Pandemic Turns Simon’s Mall-Merger Math Upside-Down

(Bloomberg Opinion) -- Malls have been falling out of favor with Americans for years. But the calculus surrounding which have the best chances of surviving and which are destined for decline was flipped on its head by the coronavirus pandemic. That helps explain the news on Wednesday that mall giant Simon Property Group Inc. wants to call off its planned purchase of Taubman Centers Inc.

A portfolio of higher-end malls in urban areas that cater to domestic and international tourism was one reason Simon agreed to pay a 70% premium for rival Taubman in February. Those same outposts are now a liability as the pandemic turns consumers off from crowded indoor venues and grinds travel to a halt. And that may give Simon the argument it needs to successfully walk away from the merger.

Simon said Wednesday it’s seeking to terminate the $3.6 billion deal, arguing that Taubman had experienced a “material adverse event” amid the pandemic and had breached its obligations under the merger agreement by failing to make “essential” cuts in expenses to deal with the fallout. While the agreement stipulates that a pandemic doesn’t on its own give Simon the grounds to walk away, there’s an exception if the company can prove Taubman has experienced a “disproportionate adverse effect” relative to others in the industry. That’s where those higher-end, urban malls come into play.

While the pandemic is far from over, there appears to be a growing consensus among epidemiologists that outdoor activities are less risky than indoor ones. The owners of the largest open-air strip centers collected 50% to 65% or more of rent due in April, compared to just 10% to 30% for mall and outlet owners, Bloomberg Intelligence analyst Lindsay Dutch observed in a recent note. It also helps that many of those strip centers are anchored by grocery stores or other outlets that were allowed to stay open through the pandemic because they sell essential items. CNBC reported that Taubman intends to contest Simon's termination of the deal and legal claims and will move ahead with a shareholder vote on June 25.

Is this short-sighted? Maybe. The idea that we are forever destined to favor strip malls in suburban areas over luxury malls in cities strikes me as debatable. Indeed, Simon shares fell nearly 10% at one point on Wednesday and were still down about 3% in the early afternoon, suggesting shareholders believe something is being lost here. As my colleague Tara Lachapelle wrote in February when the deal was first announced, scale of operations and breadth of balance sheet should be an asset in mall owners’ quest for survival.

But it’s still the right move for Simon to get out of the Taubman combination if it can. The all-cash deal and assumption of Taubman’s debt would have significantly inflated Simon’s leverage at the worst possible time, given the company’s own struggles to extract rent from shuttered retailers. Simon earlier this month sued Gap Inc., claiming the company failed to pay $65.9 million in rent for March through June. Including the coronavirus hit to the retail environment, the deal may have boosted Simon’s debt to 7.5 times its Ebitda, SunTrust Robinson Humphrey analyst Ki Bin Kim estimated in a report on Wednesday.

Simon’s argument for getting out of the deal is logical “in the court of common sense,” Bin Kim wrote. But in the court of law, “we don’t know.” The second half of Simon’s argument — that Taubman has breached the covenants of the merger agreement by failing to make significant cost-cuts — is arguably trickier. While Simon has said it’s suspended or eliminated more than $1 billion of capital development projects, cut executive salaries and implemented temporary furloughs, Taubman has been more measured, announcing the deferral of as much as $110 million of expenditures. But aggressive job cuts and cost-control measures by Taubman could have given Simon more ground to argue the business was in a disproportionately dire situation, Bin Kim writes. “It could have been one of those things that `you’re damned if you do, and you’re damned if you don’t,’” he said. That should be something of a motto for a mall industry that feels perpetually stuck on the wrong side of trends.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Brooke Sutherland is a Bloomberg Opinion columnist covering deals and industrial companies. She previously wrote an M&A column for Bloomberg News.

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