Mall giant says it's in good shape, but takes steps to conserve cash

February 9, 2009

Simon Property Group Inc. CEO David Simon hasn't lost his swagger in the ugliest retail environment of his career.

During a conference call with Wall Street analysts Jan. 30, Simon touted his firm's conservative balance sheet and best-in-class mall portfolio. Responding to a question about how the company is handling retail store closings, he called himself and a fellow executive "pros."

"We're pretty good at what we do," he added later.

But the unflappable face of the Indianapolis-based mall giant can't hide the cracks in Simon as consumers pull back on shopping and retailers suffer through their worst stretch in decades. Simon shares have plunged 60 percent from their peak, to around $43. And about 9 percent are being sold short, a bet the shares will fall more.

Despite assurances of strength, the company has decided to pay 90 percent of its dividend in stock, a move that allows the company to hold onto $925 million in cash this year but could alienate shareholders drawn by the dividend.

The holiday shopping season was a disaster at Simon malls, as comparable sales (part of the rent equation) fell at least 10 percent for the fourth quarter. Sales per square foot fell 4.3 percent to $470. Occupancy slipped nearly 1 percentage point to 92.4 percent. The company lost 508,000 square feet to retail bankruptcies in 2008, compared with just 61,000 square feet in 2007.

And Simon has seen its 4-percent stake in United Kingdom mall owner Liberty International plummet about 60 percent since it revealed the roughly $300 million investment in August.

To be sure, Simon owns many of the nation's top-performing malls and it has plenty of liquidity—$3.5 billion—to help it weather the recession. But the company's $18 billion in debt is beginning to look more daunting than it did a year ago.

Dividend shuffle

Simon's decision to pay shareholders in stock essentially is a roundabout way of cutting the dividend, said Michael Knott, a senior analyst at California-based Green Street Advisors Inc. Investors end up with more stock. But because the number of shares outstanding increases, they end up owning the exact same percentage of the company.

Besides Simon, several other real estate investment trusts are expected to pay their dividends this year mostly in stock after the IRS decided to allow the practice this year. (REITs get tax advantages in exchange for returning at least 90 percent of income to shareholders.)

"It certainly is a sobering signal of what could well lie ahead for the entire industry," Knott said.

Rich Moore, an analyst with New York-based RBC Capital Markets, sees the dividend change as a prudent move that puts Simon in an enviable position.

He points to the company's current liquidity: $1 billion in cash, $2.4 billion available on a revolving credit line, and $600 million in free cash flow. Add $925 million saved from paying the dividend in shares and, voila, you've got a recession survivor.

"Whether you're issuing shares or dollars, it's all the same," said Moore, who has a buy rating on Simon Property Group and a target price of $100.

Some investors don't see it that way.

A.M. Steinbeck, who writes for investing site Seeking Alpha and is a shortseller in Simon stock, called the decision to pay only 10 percent of the dividend in cash "the most vile of breaches between shareholder and management."

He described the company's management as "arrogant" and "delusional"—pointing in particular to a David Simon conference-call comment about the company's small tenants: "We're a lot more important to their success than they are to ours," Simon said.

"I eagerly await their next testament to the high quality of their portfolio and their exceptionally strong balance sheet (so strong, in fact that they've eliminated the dividend)," Steinbeck wrote on Seeking Alpha.

New development dead

The company declined to answer questions from IBJ for this story, but David Simon, 47, said during the recent conference call that the company—founded by his father, Mel, and uncle, Herb, in 1960—has done plenty to earn the trust of shareholders.

The company now owns or has an interest in 386 properties, including Circle Centre mall, Castleton Square Mall, Greenwood Park Mall, Washington Square Mall and the Fashion Mall at Keystone. It employs about 5,000.

"Needless to say, we have a history of strong balance-sheet management and appropriate capital allocation strategy and our past accomplishment in this area should give confidence to our stockholders," Simon said.

He said the company should get a boost from what he sees as a long freeze on new retail developments, since competitors won't be able to get a foothold. Simon described speculative retail development as "dead for a decade." The company plans to spend only $50 million on development in 2010—down 93 percent from its 2008 total.

Simon has refused to say whether it has eliminated employees as it faces hard times, but industry observers say the company has quietly jettisoned dozens of people. Locally based Duke Realty Corp. and Lauth Property Group have been more forthcoming about local job cuts.

Simon has not revealed plans to sell new shares to raise capital, a move that allowed locally based Kite Realty Group Trust to raise $48 million in October.

One of Simon's most formidable competitors, Australia's Westfield Group, this month revealed plans to sell $1.8 billion in new shares to shore up its balance sheet as it writes down malls that have fallen in value. The shares are being sold at a 13-percent discount to the previous closing price.

Such sales dilute existing shareholders but can actually provide a boost to share prices if they clear up uncertainty about a company's viability as a going concern.

Company outlook

Only a few analysts correctly forecast this year's fall in Simon shares. One of them, Norcross, Ga.-based Market Edge Research, expects the shares to fall further, in part because Simon remains overvalued compared with its peers.

Market Edge, which gave the shares a "sell" rating Nov. 3, at a price of $67, said Simon's balance sheet is sound but the company must closely monitor its debt ratios—the figures banks can use to trigger a default.

"In order for the stock to show any significant price improvement, the company must strengthen its financial performance and regain investors' confidence," Market Edge said in a recent note.

Most analysts that follow Simon are sticking by their "buy" recommendations.

A Citigroup note says Simon's "rock solid balance sheet" and "scale" should give retailers comfort in their landlord. Goldman Sachs says that while the outlook isn't great, Simon should be solid compared with competitors that are barely able to keep up with debt payments.

Barclays Capital has a mixed view on the company's financial health. The United Kingdom-based investment bank has a $70 price target on Simon's shares but is concerned about the dividend move.

"On one hand, capital preservation is pivotal in this environment and allows Simon to position itself to take advantage of distressed acquisition opportunities," Barclays wrote in a Feb. 2 note to investors. "On the other hand, long-term impact on stock performance is unclear based on investors who look at total return and cash dividend income."

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