In a feisty letter directed to the CEO of Simon Property Group Inc (NYSE:SPG), the largest mall-centric real estate investment trust in the U.S., Macerich Co (NYSE:MAC) rejected Simon’s $91 per share buyout offer for MAC stock.
Saying that the proposed deal “substantially undervalues Macerich and its prospects for continued growth,” Macerich CEO Arthur Coppola took a bold stand against a generous offer that valued MAC stock about 30% higher than where it was just four months ago, before the Simon deal was on the table.
But with the recent rally in MAC stock fueled primarily by the buyout speculation itself rather than substantial improvement in the company’s fundamentals, Macerich and its board might want to reconsider.
But they won’t. And that’s too bad for MAC stock investors.
Why Macerich Should Reconsider the Simon Offer
The whole point of investing in a REIT is to gain exposure to real estate while collecting some tidy dividends. With special tax advantages, high liquidity and high yields — REITs are required to pay out 90% of their taxable income in dividends — REIT stocks are highly sought out by income investors.
So what’s the appeal of MAC stock, which, with a 2.8% dividend yield, divvies out less than Simon’s 3% annual stipend?
Rival General Growth Properties Inc (NYSE:GGP) only yields 2.3%, but as you’ll soon see, the valuation of GGP stock is far more reasonable.
You shouldn’t think about the valuation of a REIT like you do a run-of-the-mill stock. In other words, P/E ratios don’t mean much. That’s because depreciation expenses are included in the calculation of net income, and real estate has a tendency to appreciate over time, deeming the “earnings” denominator rather uninformative for REIT valuation purposes.
Instead, investors should look at funds from operations (or FFO), which adds depreciation to net income, then subtracts any one-time gains made on property sales. Unfortunately, if you obsess over fair valuation as much as I do, you’ll need to take it a step further: Adjusted funds from operations (AFFO) subtracts capital expenditures from FFO and gives a more genuine reflection of cash flow, thus serving as a superior way to think about the sustainability of a dividend.
MAC stock currently trades at a P/AFFO ratio around 61. For comparison, GGP stock trades at around 25 times AFFO and SPG stock trades around 26 times AFFO. Sure, Macerich is growing FFO at a 25% clip — far faster than GGP or Simon Property Group — but a 61x multiple still seems mighty ambitious.
Macerich should reconsider Simon’s offer, because if it doesn’t, Mr. Market will eventually get fed up and abandon ship. Again, MAC stock’s impressive 4-month rally hasn’t been driven by the underlying business at all — the company totally whiffed on fourth-quarter earnings during that time.
With that in mind, Wall Street seems to think that the potential for a buyout isn’t out of the question just yet — MAC stock trades slightly above the $91 per share offer its board just vetoed.
Look for another buyout offer from Simon Property Group soon. If it’s high enough, Macerich may be forced to sell, if only because it’s required to do what’s best for shareholders. And rebuffing offers ever higher than the $91 is probably not what’s best for shareholders.
As of this writing John Divine held no positions in any of the stocks mentioned. You can follow him on Twitter at @divinebizkid or email him at email@example.com.
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