‘Bigger’ is not always ‘better’ in the real estate business. However, in the mall sector, size matters because of the way that large retailers make leasing decisions. The importance of scale is what makes the recent offer by Simon Property Group (SPG) to acquire Macerich (MAC) so intriguing. While lower-quality malls continue to face an uncertain future, high-quality malls continue to represent one of the most appealing forms of real estate an investor can own.
Simon is the largest global owner of retail real estate with over $90 billion of assets. Macerich is the third largest mall owner in the US with roughly $20 billion worth of properties. The recent offer followed months of M&A speculation after Simon revealed in November 2014 that it had taken a 3.6 percent equity stake in its target.
A combination of the two giant mall companies makes abundant strategic sense. Our database shows that Simon and Macerich own many of the ‘best’ malls in the country. However, the overall geographic footprint of Macerich differs meaningfully from Simon, so a combination would allow Simon to offer retailers an even broader array of location choices. In addition to high-quality malls and an appealing geographic footprint, Macerich also has a burgeoning outlet business that is certainly of interest to Simon, a leader in this rapidly expanding part of the retail real estate world.
The strategic merits of a merger are numerous, but the financial merits will depend on the deal structure ultimately negotiated. At press time its latest offer was rejected, but it is worth noting Simon’s initial offer came at a premium to the market value of Macerich’s properties. Consequently, the bid likely relies on significant cost savings (i.e., synergies) to make the deal pencil.
In general, REITs do not usually deserve the benefit of the doubt when acquiring other REITs, particularly where large premiums must be supported by synergies. In a review of REIT M&A over the past 20 years, we found that REITs systematically overpay for synergies.
Simon has bucked this trend and has been much more successful on the M&A front than most other REITs. Hence, the behemoth deserves the benefit of the doubt for the time being. However, if Simon is forced to pay even more than its initial $91 per share bid, its underwriting of potential synergies will certainly come under the microscope.
As of press time, Simon had offered to pay $91 a share or $23 billion, representing a 30 percent premium to the share price prior to Simon disclosing its 3.6 percent ownership interest last November. The offer is comprised of 50 percent cash and 50 percent Simon stock. As part of the deal, Simon disclosed an agreement to sell some malls to General Growth (GGP), the second largest US mall REIT. Asset sales will be an important financing component to the deal, while also allaying anti-trust concerns likely to be raised by retailers in certain markets.
Tangible synergies must offset the takeover premium plus transaction costs to make a merger deal work. Some synergies, such as general and administrative expense savings and reduced debt costs, are easily quantifiable. However, the most important synergy – the synergies emanating from improved operations – is unfortunately the most difficult to value.
There are three important synergies available in a combination. First, much of Macerich’s $65 million in annual overhead expense appears likely to be eliminated. Second, Macerich has primarily used secured, non-recourse financing, which has recently been more expensive than unsecured debt. Simon has long enjoyed a cost of debt advantage, with ample access to the secured and unsecured debt markets. Thirdly, Macerich is an excellent operator, yet Simon is the best in the business and can likely achieve additional efficiencies.
An important potential offset to these synergies is the potential property tax hit. In California, Prop 13 limits annual tax increases to no more than 2 percent. As a result, properties that have been held for years by the current owner can enjoy relatively small tax bills despite massive value appreciation. A sale, however, causes the property’s assessed value to be marked to market. Roughly 30 percent of Macerich’s net operating income is in California, and Green Street estimates that increased property taxes could reduce the overall portfolio value by 3 percent to 5 percent, thereby mitigating much of the synergy value.
Mall ownership in the US is highly concentrated among the publicly traded REITs, and opportunities are rare to acquire a sizeable portfolio of high-quality centers. Simon has a stellar capital allocation track record with a history of executing deals that have created substantial value for its shareholders. Nevertheless, the prospect of other bidders showing up could make for a compelling drama over the next several weeks.