utilities, advertising, trash removal and even landscaping by using national buying programs. Its platform for profitable management of shopping malls is unmatched.

Fick expects Simon would find hundreds of millions of dollars in cost savings in a merger with General Growth, cutting hundreds of jobs and eliminating in-house functions such as GGP’s architecture department, a function Simon outsources.

Simon should be able to generate at least $400,000 more in per-mall savings than Brookfield, which doesn’t yet have a U.S. retail platform. And there are opportunities for a more thorough integration of Rouse that General Growth never completed.

The Simon bid was designed to “jolt” the bankruptcy process, discouraging the judge from giving General Growth more time to restructure.

“Basically, they’re saying, ‘Let us take over from here,’” Fick said.

Not a bad option, he added: “We like co-investing with hard-negotiating owners like David Simon. It’s not always fun to sit across the table from him.”•

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