Current Price: $40.95
Offer Price: $52.50
Upside: 28%
Expected Closing: mid-2020
This idea was shared by Patrick.
A large cap merger between two premium mall REITs with a very large downside in case transaction falls apart.
Shortly before the COVID-19 outbreak Simon Property Group (SPG) announced that it will acquire Taubman Centers for $52.50/share in cash. Regulatory approval is unlikely to be an issue, while given the current situation and the impact shopping centers are/will experiencing from the COVID-19, shareholder approval is also pretty much guaranteed.
However, with majority of the malls currently closed (i.e. receiving zero revenues), the main risk is that this transaction will end up terminated or amended significantly by SPG. If that happens, downside is enormous – since the offer announcement on the 10th of Feb all of the peer REITs (especially smaller ones) are currently down ~70%+. SPG itself fell over 60%, while the closest competitor MAC is down 75%. TCO, on the other hand now trades at 20% premium to pre-announcement price and while TCO asset quality is slightly better than that its peers ( below), still it means if things go south, 70-80% downside can be expected.
On the other hand there are several arguments that favour the successful closing of this transaction:
- SPG is a credible large-cap buyer that has been targeting TCO for the last 20 years.
- The agreement is finally in place and is quite tight (doesn’t really leave any doors open for SPG to walk away). Pandemics clause is excluded from the MAE (material adverse effect), unless the buyer is able to prove that the virus affected TCO more than its peers, which would be hard thing to do given that an absolute majority of shopping centres in US have been closed pretty much at the exact same time.
- The financing is not a problem for the buyer – the transaction will be financed with existing liquidity. Last month SPG has refinanced part of its credit facility and had $9.5bn of total credit capacity vs $3.5bn needed for this acquisition.
- Furthermore, TCO assets (more in the graphs below) are top level among the peers – 80% of its assets are in the class A spectre, which should be considerably more resilient to the overall impact from the COVID. One thing is that such assets will likely attract much more help from the government given their premium quality, location etc. Another thing is that compared to lower class peers the recovery of class A malls should be significantly faster after the lock down is over. Even before COVID-19 malls were already impacted by the ongoing decline and numerous bankruptcies in the retail industry, but despite that class A centers experienced increased sales as many online stores started opening their own brick-and-mortar locations as an effective means of customer acquisition.
Therefore, as the financing is not an issue, SPG might view this as a long term/long desired/high quality asset acquisition and proceed with the transaction rather than risk its reputation and get involved in an intense lawsuit that would likely follow the termination.
Re shareholder approvals: two thirds of outstanding + majority of disinterested shareholder approval is required. Taubman family owns 29% of TCO and has agreed to sell a third of their stake, while rolling over the remaining 20% ownership into the combined company.
Taubman Centers
SPG
Simon Property is the largest REIT and shopping centre operator in US. It owns, develops or manages 204 properties including 106 malls, 69 Premium Outlets, 14 Mills, four lifestyle centers, and 11 other retail properties in 37 states and Puerto Rico.
Taubman gains 12% after proxy on Simon deal filed
https://seekingalpha.com/news/3565315-taubman-gains-12-after-proxy-on-simon-deal-filed
Re: this proxy, does anyone know if that’s something that TCO could file without SPG’s permission? Like, should we definitely take it as a sign that SPG isn’t going to try to get out of the deal?
Both companies are just proceeding with the required processes and termination can still happen at any time. Proxy release doesn’t mean that much. Still better than nothing, of course.
What I find somewhat concerning in the proxy is that Simon Property Group already ‘threatened’ to walk away from the transaction once and then managed to lower the acquisition price from $57 to $52.5. Relevant extracts copied below. Market conditions now have clearly changed again and I am guessing Simon is looking for a way out. Also during go-shop period there was very limited interest in TCO.
“On January 26, 2020, Mr. Simon contacted Mr. R. Taubman and communicated that while Simon was still interested in pursuing a transaction with Taubman, it would need to assess market conditions further and would not continue to engage in negotiations of the transaction agreements until Simon had made such an assessment.”
“On February 5, 2020, Mr. Simon contacted Mr. R. Taubman and communicated that Simon was prepared to reengage in transaction discussions, but that Simon would not pay more than $52.00 per share. Following Mr. R. Taubman’s objection to the revised proposal, Mr. Simon offered to increase the purchase price to $52.50 per share in cash (the “February 5 Proposal”), but stated that this was Simon’s best and final offer, and that the February 5 Proposal was conditioned on the agreement of the Taubman family members to certain points that had not previously been requested”
“During the go-shop period, Lazard contacted 18 potential counterparties, consisting of 4 strategic parties and 14 financial sponsor parties. None of these parties entered into a confidentiality agreement with Taubman or received non-public due diligence information about Taubman. In addition, none of these parties made an acquisition proposal with respect to Taubman.”
We’ve recently picked up SPG and think its probably one of the most undervalued REITs out there. They are a leader of Class A malls and they have been aching to get Taubman malls for decades as they have a portfolio of A+ class malls. From a strategic and valuation standpoint, I think its a very good deal for SPG, given that this will further strengthen its position in A and A+ malls.
It’s true that the current economic environment makes retail a very tough landscape to be. Likely in this difficult landscape, only the higher end malls will survive and location and sales will be key. We don’t entirely know how the COVID-19 will affect consumer demand, mall traffic and sentiment. That might be the part that raises the most concern, but we find this to be an attractive merger overall with a decent amount of upside left and this is an acquisition that SPG likely will not want to pass up too easily.
It seems more attractive for SPG to do a large buyback than to buy TCO. TCO trading at 17x EV/EBITDA, SPG trading at 10.5x EV/EBITDA. How much better are Taubman’s assets in quality to justify the valuation difference? I think shares of TCO would have quite far to fall here if SPG walks.
I have to admit, SPG does look cheap giving this a cursory look, trading at nearly a 20% AFFO yield. Debt seems high though.
True, debt can be a concern. Perhaps a back of the envelope calculations can be shown here: SPG’s NAV is about $102, if we assume the total sum of the malls are worth ~$31.6B. This valuation is derived from a capitalization rate of 5.5%. Further read up is available is on Mornginstar about SPG.
Furthermore, for debt, SPG is locked into a lot of long term leases. If we experience a rise in bankrupt retailers, that can put a strain on the rent flow for SPG. However, we found that SPG does a very good job with the repositioning of bankrupt retailers. For Aeropostale, they bought the company during its bankruptcy at $25m and today it yields 80m EBITDA, with the total ROI on it to be 300m, a 12x return on investment. Not that we are relying on this alone, but they don’t partner up with stores just based on rent collection alone. So debt likely should be manageable given their strong rental streams.
We suspect that A and A plus malls offer entertainment services and a shopping experience thats very difficult to replicate over e-commerce. I think that’s where SPG sees the value For TCO, they were acquired at a 6.2% Cap rate. The best chances of survival in terms of retail malls will lie in location and quality.
But still there is a significant amount of operating leverage and a sharp decrease in rental streams, especially if prolonged, can cause a strain. Much uncertainty remains. If I had to take a guess, mall traffic will be done for at least 1-2 years and the only “psychological” cure will come from having a vaccine.
Sorry, in spirit of the website we are on, we do like TCO still, (we like SPG more). But looking at the trend, we believe there is likely to be continued bifurcation in the highest quality assets producing growth, while the lower end tiers will continue with their decline over the next decade.
Several extracts on merger from the SPG conference call – it looks like Simon Group is very reluctant to discuss anything merger related for no apparent reason. This strongly suggests they are looking for a way out of it.
https://twitter.com/AndrewRangeley/status/1260151077342715905
If I had the position in TCO, I would close it now as the risk of deal falling apart is clearly far higher now.
Conveniently TCO is still at the same price as it was at the time of the write-up.
What about the preferred? Nearly 15% spread now, they will get cashed out too at $25. With far less downside.
If TCO EV is valued like its peers (despite being higher quality according to a recent VIC write up), preferred have pretty limited downside here.
1) It’s very difficult to find a way out of it IMO. The merger statement provides little to no wiggle room for Simon. You have to prove that Taubman has had a “disproportionate” material effect relative to the industry. Considering their A+ class malls, they probably will do better than the average peer financially.
2) Perhaps perspectives can have different interpretations (and speculations admittedly) – SPG can save $600m+ by openly buying the shares right now. As far as I know, there is no legality issues and there isn’t a need for disclosure. So, to prevent the shares from being driven up, that can be a possible reason why there is no further comment on this.
3) It likely will cost Simon a decent amount of fees with litigation, along with reputational risk if they were to proceed with that route. Still, I don’t see any breakup fees payable TO Taubman. Taubman has to pay a breakup fee if they initiate the termination, but they obviously have zero incentives to do that.
Preferred shares are an interesting proposition. Will look more into that.
I don’t like this part. Admittedly I am not exactly a legal expert, but this seems a bit vague:
” (to the extent not otherwise falling within any of the exceptions provided by clauses (i) through (xi) hereof) is, may be, contributed to or may contribute to, a Material Adverse Effect); provided further, however, that any effect, change, event or occurrence referred to in clauses (i), (ii), (iii), (v) and (vi) may be taken into account in determining whether or not there has been or may be a Material Adverse Effect to the extent such effect, change, event or occurrence has a disproportionate adverse effect on such Person and its Subsidiaries, taken as a whole, as compared to other participants in the industries in which such Person and its Subsidiaries operate.”
How are other participants defined? Just REITs in general? Or specifically shopping mall REITs?
That’s an excellent point. I forgot to mention that “peers” admittedly a vague term. I’m not a legal expert either. Perhaps I’m being naive but I would like to think that their definition of “peers” is what we would imagine (retail/mall REITs), given that there are many comparable companies. It’s more of an issue IMO if this is a one of a kind company.
They never defined “peers” exactly as in, “this guy and that guy are our main competitors” However, I would start with just the general description of what they said in terms of their competitive environment. Because I think a part of the legality of it will at least hinge on figuring out the general range of “peers”.
From Taubman’s 2019 Report: http://s1.q4cdn.com/799408505/files/doc_financials/Annual/2019/2019AnnualReport.pdf
“There are numerous shopping facilities that compete with our properties in attracting retailers to lease space. Our ability to attract tenants to our shopping centers and lease space is important to our success, and difficulties in doing so can materially impact our shopping centers’ performance. ”
From SPG’s Report (They are basically in the same industry and will have very similar ranges of peers):
“The retail real estate industry is dynamic and competitive. We compete with numerous merchandise distribution channels, including malls, outlet centers, community/lifestyle centers, and other shopping centers in the United States and abroad. We also compete with internet retailing sites and catalogs which provide retailers with distribution options beyond existing brick and mortar retail properties.”
I would say Macerich, Tangers, and Kimco come to mind as direct peers. You can even argue that both TCO and SPG are less affected then them. That’s my take. Hope that helps.
I calculate SPG Preferred J closed Friday at approx. 4.6% yield to the 2027 redemption date/price and 6.6% dividend yield. Where do you think TCO preferred J and K trade if the deal doesn’t go through? They already trade with a dividend yield over 7% so they do look interesting.
Definitive proxy was filed on the 29th of May indicating that so far the transaction is still proceeding at original terms. Shareholders meeting date is set for the 25th of June and closing is still expected in Q2/Q3.
https://www.sec.gov/Archives/edgar/data/890319/000114036120012682/nt10010096x4_defm14a.htm
SPG pulling plug on merger. Interesting to note repeated market inefficiencies here between the preferred (which would have been cashed out at $25) and the common. There were several occasions where the spread was about as wide for the prefs or wider, despite much lower risk. I guess it pays to always look up other instruments in the capital structure when researching a merger! Especially in chaotic times like these.
” downside is enormous ”
That line pretty much summed up this trade
This is not the end of the story yet – now starts a lengthy litigation process. It is hard to tell how much ground Simon’s arguments have:
All the said, I continue to stand by my 12th of May comment – if the buyers wants to find a way out of the merger, one way or another they will try, does not matter how ‘tight the merger agreement’ is.
Those who believe that ‘tightness of the merger agreement’ will prevail in court should be buying hand over fist at these levels. The spread increased to 55% and I would say that the risks are almost the same as they were on the 12th of May.
To be the devils advocate here, if you got real estate in the best areas, that probably means big cities right? Which means higher population density. Those areas had a lock down, and less busy areas often did not. Population density was probably a big factor in deciding whether a lock down was appropriate. So that means an argument might be made that shopping malls throughout the country which were mostly in less dense areas were not as badly affected as TCO malls % wise, which were more likely to go to zero traffic because the shut down.
Also if you know an area is very busy you might avoid it more than if you knew an area was less busy (like a shopping center in a smaller town). Causing a fall in traffic that is relatively larger for the best and busiest shopping centers.
Not saying this is true, but Simon might have done some digging and come to this same conclusion, and “uniquely material and disproportionate effect on Taubman compared with other participants in the retail real estate industry.” might have some merit here.
Yeah, I would agree, the risks are basically what they were then. There was some chance TCO/SPG would have just announced that the deal was going through (probably at a slightly lower price).
I see this as a negotiating tactic by SPG. If you’re trying to get TCO’s takeout price down to $42, and the common is trading at $45, it’s nearly impossible to get there. TCO’s board would get sued if they agreed to sell below the current trading price. Well… now $42 looks pretty good.
I think there’s maybe 50% chance they settle and do the buyout at a lower price than $52.50, 40% that it goes to trial and TCO wins, and 10% that SPG wins. I like and own the preferreds better than the common here.
But why don’t they just go up to TCO and say “hey we want a lower price?” Maybe they already tried that, but that seems to be the more prudent choice if they were trying to get a lower offer price and given all of these expensive legal fees they will have to go through.
As you said, they probably already tried that.
Would you mind going a bit deeper on your preference for the the preferreds here. You are capping your gain at about 25% (assuming buy at 20 cash out at 25) vs close to 50% on the equity. I am assuming your rationale is that the company is in good enough shape to honor and pay the preferreds even without SPG and that downside would be minimal on preferreds if deal fails….
Also if deal succeeds must SPG cash out preferreds vs keeping them on their books in newco? thanks
FWIW I sold next Friday 22.5 puts for .25 when the deal first broke earlier this week. Premium has come in a bit since then since I think folks realize gonna be a long haul (more than next Friday! before this gets sorted out)
“Section 6.08 Redemption of Preferred Interests and Titanium Series J and Series K Preferred Stock. On the Closing Date immediately following the Silver OP Preferred Contribution and the Titanium OP Payment and prior to the Effective Time, (a) Titanium shall issue a notice of redemption of each of the Titanium Series J Preferred Stock and the Titanium Series K Preferred Stock compliant with the Titanium Charter and otherwise in form and substance reasonably satisfactory to Silver and (b) Titanium shall deposit, or cause to be deposited, with an escrow agent (reasonably acceptable to Silver) for the Titanium Series J Preferred Stock and the Titanium Series K Preferred Stock, cash in immediately available funds in the amount of $25.00 (the “Titanium Series J and Series K Preferred Stock Liquidation Preference”) plus all accumulated and unpaid dividends to, but not including, the redemption date set forth in such notice of redemption, per share of Titanium Series J Preferred Stock and Titanium Series K Preferred Stock, respectively (collectively, the “Titanium Series J and Series K Preferred Stock Redemption Amount”). Following the Closing, Surviving Titanium shall consummate the redemption of the Titanium Series J Preferred Stock and the Titanium Series K Preferred Stock in accordance with the Titanium Charter and the notices of redemption issued under clause (a) above.”
https://www.sec.gov/Archives/edgar/data/890319/000114036120002764/nc10008524x3_ex2-1.htm
There might be a risk that the Prefs will be a victim here and not be cashed out. But if they are secured against all of SPG’s assets in merger, they would probably still trade close to $25 (since debt/ebitda will be lower then).
Yeah, it’s just better risk/reward. If you look at where various retail REIT preferreds are trading, they’re already ahead of where TCO’s are. If the deal breaks completely, I doubt there’s much risk to the preferred price. And meanwhile you get paid ~7.5% to wait.
ijw — we’re too far down in the tree for me to reply to you directly. Why do you say there’s a risk the preferreds are victims here? As I read that passage it’s pretty straightforward that they get cashed out at par.
Yeah, I think I misspoke. Unless refinance rates are through the roof, they should have no incentive not to cash out the preferred. I’m warming up now to buying the prefs.
Interesting Barron’s article about the merger.
https://www.barrons.com/articles/investors-are-overconfident-about-a-taubman-simon-deal-analyst-says-51592499427
TCO shareholders approved the merger (doesn’t mean much, but still).
https://www.businesswire.com/news/home/20200625005682/en/Taubman-Centers-Shareholders-Approve-Merger-Simon-Property
Not new news, but just to note that the trial is expected to take place in November’20.
https://shoppingcenterbusiness.com/judge-orders-simon-taubman-to-be-trial-ready-by-mid-november/
TCO Q2 results are out. Looking from high-level, TCO is not underperforming the peer average, but it is clearly doing worse than higher-quality mall peers (main competitors) MAC and SPG.
TCO Q2: FFO -63%, NOI -31%
Peer avg. Q2: FFO -65%, NOI -35%.
MAC Q2: FFO -55%, NOI -23%.
SPG Q2: FFO -29%, NOI -24%.
https://www.sec.gov/ix?doc=/Archives/edgar/data/890319/000089031920000091/tco-20200630x10q.htm
TCO fell 11% this month, apparently, due to another complaint from SPG in early September. The complaint is related to the credit facility amendment made by TCO in August. The amendment waives TCO compliance with quarterly financial covenants from Q3’20 to Q2’21 and replaces them with a minimum liquidity requirement, giving the company more financial flexibility, however apparently, during this time it also includes giving the lenders a secured interest in 4 TCO assets. So Simon states that this deal impacts TCO financial state ”granting the banks a mortgage on two of Taubman’s most valuable properties if the company’s finances deteriorate.” + argues that it was made without the required SPG approval under the merger agreement. TCO did not make any comments on that yet.
Honestly, can’t add much to that other than that this new complaint definitely seems “weightier” compared to the previous allegations. Current spread stands at 55%. The trial starts on the 16th of Nov.
https://in.reuters.com/article/legal-us-otc-simon/mall-owner-simon-adds-intriguing-new-claim-in-taubman-mae-case-idINKBN2673CS
SPG and Taubman settled for a reduced cash price of $43/share – almost 20% reduction to the initial agreement.
It seems there was a real risk that SPG will find a way to break the merger agreement if Taubman has agreed to this price cut. On the other hand, $43/share is still significantly premium to where TCO has traded pre-covid (around $30/share), while the shopping mall industry has not recovered yet (SPG shares trade 50% below pre-covid levels).
This trade has clearly not performed as expected initially it still resulted in a positive 5% return (albeit in 7 months).