Mills Buyout a Tough Grind

Mills Corp. ( MLS) shareholders may be looking for a quick sale of the beleaguered company, but the market shouldn't expect a merger announcement anytime soon.

Sources say that complications surrounding the mall owner's joint venture agreements and general confusion over the value of the company's giant Xanadu development project in New Jersey's Meadowlands are stalling matters.

The real estate investment trust put itself up for sale in February amid numerous financial woes. First-round bids were completed in early June, and second-round bids are now in the process of being submitted. "I don't think third-round bids will be for a while," says one source involved in the bidding process.

The stickiest issue remains the complicated nature of the joint venture agreements the real estate investment trust has with its primary equity partner, the German fund KanAm, the source says.

Add in the Securities and Exchange Commission investigation surrounding Mills' ongoing financial restatements, and the bidding process remains knotty.

Secret Shoppers

At this point, it's not entirely clear who is bidding on Mills, which owns 42 retail properties around the U.S., Canada and Europe. Recent Australian press reports suggested that Westfield, which was expected to be a likely bidder, did not submit a bid in the first round.

Likely candidates of interest in Mills are Vornado ( VNO), Simon Property ( SPG), General Growth ( GGP) and the privately held Lightstone Group, industry sources say. These parties, and Mills management, have remained mum during the bidding process.

One analyst also raised the issue that Mills may not be providing adequate information during the bidding process.

In a recent research note, Bank of America analyst Ross Nussbaum said conversations with several REIT management teams in recent months left him with the impression that Mills' Internet-based data portal for potential buyers "does not contain enough information with which to make a fully-informed offer for the company, especially given the associated risks related to the development pipeline, lack of audited financials, the SEC investigation and shareholder lawsuits."

However, the source involved in the bidding process says, "Mills is being very cooperative. Put yourself in Mills' situation. They're being as cooperative as they can given the fact that they're overwhelmed."

Xanadoubts

Another person involved in the Mills bidding says the key issue is not so much the joint venture agreements with KanAm, but the question of how to value the Meadowlands Xanadu project.

Construction delays and lack of leasing news continue to push back the delivery date of the massive retail and entertainment project, which is being built across the river from New York City in East Rutherford, N.J.

Nussbaum, the Bank of America analyst, is now forecasting a stabilized yield on Xanadu of 5%, down from his previous estimate of 7%. Mills' management originally said the project would yield 9% or higher. Nussbaum also now expects the overall cost of the project to rise to $1.5 billion, up from his previous estimate of $1.2 billion.

Barry Vinocur, editor of REIT Zone Publications, recently wrote in his newsletter that Mills' burn rate on Meadowlands is roughly $10 million per week, citing unnamed sources.

Nonetheless, another veteran real estate investor says Xanadu has a lot of potential upside, even if the project is a big headache now.

This person compares Xanadu to the Santana Row project that Federal Realty ( FRT) opened in late 2002 in San Jose, Calif. That mixed-use retail project was projected to be a failure by several Wall Street analysts when it opened, as they felt the yield would be disappointing because of exorbitant costs that couldn't be matched with sufficiently priced leases.

But Santana Row is now a home run for Federal Realty. If Mills were to remain a going concern and not be sold, "five years from now, Xanadu would look great," the source says.

As well, this source says Mills is fetching considerable interest in its properties because finding large mall portfolios is not an easy task, as Simon Property, General Growth and Westfield continue to build an "oligopoly" in the mall sector.

"There's plenty of money and people who want this," the real estate investor says.

And while Mills has plenty of complex issues on the table, one of the sources involved in the bidding process notes that the problems are less complex than the tax-structure issue at Trizec Properties ( TRZ). Trizec, an owner of office properties, was eventually sold last month for $9 billion after a unique multiparty deal was arranged.

Meanwhile, a look at Mills' shareholder base shows some very wise people have taken large stakes in the company. For instance, Seth Klarman, a noted value investor who runs The Baupost Group, began taking a Mills position in the winter. At the end of the first quarter, Klarman held 2.6 million shares, making it his second-largest holding. Klarman did not return a call seeking comment for this story.

As Klarman was quoted as saying in a recent Wharton Journal article, "The Baupost Group seeks situations triggered by urgent, panicked, or mindless selling."

Klarman and others might eventually prove to be right about Mills. But it looks like it will take some more time to realize the value.

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