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Time to look closer at this because, well, no one else is.

The Skinny:

Simon Properties (NYSE:SPG) gaining even partial control of GGP and its 200 malls would mean Simon Properties would have an effect on nearly 50% of the Class A US Mall Market, or a monopoly.

Case Study:

Whole Foods (WFMI) / Wild Oats Merger, 2007

Whole Foods proposed the purchase of 190 Wild Oats locations on 2/21/2007 for $691m in cash and stock. WFMI proposed to convert Wild Oats stores to Whole Foods, close some and sell others off.

After a review, on JUNE 5, 2007, the FTC challenged this, claiming the deal would cause the combined entity to have a monopoly in the “operation of Premium Organic Food supermarkets” (read: Class A US Malls in SPG/GGP)

In its complaint the FTC said (click to enlarge):

Insert the word “mall” instead of “premium and organic natural food” and you now have SPG and GGP's case.

Here is the FTC’s complaint (click to open .pdf):

Ahhhhh… you say, but the FTC lost that case. In August of that year the injunction they sought was denied and the deal closed on August 27th, 2007, six months after it was announced (the two are still wrangling in court over it).

The key lies in understanding why it was denied. In his finding the judge stated: (click to enlarge)

Whole Filing - FTC Denial (click to open .pdf):

Note that the Judge did NOT say the integration of the two did not create a powerhouse. Rather, he said that the competition had spent billions to upgrade their own offerings to compete with the new Wild Oats / Whole Foods and that the Premium Organic market has expanded to a point the merger did not create a monopoly.

In fact, a key point in the case was a Q1 2007 report from Whole Foods Co-Pres. stating (click to enlarge, redactions from court docs):

At that time initiatives to enter the “perishable organic foods” market by Wegman’s were already having a negative impact on Whole Foods. That gave the judge evidence that the market Whole foods operated in was expanding fast. Using past data, the FTC was correct in its assumptions of the market at the time of the data. The problem was that the grocery market was so rapidly changing and dynamic, that between the time the deal was announced and the July court date, a sea of change had begun in the business.

Why does this matter? In the SPG/GGP scenario, this reasoning does not exist. When the FTC challenges this deal if SPG is the winner, a Judge cannot say that a slew of Class B malls are now becoming Class A and that the SPG/GGP merger is no longer a monopoly. The number of Class A malls is stagnant, and may even decline in 2010-11 given recent CRE trends. In the two cases the key difference is that the market in WFMI was expanding at an unprecedented pace and in GGP/SPG it isn’t, and in fact, may contract.

If a decline does happen, the market share of the GGP/SPG portfolio will grow even larger. It is of little debate that there will be a general reduction in retail CRE this year, leaving retailers with fewer options. Fewer options and a consolidation of ownership in Class A malls would place retailers at a competitive disadvantage.

One could also assume the proposed combination of #1 and #2 will have an even larger effect going forward.

So, what does it all mean?

On the 29th Gropper will (most likely) make a decision. He will decide whose offer is the best based on the merits of both. NOTE: everything I now say is based on both offers as they are as of this minute. If either one changes materially tomorrow, we will need to revisit it.

The price on the two offers is essentially the same. The drawback to the BAM offer is the 120M warrants. The drawback[s] to the SPG offer is/are:

1- The possibility of SPG backstopping ~$3B in shares it will eventually sell to get share ownership down to the 20% level of their capped voting interest. This creates a “supply overhang” for shares well in excess of the warrants issued to BAM.

2- No clear plan for the GGO spin off. Brookfield has said it would eagerly appoint management to assist running it should GGP desire. SPG has announced no plans other than the stock purchase.

3- No clear ownership plan from potential investor groups. BAM/FAIRX/Pershing have all said they want GGP to emerge independent and want to be long term owners of the equity. There have been no such statements from the SPG group. It is unclear if they wish to be owners, or are simply speculators wishing to flip shares.

4- FTC. See above. Gropper has to weigh the possibility of a six to nine month delay should the FTC get involved when picking a plan. Also, under the SPG plan, they would have the right to pull out of the offer should the FTC require them to dispose of a significant portion of the malls, leaving the process back to square one. This significant issue is non existent in the BAM plan.

If Simon wants to be a significant equity owner in GGP, it can still do so even if its offer is not accepted. Let SPG deal with the FTC outside of the GGP Chapter 11 process. If the FTC looks at it and then decides a partial stake is okay, then I am sure SPG could essentially get the same equity deal it is offering now for a billion dollar plus commitment.

For those reasons, based on what we have NOW, in my opinion the Brookfield offer is far superior. It offers current shareholders far more certainty now than the SPG offer, and far more ownership stability post Chapter 11 emergence.

Disclosure: Long GGP

Source: GGP: A Closer Look at the Options