How Prime Outlets Sale Is Saving David Lichtenstein

Kris Hudson of The Wall Street Journal reports:

Buying Prime Outlets Inc. in 2003 was one of the best investments that New York investor David Lichtenstein ever made. Now selling the chain of outlet centers is giving him the cash to bail himself out of his worst deal ever.

Mr. Lichtenstein’s closely held company, Lightstone Group LLC, announced this month that it is selling Prime Outlets to Simon Property Group Inc. for $700 million in cash and the assumption of $1.6 billion in debt. The price tag reflects a significant increase from what Lightstone paid for Prime in 2003: $115 million in cash and the assumption of $523 million in debt.

After paying its 40% partner in Prime, fees and other expenses, Lightstone expects to rake in about $450 million, according to people familiar with the matter. That is more than what Mr. Lichtenstein needs to dig out of his disastrous investment in Extended Stay Hotels Inc., his 660-property hotel chain that was forced to file for bankruptcy protection earlier this year.

Lightstone still owes Citigroup Inc. $80 million of the $120 million that it borrowed to acquire Extended Stay in a top-of-the-market deal in 2007 that valued the chain at $8 billion, according to people familiar with the matter. He also agreed as part of the purchase to a $100 million “bad boy” clause, a common inclusion in large financings that is meant to deter borrowers from putting their ventures into bankruptcy by making them personally liable if they do so.

Some of Extended Stay’s large creditors have offered to indemnify Mr. Lichtenstein from the bad-boy liability. But others say he is liable, and it remains to be seen how the issue will be resolved in U.S. Bankruptcy Court in New York’s Southern District.

But regardless the outcome, the sale of Prime Outlets, a 22-mall portfolio that Lighstone overhauled, gives the company ample cash to pay off the bad-boy clause as well as the money that it still owes Citi. “They are selling a very concentrated portfolio of high-quality, pretty well run assets,” says Jim Sullivan, an analyst with Green Street Advisors Inc.

Mr. Lichtenstein’s rescue by Prime Outlets, which comes as woes mount in the commercial-real-estate world, shows that investors on the ropes can still extract cash from desirable assets as long as they aren’t too highly leveraged and were acquired before prices began heading toward the moon.

But it also means that investors sometimes have to give up their pride-and-joy investments to get back to health. In another example last year, New York developer Harry Macklowe was forced to sell his prize General Motors building in Manhattan to get the cash to pay off creditors.

The son of Brooklyn, N.Y., schoolteachers, Mr. Lichtenstein had amassed a portfolio of about 20,000 apartments and several office buildings when Lightstone bought Prime Retail in 2003. At the time, the outlet-center industry was ripe for a revamp. The format emerged in the 1970s and 1980s as a venue for manufacturers to unload their excess supplies of poor-selling and flawed goods at steep discounts. The centers were constructed along highways several miles outside of major cities due to “radius restrictions” required by department stores, which didn’t want manufacturers selling their goods at a discount too close to department-store locations selling them at full price.

The bargain appeal of outlets caught on in the 1990s, when developers rushed to open more and ended up overbuilding the market. The number of U.S. outlet centers mushroomed to 307 in 2000 from 181 in 1990, according to the International Council of Shopping Centers. More recently, though, the industry’s momentum has cooled as the weaker centers in overbuilt markets closed and shoppers chose discount retailers such as Wal-Mart Stores Inc. over outlet centers selling similar fare.

After buying Prime, Lightstone decided to move the company away from the outlet-center industry’s reputation of offering cheap goods at cheap prices. Instead, Mr. Lichtenstein and his team sought to recast the tenant ranks of Prime’s centers to focus on fashion merchandise from upscale brands. Gradually, Prime dismissed outlet-center staples such as Mikasa, Sears Hardware and the Walking Co. Holdings’ Big Dog. Lightstone replaced them with the likes of Gucci Group, Armani, 7 for All Mankind jeans, Restoration Hardware Inc. and Hugo Boss.

Lightstone put an additional $700 million of debt on the Prime Outlets portfolio, using roughly $400 million of the proceeds for other Lightstone projects and the rest for expanding and renovating the outlet centers. It built a Prime Outlets center in Orlando, Fla., that now is the company’s busiest, generating sales per square foot of $650 per year. It expanded and renovated its center in San Marcos, Texas, between Austin and San Antonio to mimic Piazza San Marco in Venice, complete with a singing gondolier navigating a canal.

Lightstone closed the portfolio’s weaker centers, whittling it to 22 centers from more than 30.

Ultimately, the result of Lightstone’s overhaul of the Prime portfolio was an increase in sales per square foot at the centers to $377 this year from $270 in 2003, according to a person familiar with the matter.

Meanwhile, the 660-hotel Extended Stay chain collapsed into bankruptcy in June after failing to keep up with payments on the nearly $8 billion of debt that Lightstone put on it. The hotels continue to operate while creditors are fighting in court over how much the company is worth and who still has claim to it.

{The Wall Street Journal/Matzav.com Newscenter}