March of the Malls, Not Always in Step

By Terry Pristin
New York Times
November 23, 2005

With a multimedia extravaganza that included magic tricks and fashion models shooting confetti out of cannons, the Mills Corporation broke ground last week in Chicago on a retail, entertainment, office and hotel complex that will fill a long-vacant block in the heart of the Loop.

It was a big moment for Mills, a fast-growing real estate investment trust based in Arlington, Va., that is known for developing huge off-price malls in outlying suburbs. Chosen by the city of Chicago from among 10 bidders, Mills is poised to begin construction on a significant site that had bedeviled other developers.

But the razzle-dazzle could not erase memories of a more somber event that occurred only days earlier. On Nov. 9, Mills, which is also developing the retail and entertainment portion of the $1.2 billion Xanadu Meadowlands complex in Northern New Jersey, announced a 5.2 percent decline in third-quarter earnings compared with the same quarter last year.

The company said that its funds from operations - a key yardstick for REIT’s that includes earnings, depreciation and amortization -plummeted by 53.6 percent. Mills blamed a number of factors, including bad debts, greater administrative costs because of the company’s expansion and write-offs for projects that had fallen through.

During a tense conference call with Wall Street analysts, Laurence C. Siegel, the chairman and chief executive, acknowledged that Mills was experiencing accounting, disclosure and planning problems and attributed them to the company’s growing complexity.

“While our external growth strategy has been successful, top management needs to increase its focus on forecasting and planning and enhancing our performance management, accounting, control and reporting functions,” Mr. Siegel told the analysts. “This is clearly under way.”

Mr. Siegel declined to be interviewed for this article.

Earlier this year, the company alarmed analysts by announcing that it would restate earnings. Several analysts said the latest difficulties have raised serious questions of whether Mills can handle an ambitious and risky development program.

“My concern is that they took on too much too fast, that they didn’t have the systems or the people or the infrastructure in place to handle all the growth,” said Ross Nussbaum, a REIT analyst at Banc of America Securities.

These concerns have been reflected in the company’s share price, which has lost 37 percent of its value since Aug. 3. “Their earnings from their core portfolio - their stabilized properties - were much lower than people thought,” said Louis W. Taylor, a senior REIT analyst at Deutsche Bank Securities, one of several analysts who recently downgraded Mills’s stock. “All the other mall companies really had terrific results.”

Analysts say the malls themselves do not appear to be the issue. In the 12 months ended Sept. 30, average sales in Mills’s nonanchor stores were $382 a square foot, compared with $348 a square foot in the previous year, the company reported. (For 2004, enclosed malls drew an average of $366 in sales a square foot, according to the International Council of Shopping Centers.) The average occupancy was 92.6 percent, down slightly from 92.9 percent.

“From what we can see, the performance has been relatively stable,” said Daniel J. Chambers, a manager at Fitch Ratings, which recently upgraded a commercial bond backed by Potomac Mills in Prince William County, in Virginia, and Gurnee Mills in Gurnee, Ill., midway between Chicago and Milwaukee.

And Mr. Siegel, who became chief executive in 1995 and earned $5.2 million last year, according to company documents, is admired as an innovator.

Instead, the criticism centers on Mills’s operations and its difficulty in predicting next year’s earnings. Matthew Ostrower, a Morgan Stanley REIT analyst, said it was telling, for example, that the carts and kiosks that bring small-scale retailers to a mall generated large revenues for Mills’s competitors but did not do as well at Mills’s centers.

He said it was also significant that the company had fallen behind in getting its retail tenants to pay bills for common charges like air-conditioning. “This speaks to a company that may have taken their eyes off the ball,” Mr. Ostrower said.

Analysts also questioned whether the Xanadu Meadowlands would ever generate enough income to justify the cost of developing the 4.8-million-square-foot complex, which is scheduled to open in 2007. Also, Mills has acknowledged spending $30 million so far - a sum Mr. Nussbaum described as staggering - on a proposed retail, recreation and office complex along the San Francisco piers that is opposed by the county board of supervisors.

The company said in written answers to questions that the leasing team at Xanadu Meadowlands “is seeing strong demand for space from prospective tenants” and that “substantial progress” has been made on the San Francisco project since 2001, when Mills was awarded the development rights by the Port of San Francisco, an independent agency.

Originally called the Western Development Company, the Mills Corporation was founded in 1967 by Herbert S. Miller, a Washington area developer of strip malls. In 1985, the company opened the 1.3-million-square-foot Potomac Mills, the first large mall to feature many factory outlet stores and no traditional department store anchors.

By the time it went public in 1994 and changed its name, Mills owned four such malls around the country, all far enough from urban centers to avoid competing with department stores. Today, the company owns or partly owns 42 malls; 18 are patterned after Potomac Mills, including the successful Sawgrass Mills, outside Fort Lauderdale, Fla.

The signature Mills malls have a circular design, similar to a racetrack, with no upper floors and huge parking lots. Brightly colored logos aim to create a “festive and social” atmosphere, according to company documents.

The company says its research shows that customers spend an average of 100 minutes in these malls, 30 percent longer than at traditional malls. Mr. Siegel is widely credited with being among the first mall developers to recognize that adding restaurants, large movie theaters and activities like bowling and skating would tend to lengthen a shopper’s stay.

In recent years, Mills has diverged from its original formula by buying 22 conventional malls, including the gigantic Del Amo Fashion Center in Torrance, Calif., and the venerable Southdale Center in the Minneapolis suburb of Edina.

With Xanadu Madrid, which features an indoor ski slope similar to the one being planned for the Meadowlands, Mills became the first major domestic mall operator to reach Europe. Recently, the company bought a shopping center in Glasgow and developed the first new enclosed mall in Canada in 14 years. Another project in the Mills pipeline is development of the site of the former Mercati Generali fruit and vegetable market in Rome.

At a time when many REIT’s find few opportunities to build malls, Mills has the opposite problem, said James S. Corl, chief investment officer for real estate at Cohen & Steers, a major holder of Mills shares.

“They tried to do too much, and they got a little ahead of themselves,” he said. “They just need to signal to the marketplace that they are going to retrench and focus on the best opportunities they have and not try to nail down every opportunity.”