|Shares Out. (in M):||71||P/E||0||0|
|Market Cap (in $M):||3,000||P/FCF||0||0|
|Net Debt (in $M):||5,000||EBIT||0||0|
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On February 10, Simon (SPG) entered a (poorly timed!) deal to buy Taubman (TCO) for $52.50/share in a deal expected to close in the middle of the year. Obviously, the world has changed an awful lot since February 10. Corona has shut the nation (and Taubman's malls!) down, and, with TCO's shares trading at ~$44/share, the market is expressing significant doubt the deal goes through.
I personally believe the deal is highly likely to go through, but this write up is not focused on TCO's common stock. Instead, I'd prefer to play the deal through Taubman's preferred shares (yes, pun obviously very much intended). These preferreds will get paid off at par (plus accrued divs) when / if the Taubman deal goes though (see section 6.08 of the merger contract), so at today's prices I think you're taking significantly less risk by buying the preferred but making a similar return to the common.
Let's start with the basics: if the SPG deal goes through, SPG will give TCO common shareholders $52.50/share and pay off the preferreds at par. At today's prices, the market is offering you a better return from buying the preferred stock through deal close than it is offering from buying the common stock (I only show upside to deal closing below; with the deal scheduled to close in the middle of this year, the IRR to the deal closing for all of these is obviously quite substantial!).
That discrepancy shouldn't exist. The preferred are higher in the cap structure than the common, so they should have lower downside in stressed scenarios (i.e. in bankruptcy, the preferred would need to be paid before the common would have any recovery). The combination of lower downside with higher upside creates the opportunity for some really interesting trading dynamics: for example, you could go long the preferred and hedge it out by shorting the common. If the deal goes through, you'd make more on the preferred than you did on the common. If the deal broke, the common should be down substantially more than the preferred (the common traded for ~$26.50/share before rumors of SPG buying them leaked in early February, and given most peers are down >50% since then I would expect the downside to the common in a break is significantly lower than the pre-deal price). Either way, you win (compliance note: this is not investing advice. Shorting in particular is risky; this is just a discussion of a hypothetical trade).
So there are two ways to play this trade:
You can play the deal either way. The rest of this article is going to focus on the investment from the "normal" standpoint (without the hedge), but I wanted to highlight the two options since they are both quite interesting.
Ok, that out the way.... why does the situation exist? There are two possible reasons:
Again, I think the reason the opportunity exists is the former (the market is just bonkers right now), but I'll address the second risk later in the article. For now, I want to spend the rest of this article highlighting three things
Let's start with the beginning: why I think this deal will close.
Putting it all together: this is a strategic deal with a buyer who is more than financially capable of closing. The controlling shareholders for TCO are motivated sellers, and the contract is tight. I think it's extremely likely this deal closes.
Moving to the second point: I don't think the preferred will get screwed.
You have to worry about the preferred in two different ways: how could they get screwed in the current deal, and how could they get screwed if the deal fell through?
Let's start with the former: how could the preferreds get screwed if the deal goes through? The current contract calls for the preferreds to be cashed out at par (plus accrued interest) when the deal closes, so TCO and Simon would need to go change the merger contract to screw the preferreds. I don't think that's likely. TCO's market cap at $52.50 (deal price) is ~$3.7B (including the Taubman family units) and the face value of the preferreds is ~$360m. Given that small size, it's probably not worth going back and trying to recut the contract to screw the preferreds.
Even if they did want to screw the preferreds, the preferreds do have some rights in the event of a change of control that results in Taubman's stock getting cashed out (you can see the series K prospectus here and the series J prospectus here). In particular, in a change of control, the preferreds have the ability to convert into shares of TCO stock (assuming that the company isn't redeeming the preferreds at par; see p. S-4). So, in order to screw the preferreds, TCO and Simon would really have to stretch. First, they'd need to recut the deal to not redeem the preferreds. They'd then need to either 1) do so in a way they doesn't trigger the change of control put provision (that would be very difficult to do, but companies have come up with clever legal structures that make change of controls not legally / technically a change of control before) or 2) cut the price below $40/share (the Series J converts at 0.6361 common shares per preferred share, so $25 / 0.6361 = ~$40/share common stock price for the preferreds to get par through the conversion feature).
The question is why they would go through all that hassle? Again, the preferreds are a very small piece of the overall deal here; I'd be surprised if either side is looking at ways to specifically target the preferreds. And why would TCO have any incentive to go back and modify the deal to screw the preferred? Doing so would likely invite a lawsuit; why would TCO do Simon a favor and recut the contract to shift a little extra value from the preferreds to Simon when doing so gets them a lawsuit and no real upside? There's really nothing in it for TCO to screw the preferreds. In fact, there's no real reason for TCO to go back in and revisit the contract at all. The Taubman family controls TCO and they've got no incentive to revisit; they're already cashing out a third of their stake at prices probably 4x where the stock would trade if it was trading standalone right now; why would they go recut an all-cash deal to get some type of stock when they struck such a good deal? Sure, Simon would probably love to do that, but why would TCO?
So I don't think the preferreds get screwed in the current deal. Let's talk super downside scenario: if the Simon deal broke, could TCO try to screw the preferreds to transfer value from the preferreds to the common? Absolutely they could try, but I'm not sure what they could do to materially impair the preferreds. Obviously they could shut the preferred dividends down, but those would likely be turned back on eventually. The preferred dividends are cumulative, and as a REIT TCO needs to pay out its taxable earnings as dividends every year and the preferred dividends must be paid before any other dividends. As long as you assume Taubman (and the mall space) will recover from Corona eventually, at some point in the future tax law would require TCO to pay the preferred dividends. You could obviously dream up more aggressive scenarios where TCO tries to dividend all their assets to the common and strand the preferreds in some other way, but I can't figure out a way they could actually do that in compliance with their debt covenants that wouldn't be an obvious fraudulent conveyance case. And, again, there's only $360m of value in the preferreds; screwing the preferreds over would get the common a very small amount of money versus TCO's ~$9B enterprise value.
Alright, at this point I've covered why I think the deal will close and why I don't think the preferreds will get screwed. The last point I want to cover is the most likely downside case: what happens to the preferreds if Simon finds a successful way to break the TCO deal.
Again, I think that's unlikely. The contract is reasonably tight, and if Simon tried to break it TCO would sue for specific performance and should win. But let's say I'm wrong and Simon claims an MAE and wins the court case. TCO would walk away with nothing and remain a standalone company. how would the preferreds look then?
I think they would be well covered. I've included two cap structures below. The top is the cap structure at the Simon deal value of $52.50/share; the bottom is the cap structure if I took TCO's price before Simon rumors came out (~$26) and haircut it by 60% (in line with how hard peers have been hit; that share price would result with a valuation roughly in line to slightly below where MAC currently trades).
Cap structure at Simon deal
Cap structure at peer draw-down
Either way, the prefs still have a decent equity cushion. In order to believe the prefs are impaired, you would need to believe that a business that Simon just valued at ~$9B has seen their asset value cut by almost 50%.
Obviously, near term earnings for TCO (and the sector overall) are going to be awful. But TCO's real estate isn't going anywhere, and they easily have the liquidity to get through the current crisis. It would shocking to me if the current crisis resulted in a big enough hit to TCO's earnings power to justify impairing the preferreds.
Note too that TCO's financing is mainly done at the asset level, not the corporate level (only ~$1.2B of TCO's debt is recourse to the holdco), which should increase the chances of recovery for the preferred in a real downside scenario.
It's also worth remembering that TCO is positioned significantly differently than a typical mall. Going over a full overview of the mall sector is a bit beyond the scope of this article, but I'll do a quick overview. Malls and retailers in general are struggling; however, trophy malls (class A are better) have been an exception. There are a few reasons class A malls have been doing well; for example, the clicks to bricks phenomenon where online retailers see boosts to their sales when they open physical locations has created a whole new class of tenants, and higher end malls have found success driving new attractions / experiences / dining options to replace older stores closing. Obviously a lot of those trends will be paused or stop for a while with Corona, but I doubt those trends stop longer term. Even if they did, class A malls are generally located in the best areas in a city and represent some of the city's most valuable real estate. They're generally surrounded by businesses and other stores and they've got great access to public transit and interstates. This real estate will always have significant value; if it wasn't in mall form, a lot of them have value redeveloping into condos and high rises.
That "class A malls are thriving / have underlying real estate value" bodes really well for TCO, as they probably have the best collection of malls out of all of their public peers. I've posted some slides from their July 2019 investor deck below to highlight how their malls are positioned, but the bottom line is that however you want to judge a mall portfolio (sales per square foot, rent per square foot, etc.), TCO's portfolio is significantly better than peers and is among the best positioned for the "class A malls outperform" trend.