Simon Property Makes A Good Move With Taubman Centers

2020 has been a wild ride for shareholders in both Simon Property Group (SPG) and Taubman Centers (TCO). Back in February, news broke that Simon was going to acquire 80% of Taubman Realty Group, the parent of Taubman Centers, in a deal valuing that 80% stake at $3.6 billion, plus another $119 million in operating units. Amidst the COVID-19 pandemic, Simon made clear in June that it was backing away from the merger, only for Taubman to take Simon to court in response. Now, on November 15^th, it has become clear that the saga is not over just yet. The two firms have come to an undisclosed settlement, plus Simon has agreed to buy Taubman, albeit at a price that is substantially lower than what it had initially agreed to pay for the firm. Assuming Taubman’s financial condition does eventually turn around from the recent downturn it has been hit by, Simon’s move will be considered a more attractive one than it was at the higher buyout price, though this does unfortunately come at the cost of Taubman’s own shareholders.

A revision to expectations

Back in February, when Simon announced plans to acquire Taubman, the company stated that it had agreed to buy the firm for $52.50 per share. To be precise, it wasn’t the entire firm though. It was 80% of Taubman Realty Group, which owns Taubman. The remaining 20% of Taubman not acquired by Simon would remain owned by the Taubman family, down from the 29% of the business they owned at the time. The Taubman family did have the right, after a two-year lock-down period, to exchange their remaining 20% of the business for cash or shares in Simon. This buyout price represented a premium of 51.4% over the $34.67 per unit that shares traded for immediately prior to the deal being announced.

In sum, Simon was slated to pay $3.6 billion in cash to Taubman’s shareholders for the 80% stake. This was on top of $119 million worth of Simon operating units that would be paid out. At the time, this implied a price/FFO (funds from operations) multiple of 15 for Taubman. It also implied a price/AFFO (adjusted funds from operations) multiple of 14.2 for the business. This was all based on 2019’s FFO and AFFO figures.

As the COVID-19 pandemic worsened, it became clear that Taubman’s operations would be impacted to some degree. The company did issue location closures, though as of the end of its third quarter this year the business announced that all of its US properties have now re-opened and that 94% of its tenants re-opened. Even though this positive string of developments has been announced, the company’s occupancy rate is fairly low as measured by historic results. In the 5 years ending in 2019, occupancy ranged between 93.9% and 94.8%. Today, that reading is lower at 89.9%.

Due to the rough year, Taubman saw its operating performance worsen relative to years prior. Revenue in the third quarter, for instance, was $131 million. This is down 19.4% compared to the $162.51 million seen the same quarter last year. Over the same period of time, the company’s net profit of $215.36 million turned into a net loss of $30.07 million. Its FFO dropped from $78.4 million to $34.5 million, and its AFFO declined from $76 million to $53.6 million. These represent declines of 56% and 29.5%, respectively.

Results for the full three quarters reported for 2020 have been similarly bad. Revenue of $408.99 million is down 15.6% compared to the $484.32 million seen in 2019. The firm’s net profit of $236.72 million turned into a loss of $44.96 million. Operating cash flow for the first three quarters this year totaled $49.75 million. This was down 76.7% compared to the $213.68 million seen last year. Adjusted for changes in working capital so far this year, the figure was $125.39 million. This represents a drop of 42.4% compared to the $217.58 million seen in the three quarters last year. FFO of $130.4 million is down 42.9% from the $228.5 million seen a year earlier. AFFO, meanwhile, was $168.5 million, which is down 30.2% from last year’s $241.5 million.

As you can see, Taubman has had a tough year, but given the quality of the firm and its operations, it will likely recover once the COVID-19 pandemic vanishes. If it doesn’t, the firm could still be attractive, but we need to take into consideration the price paid for it by Simon. This will require us to look at two different scenarios regarding pricing, but before we embark on that journey, we should discuss the changes made to the deal by the firms.

In response to these changes, Simon and Taubman struck a deal to make sure the transaction could still take place. The new deal calls for Simon to pay $43 per share for the business instead of $52.50. This implies a smaller premium from the pre-announcement earlier this year of 24%. That’s not bad in and of itself. The deal also involves a settlement regarding the lawsuit between the two firms and it stipulates that Taubman cannot pay out any distribution to shareholders until at least March 1^st of 2021, at which point Simon expects to have completed its acquisition of its 80% interest in the firm. In the event that the merger is called off, Taubman agrees to pay Simon a termination fee of $92 million.

Taking the new price into effect, the price that Simon is paying for its 80% ownership is about $675 million lower than what was originally planned. Using annualized FFO figures for 2020, the price/FFO multiple rises to a lofty 23.2. Its AFFO multiple, meanwhile, rises to 17.2. These are awfully high figures, but in the likely event that Taubman goes back to its own cash flow figures for 2019, its price/FFO multiple will be about 12.4, while its price/AFFO multiple will be about 11.5. That’s far more reasonable for a firm like Taubman.

Takeaway

Based on the data provided, it seems pretty clear to me that the move by Simon to cut the purchase price of Taubman was logical. For Taubman’s investors, the move is painful, but it does still imply a nice premium over where shares started earlier this year. In addition, Simon is taking some risk here. If Taubman’s financials don’t recover to pre-COVID levels, the purchase price for it will have been very high, while if they do, the company will have gotten Taubman for a pretty decent price (fair value or perhaps a bit lower than that).

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.