Simon Property Group and General Growth: An Operating Pro-Forma

Includes: GGP, SPG
by: Naveen Selvaraj

Simon Property Group's (NYSE:SPG) $10B offer for its nearest competitor, General Growth Properties (GGWPQ.PK) shows that Mall REITS are back in the expansion/consolidation track. Mall operators seem to have put the dreary days of 2009 behind them.

General Growth's rejection of SPG's offer though its chief executive Adam Metz's letter to SPG indicates that General Growth's management believes that they can bargain for more. Meanwhile a shareholder lawsuit has been filed against the General Growth Board (Source: Reuters) for not taking up the SPG offer in earnest. The floodgates are open now and it would be interesting to see who blinks first.

The crucial point of interest for long-term investors would be as to how the asset portfolios of Simon and General Growth look on a consolidated basis. With this question in mind, I attempt to compare and contrast the asset portfolios of the two entities across different aspects that are important for evaluating a mall operator portfolio: Rent spreads, Occupancies, tenant mix and geographic mix.

Geographic Mix

Though Simon has a substantial international portfolio, it still pales in size compared to the size of its US operations. Therefore the acquisition of General Growth is a pure domestic play and in that sense it looks risky. Since the number of properties are huge for each entity, I just looked at the % contribution of Net Operating Income (NOI) from each state/region as the companies report for different geographical areas.

Simon NOI Composition By State

(click to view enlarged image)

Source: Company filings

General Growth NOI Composition By Region

Source: Company filings

While the two sets of numbers are strictly not comparable, it looks like Simon is strong in Florida while General Growth has its biggest presence in the West - California, Nevada etc. Though General growth did not give a state-wise breakout in its latest 10Q(Sep 30,2009), it does look like General Growth has a more diversified presence compared to Simon.

So there could be a very small benefit to the combined entity in terms of (1) increasing its presence in previously untapped markets or (2) increasing the strength of its market position in select states.

Tenant Mix

In terms of tenant portfolio, the top 4 tenants for both Simon and General Growth are the same - Gap Inc (NYSE:GPS), Limited Brands Inc (LTD), Abercrombie & Fitch (NYSE:ANF) and Foot Locker (NYSE:FL). While they represent ~7.5% of total rents earned by Simon (for Malls only), for General Growth it is a higher ~10.1% of total rents earned in the nine months ending Sep 2009.

Simon- Top Tenants By Rents Paid

Source: Company filings

General Growth- Top Tenants By Rents Paid

Source: Company filings

I also collated the total number of stores that the top tenants operate based on data available at Gridstone Research. Here's a look at the revenue growth on a TTM basis till Sep/Oct09 and the number of stores:

Top Tenants of Simon and General Growth - Number of Stores and Rev. Growth

Source: Gridstone Research

Their biggest tenant, Gap Inc, has a total of 3143 stores of which ~281 are part of the Simon portfolio. Though the General Growth numbers are not available, it should be atleast a hundred as the total GLA (Gross leasable area) for the US portfolio is ~128 M Sqft for General Growth while its around ~180 M sqft for the Simon Mall portfolio(exlcudes premium outlets and International portfolio). Even if it is ~100-150, the combined entity will end up with 10% of GAP Inc's stores in its portfolio. While both have wholesale retailers and discounters as tenants, apparel and clothing retailers contribute higher rents as they occupy prime property and are willing to pay top dollar for the same. The idea is that such locations will generate higher sales per square foot and therefore apparel/clothing retailers can afford to pay higher rentals on the per square foot basis.

But as the table above shows, almost all the top tenants of the combined SPG-General Growth portfolio have shown a revenue decline in 2009(till Sep). Though the revenue would have improved in Dec09 quarter, it looks unlikely that the top tenants of the combined portfolio would be looking at aggressive expansion or willing to pay higher rents for their existing stores.

Rent or Leasing Spreads

The biggest difference between the two portfolios emerges in this area - leasing or rent spreads. The leasing spread is the difference between the average rent in new leases versus the average rents of expiring leases. The higher the difference with new lease rents being higher, it is an indication that the portfolio mix has seen increase in rents or the mix is getting skewed towards higher yielding properties.

Simon Portfolio - Rent Spreads

Source: Company filings

While spreads have declined even for the Simon portfolio, it has managed to stay positive indicating that the Simon portfolio has quality space where tenants are willing to pay higher rents even in such rececssionary times. General Growth has however seen a decline in rent spread in 2009 and the spreads have also been on a continual decline since 2007. But it should be noted that the rents would have increased due to contracts negotiated much earlier (which have standard step-up in rents year over year) and the spreads could further decline (or even go negative for Simon) as more lease expirations come up for negotiation in 2010/11.

General Growth - Rent Spreads

Source: Company filings

If both these portfolios have similar tenants but have vastly different geographical distribution of their properties, then the difference in rent spread trends could be attributed to the markets they operate in. Though the top states in terms of profit contribution could be different for the Simon and General Growth portfolio, I believe that the nationwide presence of the both the portfolios and their number one and two positions in the mall opertor space indicates that the General Growth portfolio is less attractive for tenants vis a vis the Simon portfolio. This is confirmed by the sales per square foot numbers that the companies disclose.

Occupancy and Sales Per Square Foot

In terms of occupancy and sales per square foot, the portfolios are comparable. For Simon, Occupancy has declined to ~91.4% from 92.5% in the year-ago period. Sales per square foot has declined by ~11.2% to $438 as all clothing and apparel retailers faced a severe slide in sales. For General Growth, occupancy slid by 130 bps to 91.3% and sales per quare foot declined by ~10% to $409 per suare foot. So the Simon porfolio has a much better realization in sales per square foot compared to the General Growth portfolio.

Simon Portfolio - Occupancy and Sales Per Square Foot

Source: Company filings

General Growth Portfolio - Occupancy and Sales Per Square Foot

Source: Company filings

In summary, the combined SPG-General Growth Portfolio adds little more than size and number of stores to the potential combination of assets. Any assumption that Simon would be able to increase the overall yields from the combined porfolio through better management and positioning will have to be carefully scrutinized as mall capacity is not going to go down. Its not easy to purge 'excess' mall capacity unlike production capacity and therefore any supply overhand could stay for years. The questions that come to mind are :

1. How will Simon increase the yields from the combined portfolio when occupancies are falling or are stagnant? Is it worth the risk to increase the capacity under management and are the planned improvement in yields commensurate to the risks involved?

2. Would it not be better to buy select properties which fill gaps in Simon's portfolio rather than make an offer from General Growth as a whole?

Disclosure: No Positions