Retail Opportunity Investments Corp (ROIC)

[Enterprising Investor]

Vornado Weighs Spinning Off Suburban Shopping Centers (3/11/14)

Deal Would Spin Off Strip Centers, Merge Them with Retail Opportunity Investments Corp.

Commercial landlord Vornado Realty Trust is weighing a merger of its suburban shopping centers with a West Coast company, according to three people familiar with the situation.

Vornado in recent months has discussed a deal in which it would spin off its strip malls into a separate company, which it then would merge with San Diego-based Retail Opportunity Investments Corp., the people said. Instead of cash, Vornado shareholders would take a majority stake in the combined company, a structure that would help New York-based Vornado avoid a large tax payment.

Talks are continuing and could fall apart, the people said. Vornado, which has tapped Morgan Stanley and Goldman Sachs Group Inc. as advisers, also is studying other scenarios for the business, which analysts value at $2 billion to $3 billion.

Options include keeping the strip centers or spinning them off to shareholders, the people said. Vornado Chairman and Chief Executive Steven Roth, 72 years old, is known as a deliberative executive who has taken years to pull the trigger on some big deals.

A spinoff would allow Vornado, one of the largest U.S. real-estate investment trusts, to focus on its high-end office towers and retail shops in Manhattan and Washington. The company's strip-mall business consists of over 100 properties and 15 million square feet largely in the Northeast.

Vornado raised the possibility of spinning off its strip centers last year in an apparent response to pressure from investors and analysts who have complained that the company operated in too many sectors and was unfocused. Shares of Vornado, with a market capitalization of about $18.5 billion, have lagged behind its competitors for much of the past half-decade.

"There's no good reason for an office company and a shopping-center company to be housed under the same roof," said Alexander Goldfarb, an analyst with Sandler O'Neill + Partners.

Some investors have been eager for a split.

"They'd probably be rewarded by the market if they simplified further and focused more on their New York and D.C. portfolio," said Keith Pauley, a managing director with LaSalle Investment Management, which owns about 2.2 million Vornado shares.

Vornado's skyscrapers and retail properties are high-end, with tenants in New York including Bill Ackman's Pershing Square Capital Management LP and the U.S. flagship of retailer Uniqlo.

Mr. Roth said on a recent conference call that the strip-center business is "a cash cow of the highest order." Yet he also said the company is considering many options and the future of the business is "very high on our thought pad."

Cleaving off the strip-mall business would be Vornado's most significant move yet to simplify its strategy. In the past two years, it has been selling regional shopping malls and showroom space for wholesalers, and unwinding some losing investments. Last September, it said it had sold the last of its stake in J.C. Penney Co. at a loss estimated by analysts at $250 million.

Since January 2012, Vornado has sold more than $2.5 billion in assets, helping its stock price. The company's shares have produced a total return of 18.5%, including dividends, in the past six months, outperforming the Dow Jones Equity All REIT Total Return Index, which returned 7.6% over the same period.

For Mr. Roth, an outspoken executive who grew up in the Bronx, N.Y., the strip-mall portfolio was the foundation of his real-estate empire. He built up his real-estate holdings throughout the 1980s, early on by taking control of the New Jersey-based discount appliance store chain Two Guys From Harrison.

As values swelled and Mr. Roth expanded rapidly into office buildings in Manhattan and Washington, Vornado became a stock-market darling that at its peak controlled more than 75 million square feet of commercial property. But he also hesitated on some big investments, letting a prime Manhattan development sit fallow for years before ultimately building what is today the headquarters of Bloomberg LP.

At a shopping-center conference in Las Vegas last year, Mr. Roth met with Kenneth Bernstein, chief executive of Acadia Realty Trust, to discuss the possibility of merging Vornado's strip-center business with Acadia, according to people familiar with the meeting.

Acadia declined the offer last year, according to these people, saying that the company wasn't interested in owning suburban retail assets. People familiar with Vornado's plans said that Mr. Roth would prefer to spin off the strip-mall portfolio using a deal structure known as a Reverse Morris Trust, which would help the company avoid a large tax penalty as long as Vornado holders control more than 50% of the merged company's stock. That has limited the field of potential partners to smaller companies such as Acadia and ROIC.

ROIC has a market value of about $1 billion and owns 54 shopping centers in California, Oregon and Washington.

Vornado is weighing the future of its strip malls at a time when the retail sector is recovering slowly from the downturn, and while strip centers are lagging behind enclosed malls and pricier urban retail spaces in both rent and occupancy growth.

But investors still are willing to pay strong prices for strip malls because there has been little new supply added and commercial real estate in general has been attractive in a low-interest rate environment. According to Green Street Advisors' Commercial Property Price Index, strip-center prices are up 13% over the past year.

Write to Eliot Brown at [e-mail] and Robbie Whelan at [e-mail]

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