Simon Property Group (SPG -1.67%) is one of the largest mall landlords in the world. As such, it is well aware of the "retail apocalypse" threatening real estate investment trusts (REIT) and leading to retailers closing stores or, worse, completely shut down. That said, financially strong Simon is in a good position to can get creative when it comes to dealing with troubled lessees.
Right now, it is teaming up with Brookfield Property Partners (BPY) and privately held Authentic Brands Group in an attempt to buy apparel retailer Forever 21 out of bankruptcy for $81 million. Here's why that's a good idea, some proof that Simon and its partners know what they are doing, and some speculation on what might come next.
Why Forever 21 matters to Simon
Forever 21 is a fast-fashion retailer that focuses on quickly bringing out affordable new styles on a regular basis. It is a staple of most malls. For example, Simon has exposure to Forever 21 stores in 98 of its total portfolio of around 200 enclosed malls and factory outlet centers. The troubled retailer accounted for roughly 1.4% of Simon's rent roll in the third quarter. Losing Forever 21 would hardly be a death knell for Simon, but there's more to the story.
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Forever 21's stores tend to be rather large. The 98 stores in Simon's portfolio account for about 1.5 million square feet of space. For comparison, Foot Locker has 224 stores in Simon properties, accounting for 1 million square feet of space and 1.2% of rents in the third quarter. Signet Jewelers has 364 properties, accounting for 527,000 square feet of space and 1.4% of rents in the third quarter.
Based on third-quarter rents, Forever 21 was tied for sixth-largest retailer in Simon's portfolio with Signet. But if you look at square footage, it jumps to the third-largest. And it does that with less than a quarter of the store count of the two companies that rank above it. Rent concessions pushed Forever 21 out of the top 10 tenant list in the fourth quarter (it fell to No. 12, meaning the sales date wasn't disclosed in the earnings release). But that doesn't change the fact that the retailer's stores are relatively large.
For Simon, or any mall landlord, losing Forever 21 means being left with a particularly large hole to fill. That's not good at a time when mall-focused retailers, in general, are struggling. Although the retail apocalypse is likely being overhyped, consumers are definitely shifting their buying habits. Malls need to adjust to this new reality, but that will take time. Every store closure and bankruptcy makes it that much more difficult to change along with consumers. Forever 21 is complicated because the size of its stores could mean a vacancy that requires two or more smaller additions to fill. Thus, Simon and partner Brookfield need to weigh the risk of investing in Forever 21 versus the risk of having large empty storefronts in their malls at a time of intense change. Based on the bid for Forever 21, keeping their malls filled is the winning decision here.
Not the first time at the rodeo
What's interesting is that Simon has teamed up with Brookfield (actually General Growth Properties at the time, which was eventually bought by Brookfield Property Partners) and Authentic Brands to do something like this before. This trio bought teen retailer Aeropostale in late 2016, helping ensure its survival to this day. Simon pitched in $25 million for that acquisition. CEO David Simon noted during Simon Property Group's third-quarter 2019 conference call that he believes that stake today is worth around $175 million.
That's a big win, noting that the real estate investment trust also got to keep a store in its malls. But perhaps more telling is that Aeropostale was producing negative EBITDA of around $100 million at the time of purchase. Today, after Simon and its partners stepped in, it is expected to produce positive EBITDA of around $80 million. In other words, they fixed Aeropostale. And they did it at a time when retailers, in general, were facing material headwinds.
Thus, it makes complete sense for this trio to try their hand at saving a troubled retailer again, though some rightly question the tactic. For example, Brookfield Property Partners bought General Growth in 2018, just two years after the Aeropostale deal, because General Growth ended up in financial trouble. Simon and partners might have been better off using their cash to pare debt as opposed to buying a piece of Aeropostale. That said, Simon has one of the strongest balance sheets in the mall REIT space and has around $7 billion of liquidity. So the $81 million that Simon, Brookfield, and Authentic Brands are offering for Forever 21 is just a drop in the bucket to Simon. It shouldn't have any trouble footing its share, even if it loses all of its investment.
SPG Financial Debt to Equity (Quarterly) data by YCharts
In fact, even in a complete-loss situation, Simon could still win. That's because it will continue to have a tenant filling its malls, making them more desirable for consumers and other tenants, for as long as it takes to figure out if Forever 21 can be saved. The worst-case scenario is that Simon is buying itself time to adjust its portfolio while it still gets at least some financial benefit from the space Forever 21 occupies. The best case, of course, is that Authentic Brands, which will run the store, manages to fix Forever 21. Simon states that this is the only aim and that keeping a tenant around for longer is just a happy side benefit. That may be true, but it's hard to believe that the occupancy issue wasn't a part of the decision process.
What a fix looks like is clearly still up in the air, since the offer still needs to be approved by the courts. But one thing CEO Simon was clear about in the fourth-quarter call was that he doesn't think Forever 21 is broken. He believes that management simply got too aggressive. For example, the retailer's overseas expansion was likely misguided, so expect closures abroad. The size of Forever 21 stores is also a potential issue; getting the retailer back on track could also mean shrinking the size of the average store. So Simon might still have to deal with empty space, but not nearly as much as if Forever 21 simply closed up shop.
A pretty good trade-off
Every investment involves comparing risks and rewards. Simon, Brookfield, and Authentic Brands have made that assessment with Forever 21 and decided that it is worth the risk. With a successful revamp of Aeropostale under the companies' collective belts, it appears that Forever 21 is indeed worth the effort if they can repeat their past success. And, even in a worst-case scenario, financially strong Simon will be buying itself valuable time to adjust its malls along with shifting consumer tastes. All in all, Simon is making an aggressive move, but it is one with which investors should feel pretty comfortable.
