Now is not a good time to be a mall real estate investment trust (REIT).
The stores are closed, little to no revenue is coming in, taxes and interest must still be paid, and the credit markets are tight. Before the COVID-19 coronavirus hit, Simon Property Group (NYSE:SPG) was one of the premier mall REITs, throwing off $3.7 billion in funds from operations. But the stock is currently down 57% year to date.
Has it been beaten up enough to consider buying the stock?
One of the biggest mall REITs
Simon Properties is one of the top mall REITs in the U.S. The company has interests in 204 income-producing properties in the U.S. and overseas, consisting of malls, Premium Outlets, and The Mills. Simon also owns international properties and has a 22% stake in Kleppierre (OTC: KLPEF), a French real estate company. Like most mall REITs, Simon utilizes a gross lease model and is responsible for taxes and maintenance. Retail was struggling even before the COVID-19 coronavirus crisis began, and REIT commercial mortgage-backed securities were a favorite short for credit hedge funds. But that isn't the only problem here.
A pending merger makes the situation even more complicated
In February, Simon Properties agreed to acquire Taubman Centers (NYSE:TCO) shares for all $52.50 in cash per share subject to a Taubman shareholder vote and other standard closing conditions. Total consideration for the deal is $3.6 billion and will be funded out of existing liquidity. With debt to refinance and other fixed costs to cover, I am sure Simon would be delighted to get out of this deal. That won't be easy. There is no financing condition in the merger agreement, no requirement for a vote from Simon shareholders, and the material adverse change clause in the merger agreement carves out any sort of event that affects the industry as a whole. If Simon attempts to walk away, Taubman will likely sue to force Simon to buy the company as agreed. The two companies may be able to negotiate a termination fee, but that isn't a given.
Either way, this deal will turn out to be an extra expense Simon doesn't need right now. The difference between the deal price and Taubman's current price is $6.36 a share or about 14%. That is a huge spread (in merger arbitrage parlance), which means the market is assigning a pretty hefty probability that this deal doesn't happen.
Available borrowings and commitments
Simon has $2.9 billion in debt coming due in 2020 that must be paid off or refinanced. In addition, the company owes about $743 million in interest, $468 million in real estate taxes, $551 million in committed capital expenditures, and $32 million in lease expenses. Plus, it has to buy Taubman for $3.6 billion. Total commitments are then $8.3 billion. Simon Property entered the year with $670 million in cash and $6 billion in borrowing capacity under its revolving credit agreements. One of the facilities may be increased by $1 billion. Simon also has a commercial paper program of $2 billion it can tap.
So theoretically, Simon has the wherewithal to cover these commitments. That isn't the end of it, however -- the other problem will be with debt covenants. With the stores closed and little to no rental income coming in, Simon's minimum interest coverage ratios are probably not being met.
Recovery is going to take a while
If the COVID-19 crisis gets resolved relatively quickly and stores are permitted to reopen, that doesn't guarantee that Simon picks up right where it left off. Some percentage of consumers will continue to choose to stay away from the malls out of an abundance of caution. Others may have had to live on reduced income for a while and will be putting off discretionary spending. It will take time for the company to get new tenants into expiring leases if the current tenant chooses not to renew. So, bottom line, FFO will be reduced, which means the dividend is questionable going forward. The current yield of over 13% is telling you that.
So, is Simon Property a buy here down 57% year to date with a 13% dividend yield? With all the financial commitments the company has to deal with, it is hard to recommend it. Simon may well muddle through without having to cut the dividend, but a lot of things will have to go right for that to happen. Simon had stagnant growth to begin with, was operating in a sector with issues already, and is hemorrhaging cash right now. Once the crisis is over, it will take a while for things to get back to normal. Absorbing Taubman will carry all sorts of execution risk. It makes sense to watch and wait until the storm has passed and we have clarity on the dividend situation.