My Special Situations portfolio is back to buy another spinoff company. This time it's Washington Prime Group (NYSE: WPG-WI), a spinoff from Simon Property Group (NYSE: SPG ) . Washington Prime will own and operate Simon's smaller enclosed malls and strip malls, and the current stock price values the spinoff cheaply. Oh, and the company offers a meaty dividend, too. So later this week, my Special Situations portfolio will buy shares in the company.
Washington Prime is a REIT that owns a portfolio of 54 strip centers and 44 smaller enclosed malls in 23 states, largely east of the Plains states. Its properties are leased to some of the strongest retailers around, including Kohl's, Target, and Bed Bath and Beyond, but also to some of the weakest, including JC Penney (NYSE: JCP ) and Sears Holdings (NASDAQ: SHLD ) . So far the REIT's cash flows have proven very stable and increasing. Washington Prime management is positioning the REIT for growth, not only as an acquirer of real estate but also as a developer and redeveloper of malls and strip centers.
Washington Prime's smaller properties are the less attractive cousins of Simon's portfolio, and as such they were more likely to be lost in the shuffle as Simon management focused on the company's crown jewels. By divesting them, Simon improves its own performance metrics and also frees a dedicated management team to focus on improving Washington Prime's properties as well. General Growth Properties (NYSE: GGP ) undertook a similar move a couple years ago with the spinoff of Rouse Properties, which took on GGP's B- and C-class malls.
But Simon insiders aren't running away from Washington Prime, something I view as a positive sign. Simon COO and director Richard Sokolov will become chairman of the spinoff, and Simon chair and CEO David Simon will join the board as well. Washington Prime's four top execs will have an average 24 years at Simon Property.
The REIT spinoff's occupancy metrics continue to improve, though its mall unit remains challenged. Over the last two full years, occupancy grew from 89.4% to 90.8%. The strip center unit fared better, climbing from 93.6% to 94.9%. This will be a key area to watch going forward.
So what is the spinoff valued at? Quite cheaply. Washington Prime has 155 million shares outstanding, and at Friday's closing price of $19.98, that puts the market cap at $3.1 billion. On a pro forma basis, the company would have produced about $328 million in FFO in 2013, assuming the REIT had the $1.9 billion in debt it has now. That puts P/FFO at 9.5 times, pricing in very little growth.
How does the valuation look on an asset basis? The spinoff has about $1.9 billion in net debt, so its enterprise value is about $5 billion. In 2013, it generated about $410 million in net operating income. So the market is assigning the company a cap rate of 8.2%.
Oh, and then there's the dividend. Washington Prime hasn't revealed its official dividend yet, but has suggested that it will pay at least a $1 per share. That would be a reasonable payout ratio of around 50%, and would offer a yield of 5% on the stock at today's price. That's pretty attractive.
Yes, Washington Prime isn't without risks. The biggest I see is at its mall unit. Malls have been under pressure for years, and the sector is not the growth avenue that it was during the 60s, 70s, and 80s. And it doesn't help Washington Prime that some of its biggest tenants include Sears and JC Penney, two of the largest basket cases among retailers today. Sears anchors all but one of WPG's malls, while JC Penney occupies 84% of them. And mediocre Macy's also sits in 66% of its malls. That's a lot of exposure to struggling retailers. And with calls for Sears to shutter its retail operations, life at the mall could be difficult for Washington Prime.
And this risk is one the biggest reasons I'm glad to have an experienced management team with ties to Simon. That and the low valuation here give me confidence.
Foolish bottom line
My Special Situations portfolio will be buying $500 of this cheap and profitable REIT, and will look to add more. At less than 10 times funds from operations, the stock looks like a good buy.