CEO PROFILE RESEARCH REPORT | 6/15/20

DAVID SIMON Chairman/President/CEO, Simon Rating: 5.5 (out of 7) Property Group (Ticker: SPG)

STRATEGIC VISION 5

CAPITAL ALLOCATION 5

PATTERN OF SUCCESS 5

ALIGNMENT OF INTERESTS 6

SHAREHOLDER FRIENDLY 6

 INTRODUCTION

David Simon has served as CEO of (SPG) since 1995, just two years after he spearheaded the reorganization of family business & Associates (a shopping center leasing company) as a publicly traded entity. Melvin Simon & Associates was the joint venture of brothers Melvin Simon (David’s father) and Herbert Simon (David’s Uncle), which they founded in 1959.

Simon has overseen the growth of SPG to become the largest retail REIT (Real Estate Investment Trust) in the , through a mix of organic growth and strategic acquisitions. Simon joined the family business after five years working at various Wall Street firms in the Mergers & Acquisitions (M&A) segment. It was in this environment where Simon learned the techniques he has used over the years to build SPG’s considerable retail real estate empire. Under Simon’s care, SPG has gained the well-earned reputation as a shareholder friendly organization, paying out in excess of $30 billion in dividends since the 1993 IPO. Over this period, SPG has outperformed the S&P by nearly 3% per year, on a total return basis.

Above all else, Simon’s reputation is as a dealmaker: he was responsible for the $1 billion IPO in 1993 (largest real estate stock offering at the time), along with the $3 billion merger with DeBartolo Realty in 1996, among a number of other later major acquisitions (see below). In February 2020, SPG entered into a deal to acquire fellow retail REIT for $3.6 billion. In June 2020, Simon announced his intention to exit the deal, due to issues related to COVID- 19 and the associated weakness in the retail industry.

 EARLY LIFE, EDUCATION, FAMILY AND CAREER

David Simon spent his early years in , the headquarters of Melvin Simon & Associates, his father’s shopping center leasing firm. He credits his -born father with instilling his aggressive quality, to which he attributes his success with SPG. He attended Indiana University, making the choice according to his own recalling, due to the school’s strong basketball program. After graduation in 1983, Simon immediately attended Columbia University’s Graduate School of Business and earned an MBA in 1985.

After Columbia, Simon began his career in the Investment Banking business, beginning at First Boston (now Credit Suisse). In a speech to Wharton School students, Simon discusses that he entered the firm in the “heyday of M&A” during the mid-1980s. After three years at First Boston, he joined boutique investment bank Wasserstein Perella & Co. as a Vice President covering M&A. Simon values his time in New York, remarking that every year spent on Wall Street corresponds to 4-5 years of experience, particularly considering the environment of the mid-late 1980s.

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After just two years at the bank, Simon returned to Indiana to help his father’s family business through a difficult time: the S&L crisis and commercial real estate recession of the late 1980s. Upon joining Melvin Simon & Associates, Simon quickly put his Wall Street education to work as the firm’s young COO. With the business struggling, Simon helped to re-equitize the business by bringing public institutional investors (pension funds, etc.) into the fold. With the REIT structure Simon put into place in the formation of SPG, pension funds became more comfortable with the cash flows on offer. This is remarkable considering that institutional investment in retail REITs was rare at the time. From there, Simon put in place his master plan: raising capital to grow the business to the level of scale that would drive down the firm’s cost of capital. Looking back at historical shareholder returns and at the SPG of today, it is clear Simon’s initiatives were wildly successful.

With limited video content available from Simon, the 2009 Wharton speech is crucial to understand Simon’s mindset. While Simon strives to be shareholder friendly, he says it is imperative for him to take the tough decisions and “hopefully your shareholders and colleagues will have confidence in what you do.” For his part, Simon places an emphasis on aggressiveness and toughness, which give him the foundation to make difficult and often contrarian decisions. At the same time, aggressiveness has its limit and every acquisition is made with an eye toward the balance sheet: Simon never wants to roll the dice to risk the whole business. Perhaps this is why he never went through with the attempted acquisition of General Growth Properties in 2009, a decision supported retrospectively by GGP’s eventual failure.

In speaking with NAREIT in 2010, Simon relays his view that cash flow growth is the most crucial metric he follows in assessing his current business, as well as potential acquisitions.

 THE RISE OF SPG: 1990s UNTIL THE 2010s

Before David Simon returned home to Indianapolis in the early 1990s, the shopping center business was highly fragmented, consisting mostly of family businesses like Melvin Simon & Associates. Even that environment, Simon was one of the top shopping center developers in the United States. After the 1993 IPO, David Simon embarked a mergers and acquisitions strategy, informed by his time at First Boston and Wasserstein Perella. Simon brokered the 1996 merger between his firm and DeBartolo Realty Corp. The combined entity then acquired a series of properties, including the REIT Corporate Property Investors in 1998.

Over the coming years, SPG added a significant portfolio of top-flight properties, including the Galleria, (San Diego), (Boston), Pentagon City (Northern ).

In the early 2000s, Simon completed two acquisitions that transformed the company: Chelsea Premium Outlets (2004) and the acquisition of (2007). The Chelsea acquisition positioned Simon as a leader in the premium outlet center business, which is a major segment of the business today (SPG currently operates 69 open-air outlets). In his 2009 speech at Wharton, Simon relays the story that SPG had the option of buying either Chelsea or the Rouse Group, which was ultimately purchased by General Growth Properties (GGP). He mentions that he made the decision based on Chelsea’s higher ‘cap rate’ (lower price) and the fact that he envisioned much higher growth opportunities in the outlet business. It must be noted that the acquisition of Rouse was a potential factor in GGP’s eventual bankruptcy, while the Premium Outlet business has been a key component of SPG’s success.

The addition of “The Mills” gave SPG a group of super-regional shopping centers mostly in suburban/exurban locations, including outside and the Great Mall of the Bay Area outside San Jose. “The Mills” are a mix of 14 centers encompassing mall, outlet, big box stores, and entertainment venues.

In December 2013, Simon made a move that would strengthen the business on a going forward basis: the Washington Prime Group (WPG) spinoff. At that time, Simon formed a separate REIT that included many of the company’s smaller malls and community shopping centers (strip malls). Simon managed these properties until early 2016, when they became the responsibility of WPG. This transaction solidified SPG’s status as an operator of Class ‘A’ shopping centers.

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Recognizing the changing landscape of retail, SPG has made a series of changes to the business. In late 2019, SPG partnered with Rue Gilt Groupe, which is the largest online marketplace for excess merchandise. This partnership creates an integration between the largest physical and online platforms for excess merchandise, looking to take advantage of the $200 billion market for off-price online retail. In the 2019 interview announcing the partnership, Simon notes that SPG’s 10 largest tenants in 1993 are no longer in business, which shows the ever-changing nature of this business.

 SPG: CONSISTENTLY DELIVERING RETURNS

As mentioned above, SPG has paid out some $33 billion in dividends to unitholders since SPG’s IPO in 1993. Simon had significant influence in the decision to take the company public and has been CEO since 1995, so our view is that he can take the bulk of the credit for this performance. Since REITs are required by law to pay out 90% of funds from operations (FFO) to unitholders in the form of a dividend, stock price appreciation has been understandably muted. However, a 4.26% annual capital return is commendable in this context.

It is difficult to ascertain relative performance of a business in isolation, particularly over a long time frame. In order to gain greater context of SPG’s performance over David Simon’s tenure, we provide below a chart that tracks the total returns of SPG relative to the subset of equity retail REITs, as well as the broader asset class of REITs overall:

(Source: FactSet)

 SPG IN DOWNTURNS

In this section it is important to note that SPG’s portfolio is made up of ‘class A’ malls, which are the most quality shopping center locations in the US. Below is the way that shopping centers are classified:

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Class ‘A’ malls attract the best tenants, which seems to insulate them in downturns relative to their Class ‘B’ and ‘C’ tiers which have lower quality tenants and tend to be more economically sensitive. Examples of tenants in Class ‘A’ centers like those in the SPG portfolio are: Apple, Tiffany & Co, Lululemon, Kate Spade, Michael Kors, and Coach, most of which cater to the more affluent shoppers. This could be of greater importance in the context of COVID-19, where job losses have been concentrated in the lower income echelons.

LB•LOGIC We think it is useful to use the Global Financial Crisis of 2008 as a reference with respect to SPG’s performance in downturns. As we can see quite clearly from the below chart of SPG stock performance from 2007-2010, the business was quite durable in the last downturn, delivering positive total return over the period relative to the negative performance of both retail REITs and REITs overall. Our sense is that CEO Simon’s strategy of maintaining a portfolio of Class ‘A’ malls has at least some role in the firm’s relative overperformance during the period. We also think this bodes well for SPG in the current crisis. While SPG may suffer in 2020, we are confident that the firm will outperform lower quality REITs like WPG and CBL.

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(Source: FactSet)

 CAVEATS/CONCERNS ABOUT THE SPG’S FUTURE

Conventional wisdom suggests that the emergence of e-commerce is a direct threat to the business model of all shopping centers, even the Class ‘A’ properties like those SPG holds. We are impressed with Simon’s strategy to convert floor space from former anchor tenants (think Macy’s, Neiman Marcus, Bloomingdale’s) with mixed-use developments like fitness centers and dining/entertainment options like Dave and Buster’s and Pinstripes. While “big box” anchor tenants generally operated paying little or no rent, these new tenants will actually provide revenue to SPG. However, it is unclear whether this redevelopment will work, both in the context of shrinking market share for brick and mortar, as well as because of COVID. Note also that all of these redevelopment options are highly capital intensive and it is unclear what stress this will put on the current operating model.

We have noticed a disturbing trend in SPG’s portfolio over the last 8 years: a steady decline in book value of the company’s assets. The reasons for this are not crystal clear, but the suggestion is that retail space, on a square foot basis, is become less valuable over time. Our fear is that this will eventually depress the earnings power of SPG’s business and, in turn, put pressure on SPG to continue growing dividends to unitholders over time. The question that needs answering is whether this diminishing book value is properly reflecting in the much lower stock price:

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SPG Book Value History 25.00 20.00 18.00 20.00 16.00 14.00 15.00 12.00 10.00 10.00 8.00 6.00 5.00 4.00 2.00

0.00 0.00

Jul-01 Jul-06 Jul-11 Jul-16

Jan-99 Jan-04 Jan-09 Jan-14 Jan-19

Sep-00 Sep-05 Sep-10 Sep-15

Nov-99 Nov-04 Nov-09 Nov-14 Nov-19

Mar-98 Mar-03 Mar-08 Mar-13 Mar-18

May-02 May-07 May-12 May-17

Book Value Price/BV

LB•LOGIC As we can plainly see here, SPG’s price/book ratio increased steadily since 2012, corresponding with the steady decrease in book value. In retrospect, the business likely traded at a multiple that was becoming unsustainable. After the decline in the stock price in February-March, the P/B multiple fell to a level unseen since 2014. While this means that risks are significantly lower at the current stock price, it would be unrealistic to expect multiple expansion back to the pre-COVID levels, especially considering this worrying trend in book value.

(Source: FactSet)

One other concern for SPG relates to the pending acquisition of Taubman Centers (TCO), another portfolio of Class ‘A’ malls. Simon agreed to purchase TCO in February 2020 for $3.6 billion, but in June 2020 announced its intention to pull out of the deal, citing Taubman’s particular malfeasance with respect to dealing with the COVID crisis. This transaction will be likely tied up in litigation over the coming months and years, with Taubman unwilling to accept Simon’s decision to withdraw. It must be noted that Taubman is something of a “white whale” for David Simon, who noted in the 2009 that he had already attempted to purchase the group twice at that time, the second time a hostile takeover bid. A break fee for the withdrawal for the deal is a significant risk in the coming quarters.

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 SHARE PRICE HISTORY (TOTAL RETURN)

(Source: FactSet)

 INSIDER TRANSACTIONS AND NET WORTH

Mr. Simon currently owns 954,000 shares of SPG, having purchased 150,000 shares on March 17, 2020 at a price of $60.83 per share. According to FactSet, Simon’s holdings in SPG comprise roughly 31% of his overall portfolio. This is a fair bit lower than what we have observed with many other Founder/CEOs that we have studied in past reports. With that said, the cash acquisition of shares in the rough patch in March suggests that Simon sees success for SPG in the near- to medium-term.

Please note also that some 9 major executives have made open market purchases of SPG shares since March 2020. This includes 189,000 shares purchased by Founder (and Chairman Emeritus) Herb Simon.

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 CEO COMPENSATION

According to SPG’s latest Proxy Statement, David Simon’s compensation over the last three years is as follows:

Comparisons with peer CEOs:

Washington Property Group (WPG):

CBL Properties (CBL):

LB•LOGIC Mr. Simon’s compensation is admittedly much higher than Stephen Lebovitz’s and a fair bit higher than that of Lou Conforti at WPG. With that being said, our view is that the compensation is in line with reasonable, based on the significantly better business performance at Simon and the associated high dividend payouts shareholders have consistently enjoyed over the life of the business.

 GLASSDOOR REVIEWS

Simon Property Group carries a relatively low 3.0-star rating and a dismal 43% approval rate for the CEO. On the positive side, employees cite great benefits and decent work/life balance with reasonable hours. Some negative reviews are about:

• Lack of communication between the home office and the regional and local mall-level management

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• Absence of racial diversity, particularly at headquarters; office politics “out of control” • Behind the times with respect to technology (example: still using LotusNotes for email, bad IT) • Lack of formal training, exacerbated by too many layers of management ➔ micromanaging • Management overly concerned with balance sheet and maintaining high dividend at the expense of employee pay and morale

LB•LOGIC While we are mixed in our view of a management “overly concerned with shareholder returns” (we like large and growing dividends, of course), there does seem to be a cultural problem inside this business. Far too many reviews say things like “only use this job as a stepping stone or resume builder” and “Simon’s corporate culture is one of the most toxic I’ve ever seen”. Other reviews suggest that management is “pennywise and pound foolish” as upper-level managers look to cut short term costs to preserve their own yearly bonus payments. As we all know, “brick and mortar retail” is a struggling industry, so it is incumbent on CEO Simon to address these concerns, as retaining talent in this space would be difficult even in the best of corporate cultures. This is a concern.

 CONCLUSIONS

David Simon’s history at SPG shows that he is a true innovator in the retail REIT space. The proof is in the excess returns that SPG has produced for investors since the company completed its IPO in 1993. We are impressed by the aggressiveness that Simon has shown in making transformative acquisitions over the years, many of which pay dividends even to today (outlets, Mills).

While it is clear that Simon is the best in his business, there is legitimate concern that he operates in a slowly deteriorating industry. It is the case that Simon Property Group is the crown jewel among retail REITs, but the future of the business model remains uncertain. The steady decrease in book value per share during the 2010s is also a concern that should not be dismissed.

At issue is whether SPG can find an effective way to replace anchor tenants like Neiman Marcus, Bloomingdale’s, Macy’s, and Gap, many of whom have been unable to remain current with their leases in the context of COVID. Simon’s scale will ensure that the company can operate for many years to come, but the question is whether the business will perform sluggishly in the coming years. Glassdoor reviews raise the question of whether SPG will be able to retain top talent considering the trajectory of this industry.

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 REFERENCES

Videos:

Wharton Leadership Lecture (2009)

CNBC 2019: Rue Gilt and SPG announce partnership

Milken Institute 2018: Simon and Sam Zell (among others)

Cash Flow Growth Critical for REITs (2010)

Text:

SALES AT CLASS-A MALLS INCREASE DESPITE BROADER RETAIL WOES (2018)

What is a Class A Mall? (2018)

The Retail Apocalypse is Far From Over, and Simon Property Group is not Immune (2020)

Simon Property Group is Trading at a Historically Cheap Price (2020)

The biggest US mall owner plans to have 50% of its centers reopened this week (2020)

Simon Nixes Merger; Taubman Calls Termination 'Invalid' (2020)

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