Can Simon’s mall spinoff become a growth company?

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There’s not a lot of sizzle among the 54 strip shopping centers and 44 enclosed malls that Simon Property Group Inc. plans to spin off into a new public company early next year.

After all, properties like Markland Mall in Kokomo and the Muncie Mall in Muncie offer meat-and-potatoes shopping experiences. They aren’t regional destinations for big-spenders like the Fashion Mall at Keystone, to name one of the properties staying with the mothership.

Yet second-tier malls actually can be quite profitable, analysts say, though as part of Simon, a real estate behemoth that owns some of the glitziest real estate developments in the world, they were largely ignored by investors.

In an effort to unlock that value, Simon announced Dec. 13 it was spinning off the strip centers and smaller malls to focus on larger malls, its outlet centers and international expansion. In the second quarter of 2014, existing Simon shareholders will receive an equal number of shares in the new, Indianapolis-based business, so far known only as SpinCo.

Analysts almost universally praise the move, which will improve the quality of Simon’s remaining malls—lifting sales per square foot from $560 to $616. Meanwhile, the new company will have its own management team focused on exploiting acquisition and redevelopment opportunities.

But the biggest challenge facing the new company might be persuading investors to view it as a growth company, not just as a mature business that throws off a steady stream of dividends.

Simon officials seem aware of the challenge. In a Dec. 13 conference call with analysts, company officials repeatedly cast SpinCo as a growing business that has identified $300 million in development and redevelopment opportunities.

Simon David Simon

“The fact of the matter is, there have been a number of opportunities that the team has wanted to pursue that we put at the bottom of the list because we were focused on outlet growth or major redevelopment,” Simon CEO David Simon said on the call.

Analyst Rich Moore of RBC Capital Markets said Simon needed to jettison its weaker properties, a goal the spinoff achieves. He said so-called Class B malls are among the more challenged segments of retail real estate these days but still can have significant earnings power.

“There are really two types of Class B regional mall product,” he said. “One is the dominant center in a smaller town. That one works and can be very profitable. Then there is a second-tier mall in a major market, which is a much more dangerous type of product.”

A PowerPoint presentation prepared by Simon said occupancy in the SpinCo malls range from a low of 75 percent at Rushmore Mall in Rapid City., S.D., to a high of 99 percent at Markland Mall and Muncie Mall. The other Indiana mall in the SpinCo portfolio, Anderson Mall, was in the middle, with occupancy of 86 percent.

Simon did not disclose the profitability of individual SpinCo properties but said that overall they generate more than $400 million in net operating income annually. Stifel Nicolaus & Co. noted in a report that the SpinCo properties represent one-third of Simon’s portfolio but account for less than 10 percent of its operating income.

“A small percentage of Simon’s NOI, generated from low or no-growth assets, was poised to be an increasing distraction for management,” UBS analyst Ross Nussbaum said in a report.

“Simon sees rough seas ahead for low-productivity, Class B regional malls—and rightly so!” Nussbaum added. Some of SpinCo’s malls “suffer from what we call the ‘fifth mall in a four-mall-town syndrome.’”

Nussbaum and other analysts said the spinoff also will reduce Simon’s exposure to J.C. Penney and Sears, two struggling anchors that may shed space. Penney anchors 35 of 44 SpinCo malls, Sears anchors 39, and both retailers anchor 32.

On the conference call, David Simon said Simon is putting malls into SpinCo that have net operating income below $10 million. In response to an analyst’s question, he said including so many malls with J.C. Penney and Sears as anchors had nothing to do with eliminating risk for Simon.

David Simon highlighted what he sees as SpinCo’s untapped potential and pointed out that he and Simon President Richard Sokolov will have skin in the game as significant shareholders of the new company.

Both also will be on its board, with Sokolov serving as chairman. SpinCo is in the process of evaluating candidates for its executive posts.

“Unleashing those 98 assets into SpinCo with what we think will be a very good executive team certainly allows for opportunities for that company to grow,” David Simon said on the call.•

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