Prime Retail Could Feel a Credit Crunch

The king of the outlet centers struggles to refinance its heavy debt load.
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Is Prime Retail (PRT) - Get Report experiencing a credit crunch? As the deadline for major debt payments inches closer, investors are pondering that question about the factory-outlet REIT. While the company may have the best portfolio of outlet centers, it's the balance sheet that worries investors.

The concern rests with $85 million in debt payments due by the end of the year, including a $43.6 million payment due in September to

Security Capital

and a $39 million credit line payment in November. The company will have to raise cash to make good on both obligations.

But the financing squeeze also puts a huge question mark over the company's dividend, which, at current prices, yields a tempting 14% per year. That dividend payout represents nearly 80% of funds from operations (a measure of cash flow) vs. about 70% for the average REIT, although management says it remains committed to the payout.

While Prime has known its cash needs for months, the problem refuses to go away. "Management has been going down this path for over eight months with no specific announcement," wrote

Legg Mason's

David Fick in a recent research note. "Prime's senior executives continue to assure us that at least one transaction will close by Sept. 30. However, as we move forward without an announcement, we become more nervous." At current prices, Prime stock remains near the bottom of its two-year trading range.

Fick has begun shaving his earnings estimates for the company: for 1999, by a penny to $1.51 per share and for the year 2000, by 2 cents to $1.58. And more downward revisions are likely. "We would expect that the direction of our estimates at this point would be downward, but we lack sufficient detail to determine how much," he wrote. He continues to rate the stock a speculative buy. Legg Mason has not provided banking services to Prime in the past three years.

While it is likely the company will find a way out of its current capital conundrum, a quick review of the options suggests that none of the alternatives is very attractive:

  • The company is looking at options to sell -- possibly through joint ventures -- interests in several Prime outlet centers. The company says it is in the process of negotiating with two joint venture partners for a 70% interest in eight outlets.
  • The company could refinance or add additional debt to several existing projects. However, total debt to equity already stands at 2.1-to-1 (vs. an average of 1.4-to-1 for the average REIT), and additional debt would only postpone a resolution of the company's balance-sheet problems. And any debt extensions would likely carry significantly higher interest costs.
  • The company could approach the capital markets with a high-yield-bond or preferred-stock offering, but again, the cost could be significantly higher. Nor is there any guarantee the company would have any better reception than they did late last year, when waning interest caused the company to pull a preferred-stock offering. Any offering would likely be dilutive to existing shareholders.

One buy-side money manager who has stayed away from Prime thinks the first option is the most probable one: "It's likely they'll sell a portion of the portfolio to raise cash," he says. "That may not be the best option, but it's probably the only one."

And the long-term picture remains cloudy. The company had nearly $1.3 billion in debt with an average maturity of just under six years, and that's before any talk of funding an aggressive development pipeline. That represents a debt-to-property-value ratio of more than 62%, vs. an industry average of only 55%, according to data from

SNL Securities


Furthermore, the company's ability to cover its fixed obligations is eroding. The company's funds from operations cover its total interest payments by only 1.66 times, well below the two-times benchmark most analysts cite as a minimal standard of financial health.

"They're in a box," says the buy-sider. "In the near term, they'll find a way, but next year and the next they'll face the same liquidity issues. That's not a position I envy, especially in an industry facing so much uncertainty."

Uncertainty abounds. Investors think that, of all the retail sectors, outlet centers are exposed to the most risk from the new Internet frontier. "You mention outlet centers and investors run," says Ross Weiner, president of

Gemsco Realty Advisors

, a New York real estate investment firm. "There are too many uncertainties, too many threats. Investors can't get excited about future prospects."

While Prime is attempting to develop an Internet presence to serve as a hub for manufacturers' outlets, most analysts are skeptical. "I'm not sure it holds a lot of promise," says the buy-sider. "I don't see the incentive for manufacturers to sell through a middleman on the Net when they can figure out ways to go direct to the consumer."

Fick is optimistic on the company's European strategy. Company officials were very upbeat about the development of outlet centers in Europe with a local partner at the recent meeting of the

National Association of Real Estate Investment Trusts

. "Europe is very under-retailed and

there is significant outlet tenant interest in Europe," wrote Fick. "The first factory outlet centers in Europe have been very successful."

The company's insiders have a huge interest in finding a way out: Senior officers own 9.5 million shares, or 16% of the total outstanding. That should maintain Prime's incentive to maintain its current dividend, a primary reason Fick maintains his buy rating.

But given Prime's cash challenges, Fick stresses it could go either way. "We believe this stock is either a short-term buy or short-term sell depending on an investor's risk tolerance," he wrote. "The problem is this is a high-stakes, all-or-nothing scenario, hence our speculative risk rating."

Christopher S. Edmonds is president of Resource Dynamics, a private financial consulting firm based in Atlanta. At time of publication, neither Edmonds nor his firm held positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Edmonds cannot provide investment advice or recommendations, he welcomes your feedback at