Galileo America LLC vaulted to the 25th spot on Retail Traffic's list of the largest retail real estate holders in the U.S. this summer, following a transaction that doubled its portfolio of shopping centers barely two years after it was established.
But its Australian parent, Galileo Funds Management Ltd., retains the heart of a start-up, with just eight full-time employees and an ambitious hunger for growth. Now, with 121 properties totaling 16.7 million square feet of leasable space, and the inside track on a broad pipeline of deals following a joint venture with New Plan Excel Realty Trust Inc., Galileo is closer to its goal of breaking into the top 10 in the U.S. market.
“We have aspirations to be a big player in the U.S., though I think it will still take us a number of years to do that,” says Susan MacDonald, executive director and fund manager of Sydney-based Galileo Funds. “When you're looking at playing in a big market like the U.S., you have to have critical mass. This deal has given us some critical mass and a strong platform to move forward.”
In transactions announced July 15 and completed Aug. 10, Galileo purchased 69 shopping centers from New York-based New Plan for $928 million in cash and $40 million in equity, giving the U.S. firm a 5 percent stake in the resulting partnership, with a cap rate of 7.4 percent based on 2006 projections. It's a smaller interest than U.S. firms have gotten in similar joint ventures, but it works for New Plan, which wanted capital to fund debt reduction and a special dividend, but was disinclined to give up management and leasing of its properties.
Galileo also dissolved its two-year relationship with its first joint venture partner, CBL & Associates Properties Inc., which cashed out its 8.4 percent equity interest in a portfolio of more than 50 assets in exchange for full ownership of two shopping centers in Mobile, Ala. and Wilkes-Barre, Pa., and sold related management and advisory contracts to New Plan for $22 million. The consideration is worth an estimated $100 million, and CBL retains the option to sell the two properties back to Galileo America over the next year for $63 million at a 7.5 percent yield.
“It was a tax-efficient way to structure the transaction,” says Stephen Lebovitz, president of Chattanooga, Tenn.-based CBL. “We got an attractive price on the business, and with the two assets, swapping that for ownership in the 51 properties gives us flexibility going forward. And we can sell those or continue to own them and benefit from that ownership. It was favorable economics and it allows us to be more streamlined going forward.”
CBL, the fourth-largest mall REIT in North America, has been steadily retreating from community shopping centers in favor of its core business, regional malls, which has grown over time in terms of revenue, Lebovitz says. When CBL went public in 1993, about 60 percent of its revenue came from malls and 40 percent from community centers. Following the latest transaction, more than 90 percent of revenue will come from malls, Lebovitz says, though CBL still owns 17 community centers and remains active in the development of both types of properties.
Analysts at Legg Mason have suggested CBL may continue to sell its shopping center developments to Galileo, and noted the firm has put options to sell a total of three current developments to the joint venture over the next year.
Meanwhile, New Plan's portfolio, which includes 441 community and neighborhood shopping centers with about 63.1 million square feet, more closely correlates with Galileo's focus. The deal results in $754 million in net proceeds for New Plan, which will share $316 million with its investors through a $3 per share special dividend, to be distributed Sept. 27. The rest of the profits, about $439 million, will go toward reducing debt levels, taking the company's ratio of debt to undepreciated book to 43 percent, from 47 percent at the end of the first quarter.
For New Plan's chief executive, Glenn Rufrano, the deal is part of a longer-term ambition to refocus the company, now the nation's ninth-largest shopping center owner. Since he arrived in March 2000, New Plan has become a leaner, more efficient operation, through the sale of non-core assets, such as apartments and outlet centers, and the tightening of personnel, which has been shaved to 400 from 750. The next phase, Rufrano says, was to cultivate some of that value.
New Plan is involved in two other joint ventures: one with JPMorgan Fleming Asset Management that invests in big city institutional-grade assets with cap rates in the sixes, and another with Boston-based AEW Capital Management that buys shopping centers with vacancies, for higher risk and higher returns. Between these two quality segments, the firm saw an opportunity.
“Galileo's cost of money would not allow it to buy in the sixes but there is a vast middle ground there, and that is where they'd like to be partners with us,” Rufrano says. “Maybe a Class A property in a suburban market in Chicago, and not Chicago proper; maybe not the 100 percent location but the 95 percent location … so we can provide a redevelopment; so we can get better returns over time.”
New Plan's long-term goal is to reinvest the proceeds of the deal in its current redevelopment program, and new development activity. The company expects to announce an additional four to six new projects this year, as well as acquisitions and, if appropriate, share buybacks.
Wall Street largely praised the deals for New Plan and CBL, and analysts in Sydney deemed it a significant step for Galileo, as it brightened the LPT's outlook for growth and improved its portfolio in terms of tenant quality and geographic diversity. “This is very much a trust re-defining event for GSA, given the transaction more than doubles both the number of assets and value of its portfolio,” analysts with J.P. Morgan in Australia wrote in a note to clients. “GSA's largest tenant is now Wal-Mart, and the trust has investments in 30 states.”
It's certainly a milestone for the young company, founded in July 2003 by Neil Werrett, a former property executive with AMP Capital Investors who decided to go out on his own when his employer of 25 years spun off its Northern Hemisphere business. MacDonald, a former managing director of shopping centers at AMP with 15 years experience with Australian developer Lend Lease Corp., was brought on board in August.
Merrill Lynch put them in touch with CBL, which agreed in September to sell Galileo a 90 percent ownership stake in 51 shopping centers across 16 states, totaling 6.6 million square feet. CBL netted $387 million, retained management and won access to a thriving public market on the other side of the world. The capital was raised through a public offering, and on Oct. 24, 2003, Galileo Shopping America Trust was listed on the Australian Stock Exchange.
While the firm may hire a few new faces following its recent expansion, it's never likely to need a huge staff, MacDonald says, because like most Australian LPTs, Galileo is not interested in handling management and leasing.
“Our view is we want to be a funds management organization,” MacDonald says. “We understand about real estate and the asset class we invest in, but we don't want to deal with the nuts and bolts.”
That makes the choice of JV partner extremely important, she noted. One of the reasons Galileo was attracted to New Plan was that they have a strong regional structure, with a dozen offices across the country, which will help the firm expand geographically.
New Plan concluded earlier this year that a joint venture would be the best path to greater financial flexibility, as it would raise capital and make the most of the company's existing infrastructure. Rufrano set out for Australia in April with the goal of finding a suitable partner in its thriving public market.
“The execution had to be a large joint venture, large because we had to make a dent in our balance sheet and on the dividend … we needed the size,” Rufrano says. “We didn't want to just sell assets, though, we wanted to continue to lease and asset manage.”
Rufrano met with 11 institutions on his trip; Galileo was repeatedly mentioned as a good company focused on the shopping center sector and looking to grow.
“When I met with them, I found them to be good, solid, smart people. Their biggest issue on growth was their partner, who they liked a lot. CBL was in the mall business primarily, not the shopping center business,” Rufrano says. “They helped Galileo get started, but long-term, Galileo needed someone in the shopping center business, and they saw that in us.”
Rufrano, who had known top managers at CBL for years, promptly headed for Chattanooga and won CBL's approval for the switch. It was, he says, “one of those rare situations where it was win-win-win for three public companies.”
Galileo wanted a bigger presence in the U.S. shopping center market, but joint venture partner CBL was more interested in malls.
A proposition from like-minded shopping REIT New Plan helped create value for all three firms.
New Plan is not the first U.S. real estate firm to seek a partner Down Under. In the early 1990s, Australia passed a law requiring all employers to contribute a percentage of each employee's gross salary into a private retirement fund — now 9 percent. The pension program has created a mountain of cash, providing a steady stream of capital for a blizzard of deals. Because Australia does not have a large bond market, a tremendous amount of capital is invested in LPTs, which serve as fixed-income investments for retirement savers. LPTs already own some 50 percent of Australia's real estate market, so the flood of capital has found its way overseas, with the United States a favored destination. About 35 percent of Australia's foreign LPT market is invested in U.S. real estate. It makes for a mutually beneficial relationship for capital-hungry U.S. REITs, which are all too happy to do business with a well-run and transparent public market. And it doesn't hurt that they share a language.