Description

We believe that Washington Prime Group (“WPG”) represents an attractive and timely investment at the current price of $17.29.  WPG is a REIT that was spun off from Simon Property Group (“Simon”) in May 2014 at $20 per share.  WPG owns a diversified portfolio of retail assets, consisting of both enclosed malls and shopping centers.  Following the spin-off, selling pressure from Simon shareholders combined with a dearth of financial information and a lack of any meaningful analyst coverage made WPG a classically mispriced spin-off stock.  In September, less than four months after emerging as an independent public company, WPG announced the acquisition of Glimcher Realty Trust (“Glimcher”), a similarly-sized mall REIT.  This transformative acquisition added further complexity to an already misunderstood situation, resulting in the stock falling more than 20% below initial trading levels at one point.  Since the spin, the company’s peer group has performed well and WPG stock has trailed by roughly 30%.   We believe that WPG is one of the cheapest stocks in retail real estate despite a solid portfolio and we think that shares offer near-term upside of at least 50%.

Pro forma for the Glimcher acquisition, WPG currently trades at a 5.8% dividend yield ($1 per share), 9x FFO and 11x AFFO of $1.55 per share.  Regional mall peers (RSE and PEI) trade at dividend yields <4% and 15x AFFO and strip center peers (KIM and DDR) trade at dividend yields <4% and 18x AFFO.  We think WPG shares can ultimately trade closer to 17x AFFO (the average of the comps), equating to a price of a $28 per share and total value in one year of $29 per share (including dividends), 70% above current levels.

Over the next couple of months, we anticipate a number of catalysts will unlock value for shareholders:

1.       Closing of the Glimcher transaction

2.       Filing of first supplement with detailed financial and property information

3.       First earnings call

4.       Initiation of research coverage (SunTrust is the only current coverage)

5.       ETF and mutual fund additions

6.       Retail investors bidding up the dividend (the yield is significantly higher than comparable alternatives)

We think this is an investment that is attractive on both an absolute and relative basis.  While we are recommending this as a long position, we believe that partially pairing a long position with a short position in some of its more expensive peers represents a very attractive risk-adjusted option as well. 

Background

Last December, Simon, known for its larger mall and premium outlet portfolio, announced plans to spin off its strip center and smaller enclosed malls portfolio.  WPG’s initial portfolio of 98 properties represented nearly one-third of Simon’s total portfolio by number, but just a small fraction of its total operating income.  For every dollar of Simon stock owned, an investor received just a nickel of WPG stock.  Given the small size of the spin-off and Simon’s heavy weighting in real estate indices and ETFs, we believe WPG shares experienced significant technical selling pressure.

WPG was spun off with an underlevered balance sheet and without a corporate infrastructure.  The accretive acquisition of Glimcher quickly levers the balance sheet to a level more in-line with peers and eliminates the need to build out a new corporate overhead.  Additionally, the acquisition offers diversification into a faster-growing, high quality mall portfolio and provides additional future development opportunities.  The combined entity will have significant scale, and with a market capitalization of nearly $4 billion, it will be one of the 15 largest retail REITs in the United States.

Transaction Details

Glimcher shareholders will receive $10.40 of cash and 0.2 shares of WPG stock per share of GRT stock owned.  The deal is expected to close in Q1 2015 and shares trade at a small discount to the deal price.

WPG will finance the transaction with a combination of shares, debt and proceeds from asset sales and JVs.  WPG expects to raise $1.6 billion in proceeds from asset sales and JVs.  Simon has already committed to buy two assets from Glimcher for $1.1 billion.  Pro forma for the transaction, WPG will be levered more in line with peers and have a similar dividend payout ratio.

Pro forma for the transaction, WPG will have a market capitalization of $3.8 billion and an enterprise value of $8.1 billion.  Mark Ordan, who has completed successful turnarounds and sales of The Mills Company (sold to Simon and Farallon in 2007 for $7.9 billion) and Sunrise Senior Living (sold to Health Care REIT in 2012 for $845 million), will serve as Chairman and Michael Glimcher (Chairman and CEO of Glimcher) will serve as CEO.  David Simon (Simon Chairman and CEO) and Richard Sokolov (Simon President and COO) will continue to serve on the board.

Simon insiders will continue to hold ~15% of the company through LP units and since the beginning of November, Ordan ($438k) and another director ($343k) have been buyers of the stock in the open market.

Below are our estimates for FFO and AFFO of the combined company:

The combined portfolio will consist of 119 properties and approximately 68 million square feet of gross leasable area:

For Glimcher, we simply use Glimcher’s pre-acquisition trading multiples (based on the average price for the 60 days prior to deal announcement).  With sales per square foot in the $400-$500 range, Glimcher traded better than RSE and PEI ($300-$400 Sales PSF), but below higher quality mall operators like GGP and MAC ($500+ Sales PSF) that trade near 25x AFFO and 3% or better dividend yields.

WPG Versus Peers

We believe the discount in WPG shares relative to peers is simply a function of the factors we cited above (technical pressures from spin-off, lack of sell-side coverage, limited financial information, etc.) and not because WPG owns a relatively disadvantaged set of assets.

Our conversations with industry experts and former Simon employees confirmed our thesis that WPG owns a relatively high-quality, well-maintained portfolio that compares favorably with comps and there is no identifiable reason why it should trade at a discount.

On a quantitative basis, WPG compares favorably with peers when considering recent performance, Sears & JCPenney exposure and leverage:

Addressing the Key Risks

We recognize that there are reasons to be cautious around any retail real estate assets given the underlying issues at Sears and JCPenney and the increasing impact of e-commerce.  As we highlighted above, Sears and JCPenney represent a small percentage of rents to WPG on both an absolute and relative basis.  While we won’t argue for the long-term survival of these companies, we don’t expect there to be an overnight unwind and believe this is a manageable headwind over a multi-year period.  Additionally, Sears and JCPenney typically pay below market rents and store closures offer an opportunity to rent boxes at higher rents to off-price clothing chains like TJMaxx, Ross Stores and Burlington Coat Factory or emerging fast fashion retailers like H&M and Primark.

Internet retail continues to increase its share of total consumer spending, but owners and developers have reacted and rationalized.  New construction in the retail real estate industry is at a 30-year cyclical low.  This industry discipline has had a positive impact on WPG and Glimcher’s results.  Occupancy trends are favorable (+50 bps YoY at WPG and +130 bps YoY at Glimcher) and increasing new base rents are a tailwind to NOI growth.  YTD, the average base minimum rent for new leases is up 14% YoY at each company and upcoming lease expirations in 2015 and 2016 are more than 15% below current new lease rates.    

Valuation and Target Returns

We expect WPG will generate $1.55 of AFFO in 2015 and conservatively estimate $1.65 of AFFO in 2016.  We believe that shares can re-rate early in 2015 once the Glimcher deal has closed, the company hosts its first earnings call and meaningful sell-side coverage commences.  In our conservative valuation scenario (WPG’s valuation converges with its mall peers), investors can generate one year returns of 50%:

Catalyst

- Closing of Glimcher transaction

- Filing of first supplement with detailed financial and property information

- First earnings call

- Initiation of research coverage

- ETF and mutual fund additions

- Retail investors bidding up the dividend