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Proposed Westfield/Unibail Deal Could Spark M&A, Breathe Life Into Embattled Mall Sector

Merger Talk, Activist Takeover Activity Seen Driving Recent Market Rally
December 20, 2017
Unibail-Rodamco has offered handsome price of $16 billion for Westfield Group, in part to land such attractive U.S. assets as the $1.5 billion Westfield WTC mall adjacent to the 911 Memorial in Lower Manhattan shown here.

Paris-based Unibail-Rodamco's agreement to acquire Westfield Corp. for $15.8 billion in cash and stock has emerged as a potential turning point for the U.S. mall sector as Wall Street struggles to assess the implications of a flurry of mall and shopping center buyout and spin-off reports which has helped boost shares of mall REITs as much as 37% in recent weeks.

The proposed Unibail-Rodamco/Westfield pairing, coming on the heels of reports that GGP, Inc. (NYSE: GGP) turned down a $15 billion buyout offer but remains in merger talks with major shareholder Brookfield Property Partners, and the sharp lift in mall share prices over the past six weeks, has created a groundswell of positive sentiment for the mall sector over the past week.

The shift in sentiment suggests that high-quality malls remain a profitable play for prominent and well-heeled investors, despite the high-profile retail chain bankruptcies and the thousands of stores expected to go dark in coming months as e-commerce and changing consumer buying behavior continue to disrupt brick-and-mortar shopping centers.

Media outlets have reported recently that Taubman Centers (NYSE: TCO) and Macerich Co. (NYSE: MAC) may again be subject to takeover efforts, possible by the world's largest mall owner, Simon Property Group (NYSE: SPG), which made a $16.6 billion bid for Macerich in 2015 which was rejected by MAC's board of directors.

Other mall and shopping center operators are pursuing a spin-off strategy to improve their portfolios and bolster share prices, including DDR, Inc. (NYSE: DDR), which announced plans earlier this year to dispose of $900 million in properties and last week announced plans to spin off its non-core assets into a separate publicly traded REIT, Retail Value Trust.

"We certainly could see more consolidation in the space, given the recent activity and continued disruption," said Matt Kopsky, REIT analyst for Edward Jones. "There are synergies to scale with improving tenant relationships and better access to capital. We wouldn’t rule Simon out as a potential consolidator."

While Simon is viewed as being unlikely to enter the fray in the GGP/Brookfield talks, there's a small chance the huge mall and outlet center owner could pick off certain assets from GGP," Kopsky said.

"We'll see if and when there are some fireworks in the mall space," Kopsky said.

Consolidators, Activists See Unibail Deal as Trigger

The Westfield deal, which would make Unibail-Rodamco the second-largest mall operator behind Simon with 104 centers in 13 countries, is "very positive for the U.S. mall space overall" given a lack of price discovery due to the very few number of deals negotiated for high-quality properties in recent years, Kopsky said. The capitalization rate for the Westfield deal appears to be in the mid-high 4% range, compared with the initial offer for GGP by Brookfield, which was in the high 5% or low 6% range, he added.

"When the initial Brookfield offer came in at a less favorable price than many had hoped, some of the market's fears became reality," Kopsky said. "However, the Westfield deal certainly alleviated some of those fears and provides some good support for Class A malls."

Land & Buildings founder and chief investment officer Jonathan Litt, who along with Paul Singer's Elliott Management have led hedge fund efforts this year to take Taubman private or spin off some of the company's assets, this week cited the Unibail-Rodamco deal as "just the latest data point highlighting the severe discount that Taubman trades at relative to the underlying asset value."

"Opportunistic buyers are taking advantage of extreme discounts at publicly traded retail real estate companies," Litt said in a presentation released Tuesday. "The announced $25 billion sale of high-quality mall company Westfield Corp. is the latest transaction highlighting deep value in the sector."

In fact, Litt argues that Taubman merits an even higher valuation than Westfield given its superior sales productivity, exposure to malls with sales over $800 per square foot, and 30% higher concentration of Class A assets as a percentage of net operating income.

The reports have definitely jump-started mall REIT shares. GGP shares have increased nearly 25% in the wake of the reports since falling to a year low of $19 on Nov. 6. Stock prices for Macerich and Taubman have increased 23% and 37%, respectively, during the same period.

Investor Sentiment for Malls Hanging in Balance

While the recent rally by mall companies has been cause for investor optimism, some analysts caution that the round of merger and acquisition activity that investors appear to expect may not materialize.

"Success is not a given," and completing deals at prices that exceed current market valuations "may be easier said than done," Morgan Stanley equity analyst Richard Hill noted in a recent report. "We believe this a critical but untested crossroads for mall REITs."

On one hand, success in selling or privatizing higher quality mall REITs could demonstrate that mall stock prices have finally bottomed and are beginning to turn around after years of stagnation. Morgan Stanley's Hill said the buyout activity "couldn't have come at a better time" as malls may finally be due for a rally with share prices falling to a six-year low. Many stronger retailers are reporting better-than-expected earnings in spite of bankruptcy and closure announcements by department stores and apparel chains.

"There is certainly no guarantee that anything will happen, but sentiment is improving given the Westfield-Unibail deal, activist investors, and optimism that 2018 will not be as bad as 2017 in terms of retailer store closing and bankruptcies," Kopsky agreed.

If current M&A deals fall through or close at lower-than-expected prices, however, investors may see continued erosion in growth prospects and valuations, with share prices falling even lower, Hill noted.

According to an analysis of past merger and acquisition activity by Hill and his Morgan Stanley team, merger deals in the broader REIT sector have historically succeeded at share prices near the takeover target's 52-week high. However, mall REIT shares before the rally traded at 15% to 40% below their year highs,

Recent comments by retail real estate executives at the recent NAREIT annual conference suggested "there may be a disconnect between [the seller's] ask and the market's bid for malls given the current retail environment," Hill said.

The surprise $24.7 billion bid for Westfield, owner of high-profile properties around the country such as Westfield WTC in Lower Manhattan, Horton Plaza and UTC in San Diego and Century City mall in Los Angeles was nearly 18% above Westfield's share price as Unibail pays a princely sum in the view of some analysts to gain a foothold in the U.S.

Unibail CFO Jaap Tonckens addressed the bid pricing in a presentation on the sale last week.

"Based on our preliminary calculations, we're buying [Westfield] at an approximately 6% premium to our estimate of their NAV, so overall, this makes sense," Tonckens said, noting that the pricing is "well within the range" of other proposed transactions around the world, including Brookfield's reported offer for GGP.

As mentioned, Simon Property Group has previously attempted to buy both Taubman and Macerich. Activist investors Third Point and Starboard Value last month reported a stake in Macerich in a potential prelude to a buyout.

Rating Agencies Offer Differing Mall Outlooks

A Nov. 30 study by S&P Global Ratings suggests that investors still see value in U.S. retail, with the low U.S. unemployment rate helping bolster the mall sector in the face of other variables, such as the growing competition from e-commerce.

S&P said while retail collateral exposure in CMBS transactions clearly shows the potential for extreme default and loss rates among malls, "we still see the inclusion of this property type as helpful to diversifying multi-loan pools as long as the properties are underwritten based on an evaluation of their location, competitive landscape, and long-term performance trends."

Well-located brick-and-mortar stores within shopping centers and freestanding properties in areas with strong demographics are usually competitive and should continue to perform well. However, "the need to focus on local market analysis, competitive positioning and performance trends of each property is clear," S&P said.

While overall retail cap rates remained unchanged in 2017, spreads between higher-quality and less-desirable properties are widening, CoStar Portfolio Strategy Managing Consultant Ryan McCullough said.

"Highly productive assets, including A-rated malls and high street retail, have been commanding cap rates roughly 40-50 basis points below what comparable properties would trade for during the peak of the last cycle," McCullough said. "Yet investors are demanding higher returns on weaker product, which include C malls and exurban retail trade areas. The cap rate curve is therefore steeper in 2017 than at any point this decade, which is emblematic of a bifurcated market."

Morningstar equity analyst Brad Schwer has taken a more bearish view on malls, arguing that the rise of e-commerce has hit malls hard and "the pain has just begun."

Although online accounts for only 10% of total retail sales, this percentage is climbing at a double-digit pace annually, softening demand for physical store space.

"While we believe retailers desire a storefront presence to interact with customers and display and market their brands, we see malls taking a significant hit in an already over-retailed environment," said Schwer, who recently reduced value estimates for Simon, Macerich and GGP.

In the e-commerce era, mall owners no longer enjoy the traditional "moat," or competitive advantage, offered by scale and network efficiencies. Rising occupancy costs will continue to financially pressure tenants and reduce mall owners’ abilities to push rents, Schwer said.

"Our uncertainty surrounding the physical retail environment is too high to award an economic moat," Schwer said. "We see a diminishing network effect as retailers shift strategies and place less emphasis on physical storefronts."

"Mall landlords believe they can revitalize the shopping experience with lofty redevelopments, but this approach is highly capital-intensive and also carries great uncertainty, making it a risky endeavor," Schwer said. "With the U.S. massively over-retailed as it is, we think the industry as a whole will have a tough road ahead."

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