If bigger is better, then the Simon Property Group/DeBartolo Realty Group merger is the best, since it creates the nation's largest regional mall company and the largest retail REIT.
But more importantly than just hugeness and greater economies of scale, this merger could be the kickoff to a series of such combinations. REIT observers have long cited the "ego factor" as the primary reason that more REITs have not combined to create more viable companies. In this mall battle, anyway, it appears as though the Simons have won.
Here are the facts:
* The merger is expected to close this summer.
* Each DeBartolo shareholder will receive 0.68 SPG shares of stock.
* The new company will be called Simon DeBartolo Group and will own 110 million sq. ft. in 111 regional shopping centers, 66 community centers and six specialty centers in 32 states. The new company will also manage 16 million sq. ft. for third parties. Total shares outstanding will be about 155 million for a total equity market capitalization of $3.6 billion with about $3.7 billion of debt. SPG CEO David Simon will be the new company's CEO, and DeBartolo CEO Richard Sokolov will be the COO.
With the scale of the deal in mind, we asked two of the nation's top REIT analysts, Jim Sullivan with Prudential Securities, New York, and Lee Schalop with J.P. Morgan, New York, to discuss the implications of the merger, its impact on the REIT market and what it means to the malls of America (and their tenants).
Jim Sullivan/Prudential Securities
NREI: How will the merger affect retailers'
JS: I do believe that Simon DeBartolo will gain some leverage in negotiations with retailers, simply because of their size. They are a stronger company. They will have more control over certain parts of the distribution channel for retail.
If you're a major retailer and you want to expand into the Florida market or the Texas market, or if you want to have a major presence in the Midwest, you will be dealing with Simon DeBartolo. Simon DeBartolo can be really helpful in addressing your space needs in those markets in those regions.
On the one hand, it makes an efficient contact for the retailer. When you're negotiating with developers, it's nice to have a developer who can show you that much product.
The objective is this should make them better at leasing to both the corridors and the ends of the mall. A good mall needs good leasing strength at both ends. You want to have the best mix of the specialty stores that you think your mall can achieve.
NREI: How will Simon DeBartolo's greater economies of scale play a role with tenants?
JS: It's not so much that the Limited is going to suddenly pay these guys $22 (per sq. ft.) now instead of $20 a foot. It's more a case that this company with its huge portfolio will be able to have more chips to play and to trade with at enhancing the performance of their overall portfolio, because it's a combination of size and quality.
NREI: Is this the start of a serious consolidation trend?
JS: Many REITs were formed where the family had a significant stake in the business and took an active management role.
Especially since the death of Mr. DeBartolo Sr., this has become much less the DeBartolo family REIT than it has a large independent company. DeBartolo had always been valued at a discount to Simon by the public market since they came public, and was trading below its IPO price. The way this transaction was priced basically in one fell swoop bridged that valuation gap that had always existed. It also took out DeBartolo shareholders at a premium to where the IPO was priced, and took the stock to a new high.
NREI: Where does this put Simon DeBartolo in relation to its competitors?
JS: To some extent it certainly levels the playing field between mall owners and department stores. We've had a lot of consolidation in the department store industry for a couple of years now. So you may see the same thing happen in the mall business, where at the end of the day you're going to have ever larger mall owners and a consolidation similar to what you've seen in the department store industry.
Lee Schalop/J.P. Morgan
"The most interesting issue raised by the Simon DeBartolo announcement is whether the transaction, which creates the largest mall company and the largest REIT by market capitalization, is an indication of things to come in the REIT market, or merely a one-off event," says Schalop.
"Although the merger makes it more `socially acceptable' for REITs to merge, we do not expect a wave of mergers to follow SPG/EJD (EJD is DeBartolo's listing symbol). We expect mergers to remain few and far between because most REITs do not have the two key factors that made EJD a good acquisition candidate:
1) a company with a negative perception from investors, especially a company that continually trades at a discount multiple to its peers, and
2) a company that does not have a founding family actively engaged in the business.
Nonetheless, other consolidations are possible, including consolidations in the mall sector."
In terms of leasing leverage (the new company will control 7% of all mall space in the United States, making it the largest landlord for most retailers), Schalop does not expect the balance of power between the new company and its tenants to shift dramatically toward the new company simply because it is bigger. "Quality of assets matters more than quantity, and both companies were already major landlords in the mall sector," says Schalop.
Lessons from the new No. 2
General Growth Properties (GGP) held the No. 1 position among mall REITs for all of three months after acquiring the huge Homart portfolio, until the Simon DeBartolo merger announcement. Recently NREI spoke to executive vice president John Bucksbaum, who related a few of his thoughts on being the new No. 2.
"I think it (the merger) will focus more attention on the mall REITs. Because of the size, there will be some institutional investors who might not previously have been interested in REITs in general because of the small market cap," says Bucksbaum.
For GGP, getting bigger has been better. "Size provides you with marketing program synergies. There are also leasing opportunities. You try to make the malls one-stop shopping for the customer, and we try to make the company one-stop shopping for the retailer."
How will it work out? "It's a wait-and-see approach. That's how the market looks at these things because it takes time for the analysts to determine how it's going to be accretive, is it going to be accretive. Real estate isn't an overnight kind of business," says Bucksbaum.
Relating this to General Growth, "We don't worry about being No. 1, we just worry about being the best."