Insider Purchase: Washington Prime Group's Unorthodox CEO Loads Up On Shares

Summary

• WPG's management presented on Wednesday morning at the Citi 2018 Global Property CEO Conference.
• CEO Lou Conforti was blunt, relatively unguarded, thoughtful, funny, and a huge cheerleader for his stock.
• His leadership and communication style are incredibly unorthodox for a CEO - which might be the prescription needed for an industry in the middle of being disrupted.
• Lou backed up his bullish comments with an open market purchase of $183K of WPG stock on February 28.
• CFO Mark Yale hinted that WPG may have significant one-time gains in 2018, implying a potential O'Connor JV III.

I listened to Dan Carlin's six-part Hardcore History podcast focused on World War I in late 2017 (Blueprint for Armageddon I). If you have a spare 40 hours, I heartily recommend it.

In the early part of the war, virtually every country ended up firing most of their generals within the first year. Europe hadn't seen a large-scale war in decades, and military technology had evolved while leadership tactics had not. The early-war generals sacrificed hundreds of thousands of soldiers fighting with strategies that had been developed before the advent of the machine gun. Eventually, as generals were replaced with new officers who could adapt to modern weaponry, the war evolved into the long slow slog we remember as World War I.

The countries who were quickest to change were the countries who wasted the fewest resources in the early part of the war. Those that waited too long ran out of resources and inevitably saw their governments collapse to internal revolutions caused by starvation as much as by invading enemy armies.

I'm reminded of this history when I think about the shopping mall space today. Technology and times have changed, and the shopping mall industry is facing incredible disruption. It's not just Amazon.com (AMZN), but changing preferences, changing demographics, and changing wealth and income distribution among Americans. I can't say with confidence who will survive, but I am willing to bet it won't be those companies whose management teams don't adapt fast enough.

I initiated a sizable holding in Washington Prime Group (NYSE:WPG) in large part because I think highly of its management team. In my last article on WPG, I walked through the board battle that forced out former CEO Michael Glimcher and brought Lou Conforti's proactive strategy into the C-suite. The article also examines the dozens of value enhancing moves that Conforti, CFO Mark Yale, and the rest of the WPG management team have made over the past two years to proactively position WPG to survive the disruption.

On Wednesday, Conforti and Yale presented at the Citi 2018 Global Property CEO Conference. The slides are available here, but the Q&A provided some excellent insight. Conforti mixed comedy and clear analysis on a wide range of issues facing the company. I encourage shareholders and potential investors to listen to the presentation. Of course, if you just spent 40 hours learning about WW I and are short the 36 minutes, I'll bullet-point several of Lou's answers and comment on what we learned. (Unless otherwise labeled, all quotes below are from Lou.)

Unfortunately, if you're like me and missed the live presentation, you missed the Mimosas that Lou brought for the attendees of his 8 a.m. presentation.

What really matters

Lou started by reiterating his belief that "financial buttressing" and "operating efficacy" are the two factors that really matter right now. The financial buttressing relies on lowering leverage and maintaining an investment grade balance sheet. The operating efficacy is about generating stable rent from their properties.

He also reiterated comments that he previously thought investing in single-family homes following the Great Recession would be the biggest real estate opportunity of his career, but he now believes the investment opportunity in "dominant secondary properties are unlike anything I've ever seen." He went on to explain that the industry failed to foresee changes and valuations are binary between 'primary assets' and 'secondary assets.' He believes it's a false dichotomy.

What's clear is that he believes WPG is "working to change the industry."

Differentiation

[2:40] "The vast majority of the sector has been lazy and reactive and been rent collectors instead of, and I know it's a hipster word, but curators."

[3:10] After mentioning that WPG has 43% tenancy of junior fashion, Conforti asked for a show of hands for who in the crowd was wearing underwear from Victoria's secret. "I know Mark, me, Stewart? Oh yes you are. Liar... [laughter] Unless 4 out of 10 of us are wearing a Claire's bauble, or a Junior, a Vickie's or a Pink. We're too long. We're way too long certain retail categories, and it's incumbent upon us to modulate that. To fix that, and we're doing that with real-time incentives to our leasing professionals."

Valuation

[4:10] "We're being valued as if we're a defacto liquidating trust."

[4:55] "There is a pretty robust current return. I think about it as you have a current return vehicle with hopefully a short-dated, but it might be a mid-dated option for upside."

[7:00] "David Simon is the best CEO I know in any industry quite frankly... and he loves hearing it, so I'm not going to tell him that... I don't need to trade at his multiple, but Jesus Christ, trading at a F*ckin 4 times with an investment grade balance sheet? It's that there's no stratification. There's these binary paths. You're either a 4 or 5 multiple or a 16, 17, or 18 whatever? It's an obtuse characterization!" (Emphasis is not my own - this expletive outburst is worth listening to as he's trying to open a bottle at the same time he's talking.)

[8:15] "For the fat part of our bell curve, after cola adjustments, we're above the mean for national income. [Our valuation,] It's a lack of understanding, and quite frankly it's a disrespect for my shoppers... OUR shoppers."

Better Management

After an anecdote about what happened when one got caught shoplifting in a 1990s mall and getting taken to the back office where there were "gnomes and shit," Lou started talking about the importance of how they're improving local property management.

[11:40] "We Found 10 general managers who really embody the concept of a Goodwill Ambassador. We had them out last week." He continued, "These are folks that run $300-$400 million dollar companies, larger when you consider the GDP impact of their catchment into account. We pay them crappy. We don't respect them. We don't profit participate them with the individual asset. We don't let them go find local [tenants]. Who knows better than Tembra Aldridge about Johnson City? We're moving the front office front and center. The receptivity by both corporate and local management was amazing. It cost practically nothing to do. They want to be more interactive. And those that don't... I want goodwill ambassadors. It's been amazing with the receptivity of what we're trying to do."

[16:28] "Think about the Dad sitting on that, you know that metal lattice, [snores] you know snoring. We brought in a couple of craft brewers. We're going to roll them out all over. We've got comfortable chairs and some big screen TVs. We've got Artisinal sandwiches... there are lines of people there. And quite frankly, our goal is to increase duration stay... and it does it... In our middle-America we are the town center. And sometimes I'm befuddled that people are still hanging around with the lack of anything exciting or differentiating that we've brought, so we've brought in local craft brewers."

Shelby's Sugar Shop and 'Kinetics'

[19:30] "These things cost nothing to do. Shelby's Sugar Shop, which is our candy outlet. If you're really fancy you get a Dillon's. You know what we get in middle America? Those shitty gumball machines or some weirdo local operator. Visit Shelby's Instagram. It cost us about $250K. It will take about a year to break even. It's saleable and it's sponsorable. We've already got folks like Coca-Cola talking to us. We will continue to strengthen the annuity stream of in-line and long-dated. There's a rotational and almost event aspect of what this industry needs."

Source: Shelby's Sugar Shack Instagram Feed - Chocolate

I am highlighting Lou's comments on Shelby's because there has been a lot of criticism of this initiative on Seeking Alpha, and this is the most information I have seen about the shops, specifically the cost of the initiative. For an initial cost of $250K with a one-year break even, this initiative is a very low-risk, but potentially high return value driver that can be flexibly rolled out to many of WPG's 100+ malls. (If you're interested, here's the Shelby's Sugar Shop website. It lists four locations with a fifth opening soon.)

Rent Concessions

[21:15] "We certainly do the Faustian deals, and again, I'm not delusional. We can only negotiate from a modicum of strength because of what Mark has done to strengthen our balance sheet over the last year. When we look at our tenant watch list, we did a relative study of us, TCO, SPG... we all have the exact same watch list constituents... And Last year, 70% were over-levered Private equity sponsor or Junior Fashion and Accessory. So, when they come back for rent concession, they're coming back to either solve for an [investor] distribution or interest expense reduction with their creditors. No way! If they ain't putting back into their stores, we're not cooperating... It really is a disservice to you all, me included as a shareholder, and to our guests, but to those tenants who are doing interesting things and are evolving. If you don't put money back into our stores, we're taking a much harder stance than some of our competitors. It's self-fulfilling in that we're leasing 4 million square foot a year. A little less than half of that is in alternative categories, if we don't change [the mix], it will become a self-fulfilling property, and we're not letting that happen."

Stock Buyback

[27:30] "I've thought about it academically, practically... I don't have the answer. If you're an efficient market theorist you look for the best return on invested capital, but you have to look at the second and third derivative impact of decreasing float and increasing leverage. If I'm sitting in Hyde Park, I'm sure there are some professors who will think we should buyback. We live in a much more multi-factor world. It's a great question. People buy shares generally for the wrong reasons to artificially buttress share price. I've seen it time and time again. You have to buy enough shares for it to be meaningful. I don't know. We evaluate it. We think about it. We think about it holistically. Are we doing something that might only have a 9.5% direct return, and that's direct, so we don't include adjacent space when we do redevelopment. Then there's the incremental benefit of getting better rent for unproductive space, then there's multiple expansion because you're doing the right thing. So, it's much more iterative than 9.5% vs. that 13-15% dividend, but I don't have the answer."

Lou is a Chicagoan and his mention of Hyde Park is a reference to the Booth School of Business at the University of Chicago. UChicago is the birthplace of the efficient market theory, located in the Hyde Park neighborhood of Chicago.

On CBL's Dividend Cut and not cutting WPG's Dividend

[30:15] "Look at the historical stability of our cash flows over the past few years. We're about at a 78-79% payout ratio, and we have the ability to modulate capital spend... We don't discuss dividend policy... but my charter is to have you guys have an outsized return - an asymmetric return profile while we are waiting for this industry for there to be another stratification vs. that primary or secondary."

Mark Yale chimed in: "There's also the practical side of our taxable income and distribution requirements. In 2017, 100% of our dividend was income. There was no return of capital. Now, we had some one time items that drove that up. We have to manage through. There could be some other one time items in 2018, so we're managing through that. I think that just looking at the 1031 [gain] and the reasons why we wanted to shelter that gain, probably indicates that we're trying to manage through that. It's a well-covered dividend as Lou said. It's just under 80% projected in 2018. We're confident of our cash flows as we look forward, and we have to manage our taxable income as well... In 2018, we're projecting at the midpoint of our guidance about $55 million of free cash flow."

In this quote, Mark Yale is referring to WPG's recent sale of ~60 income producing restaurant outparcels at a 6.5% yield. The company took the gains on those properties and rolled those using a 1031 exchange into purchasing Southgate Mall at an approximate 10.4% yield. This transaction increased WPG's expected 2018 income and it raised eyebrows as it was WPG's first acquisition in nearly three years. To my hearing, implying that the company may have additional one-time gains in 2018 and that the company wanted a 1031 exchange so as not to increase taxable income, which could force a higher dividend distribution - implies that WPG is working on another transaction that will create meaningful capital gains in 2018. In 2017, the O'Connor JV II transaction created significant one-time gains, and I suspect the company may announce an O'Connor JV III soon. This would most likely be very bullish for WPG.

Conclusion

There is a lot of uncertainty in the mall REIT space and success will be partially determined by the quality of management. I'm impressed by Conforti and the WPG management team, but I can certainly see where I could be wrong.

Lou is brash. He's a good story-teller, which can sometimes fool people (myself included), but he's constantly referencing the data-driven nature of their management decisions. Most importantly to me - I think his personality is the type necessary to drive change within an organization. Shopping malls need to change, and I feel comfortable investing in a company that was early to change leadership to an individual who is emphasizing the need for the whole industry to adapt.

(Of course, David Simon acted earliest by choosing to spin off WPG from Simon Property Group (NYSE:SPG) in a move that seems truly prescient. From what I know of SPG, I've been impressed with their management, but their valuation doesn't meet my return profile.)

Finally, I am also encouraged by Lou's recent purchase of $183K of stock on the open market a few days after the last earnings call. Lou has previously been awarded equity compensation as the CEO, but this was an open market purchase, and I'm glad to know he's got skin in the game given his comments on valuation.

Analyst’s Disclosure: I am/we are long WPG, CBL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

I am long WPG with a significant position. My dividend-adjusted cost basis is $6.61/share. I am also long CBL with an insignificant position.