NEW YORK (Real Money) -- Better start paying attention to Simon Property Group's (SPG - Get Report) hot pursuit of smaller mall owner Macerich (MAC) because a combination would have several major ramifications.
A merger between the two entities would arrive at a time of major retail consolidation, with Dollar Tree (DLTR) set to swallow Family Dollar (FDO) and Staples (SPLS) readying to integrate Office Depot (ODP). This is on top of a wave of broken retailers, like RadioShack (RSHCQ) and Wet Seal (WTSL),simply vanishing from malls across the country, along with beleaguered Sears (SHLD), which is going out of business in front of our eyes.
Power is ultimately being shifted into the hands of the strong in retail -- which is part of the reason why I have been bullish on Simon Property Group and lately warmed up to Staples after years of criticizing the company for inept strategies and fledgling performance.
Here is what a Simon Property and Macerich merger would likely bring:
- Trouble for J.C. Penney (JCP) and Sears: In spite of each retailer closing unproductive stores in the past two years, both remain fundamentally weak. Debt levels are high and, as a result, so are interest payments. Stores are trapped in permanent markdown land, and profit margins continue to thin. This clouds the cash flow outlooks and, over time, access to outside liquidity. If Simon Property lands Macerich, it's going to raise rents on these retailers store by store. Simon Property could certainly do this at will, as both retailers are concentrating their efforts on the very best locations -- Simon knows these anchor tenants are struggling, and need their best locations to service their obligations. Higher rents could force J.C. Penney and Sears to try and pass along higher merchandise prices to middle-to-lower income consumers. It could also cause the companies to pull back on investments in key areas of the business, such as those being made to support online and mobile shopping.
- Trouble for Aeropostale (ARO) and Abercrombie & Fitch (ANF): These are the two J.C. Penney and Sears cases from within the specialty apparel business. Two struggling retailers that are doing so because of a massive generational shift in what young people are buying. Higher rents by Simon Property could destroy Aeropostale, while Abercrombie hangs in for longer, given its international exposure via flagship stores. Similar to J.C. Penney and Sears, Aeropostale and Abercrombie will likely try to pass on higher prices to consumers, but consumers will balk. Closed stores will go to health clinics or fast fashion retailers H&M, Forever 21 and Zara, creating a three-headed monopoly in the teen apparel business.
- Small businesses could be hurt: Say goodbye to many mom-and-pop kiosks typically found in the middle of the mall, which already pay hefty monthly rents to Simon Property. I think franchisees of Buffalo Wild Wings (BWLD), McDonald's (MCD), IHOP and Yum! Brands (YUM) that often open inside of malls could also be hurt by higher fees from Simon Property. That could realistically lead to menu price increases that cause consumers to forego a purchase, which would dent the fee income sent back to the parent company.
As we, cool millennials, say on Instagram: #SorryNotSorry for the dose of reality on this subject. These things aren't going to happen overnight, but they inevitably will. But bankers should actually rejoice. Property developers thrive on issuing debt to fund splashy mall remodels and enhance capital return plans to shareholders. I suspect a combined Simon Property and Macerich would embark on a five-year spending spree to upgrade the latter's locations to meet the high-quality standards of the acquiring entity.
After the Fed decision, I noted the dollar was destined to weaken -- it did, falling about 3% last week. In turn, that made me become optimistic on multinationals, which have been hammered by falling earnings estimates related to dollar strength. I think that remains a trade that should stay on at the moment, as Fed officials begin to make their speaking rounds.
Editor's Note: This article was originally published at 9 a.m. EDT on Real Money on March 23.