Thu 05/21/2020 12:21 PM
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Takeaways
 
  • In the event that Simon Property Group’s acquisition of Taubman hits a roadblock and the parties litigate, Simon may rely on specific language in the merger agreement to prove that Taubman has suffered disproportionately compared with its peers.
  • The language in the merger agreement calls for such comparison to be made against “other participants in the industries in which such Person and its Subsidiaries operate.” F.L. Gorman, co-leader of the real estate developers industry team at Harris Beach, noted that Simon could point to the phrase “industries” in the MAE clause in defense of using a broader REIT category to compare Taubman’s performance against.
  • In a potential litigation, the court may look to determine whether the phrase “other participants in the industries” should be restricted to other Mall REITs or encompass a broader set of retail REITs including shopping center REITs and freestanding net lease REITs.
  • According to the latest company filings, April rent collection metrics hovered around 75% for the top freestanding net lease REITs and 58% for the top shopping center REITs. In comparison, for mall REITS that reported rent collection numbers, average April rent collection percentage stood at 22%. Taubman did not report rent collection numbers for April.
  • Any potential litigation action would likely meet with delays, considering the logistical difficulties facing the courts amid the ongoing coronavirus crisis. Assuming the two companies are engaging in behind-the-scenes negotiations, and should such discussions break down, the probability that either company could get expedited actionable relief from the courts appears low.

In the event that Simon Property Group’s acquisition of Taubman hits a roadblock and the parties litigate, Simon may rely on specific language in the merger agreement to prove that Taubman has suffered disproportionately compared with its peers.

The language in the merger agreement calls for such comparison to be made against “other participants in the industries in which such Person and its Subsidiaries operate.”

F.L. Gorman, co-leader of the real estate developers industry team at Harris Beach, agreed that Simon could make this argument. According to Gorman, Simon could point to the phrase “industries” in the material adverse effect clause in defense of using a broader REIT category to compare Taubman’s performance against. “You’re getting into the issue of, ‘Is this language specific?’” Gorman said.

On the May 11 earnings call, Simon Property Group President David Simon dodged several questions related to his company’s acquisition of Taubman, fueling speculation that the deal may be headed for trouble.

As Reorg analyzed previously, the merger agreement specifically excludes “pandemics” from being taken into account in determining whether a material adverse effect has occurred or may occur, unless “such effect, change, event or occurrence has a disproportionate adverse effect on [Taubman], taken as a whole, as compared to other participants in the industries in which such Person and its Subsidiaries operate.”

In a potential litigation, the court may look to determine whether the phrase “other participants in the industries” should be restricted to other Mall REITs or encompass a broader set of retail REITs including shopping center REITs and freestanding net lease REITs.

Shopping center REITs include outlet centers, grocery-anchored shopping centers and power centers that feature big-box retailers. Freestanding net lease REITs own freestanding properties and structure their leases so that tenants pay both rent and the majority of operating expenses for a property.

This determination would assume significance, as the impact of the coronavirus crisis on Taubman could appear to be “disproportionate” when compared with a broader category that includes shopping centers and freestanding net lease REITs that have performed relatively well during this crisis.

Figure 1: April Rent Collection Metrics for Retail REITs

(Source: Company filings)
 
(Source: Company filings)
 
(Source: Company filings)

As Figure 1 illustrates, the average April rent collection metrics - the first such metric that provides a glimpse into the health of retail REITs post coronavirus - hovered around 75% for the top freestanding net lease REITs and 58% for the top shopping center REITs. In comparison, REITs such as Simon and Taubman that derive their earnings from retail establishments in enclosed mall settings chose not to disclose rent collection percentages for April. Among other mall REITS that reported rent collection numbers, average April rent collection percentage stood at 22%.

In fact, most recent data from NAREIT indicates that freestanding net lease REITs and shopping center REITs overall continued to sustain relatively healthy rent collection metrics in the month of May. According to NAREIT, freestanding and shopping center REITs reported rent collection at 70% and 48% respectively in the month of May, compared with 71% and 46% in April. The report argued that “prevalence of essential businesses such as grocery and drug stores among the tenant base for many shopping center[s] and free standing REITs is a stabilizing factor for these types of retail properties.” Mall REITs, on the other hand, did not participate in the NAREIT survey.

Figure 2: Share of Rent Received in April and May
 
(Source: NAREIT)

Another interesting fact that emerges from Figure 1 is that freestanding net lease REITs that reported on average 75% rent collection in April were hardly able to collect rent from apparel, entertainment retail and movie theater establishments. Considering that these retail sub-categories form the mainstay of enclosed high-end malls controlled by Taubman and other mall REITs, the near-term outlook for the latter does not look promising.

Distress in the high-end retail sector, which includes Macy’s, J.C. Penney, Neiman Marcus and J.Crew among others, could further solidify the divergence in financial performance between Mall REITs and the broader retail REIT sector.

For instance, Macy’s is weighing the possibility of raising as much as $5 billion of new debt. And as part of the new financing, the company will undertake a major restructuring of its business, including cost savings initiatives that would involve closure of 125 stores over the next three years. Macy’s is integral to Taubman, as the retailer’s stores constitute anchor stores for 18 out of 24 properties controlled by Taubman.

Similarly, J.C. Penney announced that it was closing 240 stores as part of its bankruptcy plan. In addition to J.Crew and Neiman Marcus bankruptcies, The Gap has given notice that it will suspend rent payment for all of its stores and may even close some of its stores permanently. Two of Taubman’s properties - University Town Center in Sarasota and Tampa International Plaza - are currently impacted by Gap’s closures and suspension of rent payments. According to Taubman’s 10-K filing, J.C. Penney and Neiman Marcus constitute anchor stores in nine out of 24 properties controlled by the company.

Figure 3: High-End Retail Distress / Bankruptcies Affecting Taubman
 
(Source: Taubman 10-K)

In this context, David Simon’s reiteration that Simon is not a “mall company” on the May 11 earnings call is particularly interesting. In response to a question, Simon argued that “we are not a mall company. We are predominantly a retail real estate company, but we're not - I wouldn't, by any stretch of the imagination, consider us a mall company.” Simon went on to stress again during the call that “you got to understand we're not a mall company. And number one, we've never said that even for years and years and years.”

According to Gorman, Simon could argue that all retail REITs have been impacted by the pandemic, but that Taubman’s poor financial performance would stand out even when taking this into account. “Simon would argue that you can do a comparative analysis - maybe with community or grocery centers - and there’s very few retail sub-industries that are escaping the effect of Covid-19,” Gorman said.

David Simon’s comments regarding how the market should view companies such as Simon and Taubman as not just “mall companies” but “retail real estate companies” could indicate a potential legal strategy revolving around a comparison between Taubman and a broader set of REITs. Such a comparison may aid Simon and its legal team in proving to the court that Taubman would have suffered “disproportionately” compared with “other participants in the industries in which” Taubman operates.

Even then, it would be pertinent to note that the court would likely consider such comparisons if it were “durationally significant.” In the Akorn case, the court studied Akorn’s negative performance over a span of five consecutive quarters. For Simon to succeed in a potential litigation scenario, the company would have to prove that Taubman has suffered “disproportionately” compared with other industry participants, including shopping center and freestanding REITs, for a substantial period.

Additionally, any litigation action is likely to meet with delays considering the logistical difficulties facing the courts amid the ongoing coronavirus crisis. Assuming the two companies are engaging in behind-the-scenes negotiations, and should such discussions break down, the probability that either company could get expedited actionable relief from the courts appears low.

“If Simon loses on summary judgment saying that this provision allows them to get out of the deal, then they start bringing in experts to define the markets,” said Gorman, noting the importance of the specific judge and expert witnesses. “From there, it would be a hard and expensive litigation.”

Reorg’s previous coverage of this transaction can be found HERE.

--Shrey Verma and Matt Tracy
 
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