Market conditions for the retail sector have truly been apocalyptic this year. Most retailers had to close their stores to help slow the spread of COVID-19. That forced an acceleration in the migration of more shopping online. Because of that, more retailers have filed for bankruptcy while many others will likely permanently shutter additional physical locations.
The sector's worsening environment upended the growth ambitions of leading mall owner Simon Property Group (NYSE: SPG). It had agreed to acquire rival mall real estate investment trust (REIT) Taubman Centers (NYSE: TCO), which would give it control over leading the redevelopment of its prime real estate. However, Simon recently pulled out of that deal, citing the outsized impact COVID-19 had on Taubman. That unraveled transaction doesn't bode well for retail real estate values.
When Simon Property Group agreed to acquire fellow mall owner Taubman Centers earlier this year, it stunned the retail real estate market. The company's all-cash offer came at a 51% premium above Taubman's market value and 19% higher than its enterprise value. That hefty price tag reflected Simon's belief that the market had significantly undervalued Taubman's real estate, driven by overblown concerns on the continued shift toward online shopping.
Simon Property believed it could maximize the value of Taubman's well-located real estate by reimagining its properties. It wanted to invest in the creation of "innovative retail environments that create exciting shopping and entertainment experiences for consumers [and] immersive opportunities for retailers," according to CEO David Simon.
However, those plans seemed to go out the window as a result of the COVID-19 outbreak. Simon believes that the pandemic disproportionately impacted Taubman because of the location of its assets. It also faulted the company for not cutting expenses as deeply as Simon and its peers.
Reading between the lines
There's no doubt that the COVID-19 outbreak impacted Taubman's operations. The company closed most of its malls to slow the spread. Because of that, many of its tenants refused to pay rent in April. However, Simon also closed most of its malls and experienced issues with rental collections.
Meanwhile, Taubman took action to offset some of this lost income by deferring between $100 million and $110 million of capital spending and cutting operating expenses by $10 million. The company noted in its first-quarter earnings release that "these actions have materially lowered expected cash outflows." The company also did not declare a dividend during the second quarter.
While Simon doesn't believe Taubman did enough during the pandemic, that doesn't seem to be the real reason it abandoned this deal. The primary issue is that Taubman's assets are no longer worth the premium price Simon agreed to pay a few months ago. That's because the COVID-19 outbreak has supercharged the retail apocalypse, which will see more online shopping migration, resulting in additional retail bankruptcies and store closures. That will put more pressure on occupancy and rental rates at retail centers.
Analysts agree that the COVID-19 outbreak has significantly compressed retail valuations. For example, Compass Point estimates that if Simon wanted to renegotiate, a reasonable price to pay for Taubman these days would be between $36 and $42 per share, well below the $52.50 per share of the initial merger agreement.
That suggests shares would have even less value without a potential deal premium. It also implies that retail properties overall are worth considerably less today than they were earlier this year.
Pressuring retail property values
The collapse of this mall deal has big implications for retail real estate values. With Simon walking away, it suggests that it no longer sees the same value proposition and upside potential in Taubman as it did earlier this year. That's due to an acceleration of the retail apocalypse as well as concerns that redeveloping these properties into shopping, dining, and entertainment complexes might not pay off if the economy remains in a prolonged slump. Those same concerns will likely weigh on the entire retail property market unless conditions show clear signs of improvement.