Simon Property Group (NYSE:SPG) has agreed to acquire smaller peer Taubman Centers (NYSE:TCO) for $3.6 billion. The deal is a huge statement about the mall industry, but it also has massive implications for Simon and Taubman. Here are four things to consider as you weigh the effects of this massive buyout and what it does to Simon's future.
1. A huge premium for the shares
Simon is paying $52.50 a share for Taubman. That's a 50% premium to where the shares of the mall-focused real estate investment trust (REIT) traded just prior to the deal's announcement. It's also about double what Taubman's stock price was on Feb. 1, before merger rumors started to swirl. Taubman's shares have actually traded above the offer price, too, which suggests that investors think that another suitor might come in with a higher price offer.
However, given the so-called retail apocalypse and the massive premium, a better offer is probably unlikely. In fact, there are only so many companies that would be interested in Taubman, and even fewer with the financial strength to make a higher bid. So Taubman investors should probably sell now to lock in the gains. That said, Simon's willingness to pay such a large premium suggests that it believes mall REITs have been significantly undervalued by investors.
2. A mild hit to Simon's liquidity
Paying so much for Taubman, however, will have an impact on Simon's financial strength. For example, the REIT ended 2019 with roughly $7.1 billion in liquidity, made up of cash and lines of credit. It isn't intending to sell stock or bonds to fund the deal (at least not right now), so that $7.1 billion total is likely to be cut roughly in half once the acquisition is consummated later in the year. That means less cash will be available for upgrading its portfolio to keep its facilities fresh and desirable for tenants and consumers. Still, $3.5 billion of liquidity is a lot of breathing room, so there doesn't appear to be any reason to panic.
In fact, including the debt that Simon will have to take on from Taubman, the REIT estimates that its net debt to net operating income ratio will increase from 5.2 times to 6.1 times. Increasing leverage isn't great news, but Simon will still be among the strongest names in the mall REIT space. Notably, it isn't expecting any changes from the credit rating agencies, so it will remain solidly investment grade.
All in all, Simon is making a bold move, but it appears to be one that it can afford.
3. More, and better, malls to manage
The real allure here for Simon, meanwhile, is that Taubman has one of the most desirable mall portfolios in the industry. Although it only owns around 20 or so enclosed malls, they are all well located and highly productive. Taubman is one of only two industry players where average sales per square foot and rent per square foot are actually better than Simon's figures. In other words, Simon is upgrading its portfolio with this transaction.
Why would Taubman make this deal if its assets were so good? Simple: It is far more leveraged and doesn't have the financial flexibility that Simon does, so it wants access to Simon's cash. The Taubman family, it's worth noting, is keeping a 20% stake in the Taubman business, and will continue to operate the malls being sold to Simon.
Basically, Simon is providing Taubman with the financial leeway it needs to deal with the changes taking shape in the retail sector. Simon, meanwhile, gets an 80% stake in some of the best malls in the country.
4. The balance sheet is something to watch
All in all, this opportunistic acquisition appears to be an aggressive but worthwhile move by Simon. However, with a bigger portfolio and less liquidity, investors shouldn't simply forget about this deal's impact on Simon's future. Yes, it opens up potential growth avenues (as Taubman stands today, the deal is expected to increase 2020 funds from operations by 3%), but it also means more money will need to be spent because of the increased size of the REIT's portfolio.
This is no small effort -- on Simon's fourth-quarter-2019 earnings conference call, it noted that it had roughly $1.4 billion in capital projects in the works. Taubman will simply add to that total, even though Simon's liquidity will be cut in half because of the acquisition. And while there's no way to tell what Taubman's spending will be after it gets bought out, the number won't be zero. So Simon will have a better portfolio, but investors should pay increasing attention to its balance sheet. There's no need to worry, per se, but there is a good reason to verify that Simon hasn't bitten off more than it can chew.
Net/net, this is a win
There are puts and takes in every corporate transaction, and Simon agreeing to buy Taubman is no different. While the end result is likely to be a win for Simon, investors should be more cognizant of the costs the mall owner will face following the deal, because it will no longer have the same level of cash at its disposal. All in all, though, Simon and its generous 6% dividend yield still look like an attractive option for dividend-focused investors. You'll just need to follow the company's balance sheet and spending plans a little more closely for a while.