Jonathan Litt’s Battle with Taubman Highlights Several Key Aspects of the State of Shopping Mall REITs, and the Increasing Importance of Activists Targeting REITs
This is Part 1 of a 2-part series that will discuss Jonathan Litt’s battle with Taubman Centers and how it relates to the current state of the real estate market.
Activists have always been a particularly interesting breed of investor. They have been labeled a range of descriptors, from shareholder’s heroes and whistleblowers to publicity hounds, and even frauds, sometimes even being called the latter by other activist shareholders. Amidst the stories about Bill Ackman or Carl Icahn’s latest proxy battle, one name that is surfacing in the financial press with increasing frequency is Jonathan Litt, the founder of Land & Buildings Investment Management, LLC (L&B), a hedge fund based in Stamford, Connecticut. Despite having approximately $200 million in assets under management as of 2016, a low level for an activist fund, Litt has already played a role in prodding for what resulted in one of the biggest real estate mergers in 2016 – the merger of Colony Capital and Northstar Asset Management. In recent weeks, Litt has been engaged with Bloomfield Hills, Michigan-based shopping mall REIT Taubman Centers, Inc. (NYSE: TCO). The battle brings attention to a number of issues that illustrate the current state of the shopping mall sector as well as the increasing role of activist investors in the REIT space, a sector from which they were, for the most part, previously absent.
Litt founded his firm in 2008 after spending more than a decade at Citigroup as Managing Director and Senior Property Analyst, a position in which he led a team of 44 research analysts in more than 15 countries. In 2015, L&B’s performance was among the best in the industry, returning nearly 25% thanks to successful bets on firms such as American Residential Properties and Associated Estates, both of which were acquired. According to Forbes, Litt’s firm has generated 17.2% annual returns, net of fees, which has outperformed the REIT benchmark index by 6.7 percentage points, and the S&P 500 by 4.4 points. This track record is more notable when considering the current market environment, in which hedge funds are losing investors left and right due to underperformance. In 2016, many funds have cut fees, and others have even returned capital to investors. The most notable example of the latter was perhaps the shuttering of Richard Perry’s 28-year old fund, Perry Capital.
Litt’s activist strategy does not differ much from the basic modus operandi of larger activist investors. The process involves taking a large position in a publicly-traded real estate firm which L&B believes is undervalued, reaching out to management with suggestions to improve performance, and then going public with the battle, agitating for change while building pressure on the firm’s management, and initiating a proxy battle if necessary. In early 2016, L&B began acquiring shares of TCO, and as of this writing Litt is believed to own approximately 1% of the shopping mall operator’s shares.
The public saga between L&B and Taubman began in June, when Litt reached out to Robert Taubman, TCO’s Chairman, President & CEO, to discuss several suggestions to create value. After Taubman disregarded his recommendations, Litt went public with the battle. On October 19, Litt sent a strongly-worded letter to TCO’s board in which he criticized the company for its “drastic discount to NAV, inferior margins, poor capital allocation and horrible corporate governance practices.” Simultaneously, he publicly released the letter along with a slide deck that outlined TCO’s missteps and his plan to unlock the company’s intrinsic value.
To improve its performance, Litt called on TCO’s management to curtail expansion plans and explore strategic alternatives, which include a sale of the struggling Beverly Center mall in Los Angeles, as well as to consider a management-led privatization or sale of the company. In the slide deck, Litt outlined the reasons that he believes the firm’s shares are undervalued, stating that the stock is currently trading more than 30% below its NAV of $106 (TCO closed at $72.27 on November 11), and laying out a case for the stock to surpass $140 if his recommendations are adopted. Finally, Litt called for TCO to modernize its corporate governance through the separation of the Chairman and CEO roles and, at the board level, appointing a lead independent director, un-staggering the board and reducing the tenure of the current directors. Litt summarized his thesis by stating that “(Taubman) has massively underperformed its peers over the past five years, over the past three years, and even in the past 12 months,” he said.
Taubman Centers (NYSE: TCO) stock performance compared to competitors Simon Property Group and General Growth Properties, November 2011 – Present
Later in the day on October 19, TCO released a statement that “Taubman Centers values the strong relationships we have with our shareholders and welcomes open and constructive dialogue toward the goal of enhancing long-term value.”
Litt’s decision to take on Taubman is not surprising given the current dynamics of the Shopping Mall REIT sector, and the current state of the retail sector in general. As most investors know, the retail sector is broadly under pressure from e-commerce and internet sales. Indeed, Litt acknowledged this in his communications to the TCO board, as well as his presentation. Taubman Centers, however, owns the most productive mall portfolio in the U.S., and its properties are “highly sought after” by high-end retailers, high-end consumers, pension funds and other institutional investors. A good portion of Taubman’s portfolio consists of “Class A” malls, which have continued to prosper in the face of online competition and the diversification of the retail landscape into mixed-use developments and lifestyle centers. Litt said that Taubman malls, along with other Class A malls, will likely continue to prosper and register NOI and rent growth over the next several years. Despite this, the stock has underperformed compared to its larger peers such as Simon Property Group. The relatively small number of REITs in the shopping mall sector not only provides a small number of potential buyers for properties, but it also reduces the number of merger partners. These and other aspects will be explored further in Part 2.
Commenting on the back-and-forth between Litt and Taubman, Mizuho Securities USA Inc. analysts Haendel St. Juste and Jieren Huang said in a note that “Although we see merit in most of Litt’s points, we see little chance of meaningful change at or sale of TCO.”