Simon Property Group bids for General Growth Properties and both stocks gain ground

2010-02-16

General Growth Properties (GGWPQ) opened up ~20% and closed with 27% gains over the prior close at $12.  Simon Properties Group (SPG) has been looking at GGP as hinted by its purchase of a large portion of GGP's unsecured debt, along with other like-minded institutional investors.  Finally, today, SPG disclosed to the public an offer that it made a week ago to GGP's CEO to acquire the company.  The acquisition terms call for paying off all unsecured debtholders at par plus accrued interest and giving common shareholders $6 in cash as well as the interests in the Master Planned Communities, which are valued at $3 by GGP on its balance sheet.

The price action is explained in the following two ways.  First of all, SPG's bid put a floor valuation on GGP's common at $6 - $9 (depending on investors' assessment of the value of the MPC interests, which ranges from $0 to $3).  This floor valuation at close to the last market close prompted a lot of short-sellers to cover their positions, since there is no opportunity for profits.  Short-covering in a bankrupt stock with generally muted volume can drive the stock price much higher.  Secondly, this is the first bid by SPG, which paves the road for more competitive bids by competitors, who also own GGP's debt.

A number of new investors in GGP joined short-coverers, because SPG can offer a lot more to make common shareholders vote for the plan.  Even though the unsecured bondholders' committee supports SPG's offer, it is up to the judge to determine if the offer is fair and to cram down either of the large impaired classes (the unsecured bondholders or the common shareholders, though absolute priority rules would call for cramming down the common).  The rub in the offer is that SPG trades at a cap rate of 6.9% (the rate at which the market effectively capitalizes the company's net operating income in order to arrive to a valuation of its income-generating assets, which is calculated by dividing the LTM NOI by the company's Enterprise Value), yet its offer for comparable-quality assets values GGP at an 8.1% cap rate.  

This cap rate differential is too wide and would be very accretive to SPG shareholders, which explains SPG's positive action today as well (up 3.9%).  The bull case that attracts new buyers is that SPG could easily bid $20 for GGP's common shares and still would be getting the assets at an implied cap rate of 7.3%.  On top of that, SPG can realize significant revenue synergies and cost savings, sweetening the deal and allowing it to bid at an even lower cap rate (higher price for GGP shareholders).  

On the other hand, the bear case is that GGP common shareholders will be crammed down so that unsecured bondholders can get what they are owed in cash.  SPG may be the only bidder for GGP's assets and is offering cash to the unsecured bondholders, which they would much rather take instead of getting equitized (converted into equity) with potentially overvalued GGP stock.

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