When investment bankers approached Tom Hofstedter to see if he might bid for one of the country's biggest owners of shopping malls, it seemed like an offer he could easily refuse.
His company, H&R Real Estate Investment Trust, isn't in the enclosed-mall business; it owns office towers and big box stores. But as he examined the idea of taking over Primaris Retail REIT, he spotted an opportunity: Target Corp.'s stores are about to splash into Canada and force other retailers to up their game. The deal seemed like a good avenue for growth.
So Mr. Hofstedter, who has real estate in his blood, decided to pursue a nearly $3-billion deal that would make H&R the sector's largest player by enterprise value.
But his offer isn't getting a warm welcome from Primaris's investors, some of whom question whether the company could have done better.
Mr. Hofstedter skipped some common steps, such as notifying a rating agency and hiring investment bankers, in an effort to ensure that a consortium led by KingSett Capital – which had submitted a hostile offer for Primaris in December – didn't hear about his plans and boost its bid. And he secured an unusual break fee that includes the right to buy Toronto's Dufferin Mall, one of Primaris's prized assets, at a discount.
That means if KingSett or another bidder were to top H&R's bid, that mall would likely go to H&R.
After investment bankers from Canaccord Genuity approached him about making an offer for Primaris, "we started to think about it, and putting two and two together it made beautiful sense," Mr. Hofstedter said in an interview Thursday.
Primaris owns more than 30 malls and shopping centres across the country, and 10 of them will soon have Target as a tenant.
"No one's building enclosed shopping centres any more, they haven't for years already, no one ever will," Mr. Hofstedter said.
And with U.S. and international retailers moving in, he believes the landscape will change dramatically. Target's entry will drive more traffic to malls, which will drive rents higher, he said.
While these types of malls are a new business for him, Mr. Hofstedter, a chartered accountant by training, has a long history in real estate. His relatives got into the game, first with a few houses, then with apartment buildings, after emigrating from Hungary.
"We've been a real estate family literally since the Second World War, since my parents came across from Europe," he said. After working in accounting, Mr. Hofstedter joined the family business, which ultimately spun off a portfolio of office buildings he had built to form H&R REIT in a $173-million initial public offering in 1996.
Mr. Hofstedter made a splash in early 2007 when he announced it would develop The Bow in Calgary, a 58-storey building to house oil patch powerhouse EnCana Corp. But the financial crisis hit before the REIT had secured funding for most of the project, putting it in jeopardy. Insurer Fairfax Financial Holdings Ltd. stepped up with private financing for H&R in 2008, but forced it to cut its monthly cash distributions to unitholders in half.
Mr. Hofstedter is a private individual and can be brash. H&R REIT does not hold quarterly conference calls with analysts and investors to discuss its results, a practice that's relatively standard. When one analyst asked Mr. Hofstedter on a conference call Thursday about fees he could potentially earn from this deal, he became testy.
His direct compensation is not linked in any way to deals or to gross revenue. But the REIT's properties are managed by a property manager, and Mr. Hofstedter's family is one of the shareholders of the property manager. The property manager gets fees based in part on doing deals.
On the conference call Mr. Hofstedter read a prepared statement saying that H&R's independent trustees and external managers have agreed to re-evaluate the terms of the agreement that sets out fees, and that this will conclude discussions about the acquisition fee that could be paid if the bid for Primaris succeeds. He said the revised agreement will be released before unitholders are asked to vote on the bid. When an analyst pressed him for more information he became angry, telling her to go back and read his statement.
Reaction to H&R's bid was mixed. "Our conclusion is that this is a good deal for Primaris unit holders as they are receiving fair value for the REIT, can continue to participate in future upside at what will become Canada's largest REIT and benefit from a substantially tax-deferred transaction," National Bank Financial analyst Heather Kirk wrote in a note to clients.
But many Primaris investors remain skeptical, and wonder if the REIT couldn't have done better by asking KingSett to make another bid. Primaris agreed to H&R's offer, and a break fee that some analysts and investors characterize as steep, without explicitly telling the KingSett group that a competing bid had come in and asking if it wanted to boost its offer.
"It's disappointing," Macquarie analyst Michael Smith said in an interview. "I think it should have gone for a higher price.
"Most investors, especially in the U.S., are upset with the structure of the break fee, and some are calling it a poison pill in disguise."
If Primaris ultimately accepts an unsolicited bid that tops H&R's, then H&R would receive about $70-million in cash as well as the chance to buy Toronto's Dufferin Mall and other properties along Yonge Street in the city's downtown at a discount.
A number of critics said that Dufferin Mall is one of the most appealing aspects of Primaris's portfolio, and that this fee reduces the chances of KingSett or any other bidder submitting a higher offer.
After learning of the deal late Wednesday, a large team of executives and advisers involved in the KingSett bid gathered in downtown Toronto early Thursday morning, poring over their options.
They had put Primaris in play in December when they pounced with a surprise all-cash $26-per-share bid that expired Thursday. Ultimately they decided to extend their offer until Feb. 4.
Primaris CEO John Morrison defended the break fee, saying it could be argued that it's actually below average as a percentage of the bid.
After KingSett launched its offer, analysts had been skeptical that Mr. Morrison would be able to drum up a higher bid.
In the end Primaris received a lot of interest, and various proposals, but H&R's was the only other bid for 100 per cent of the company, Mr. Morrison said in an interview Thursday.
With files from Janet McFarland
WHAT THEY OWN
Incorporated in 1996, its North American real estate portfolio holds 45 million square feet, made up of 42 office properties, 115 industrial and 138 retail properties and two development projects.
Retail tenants include Home Depot Inc., Wal-Mart Stores Inc., Rona Inc., Lowe's Cos. Inc., Cineplex Inc. and Shopper's Drug Mart.
Formed in 2003, it owns and manages 35 shopping centres across Canada, comprising about 14.7 million square feet.
Holdings include Toronto's Dufferin Mall, Calgary's Northland Village, Woodgrove Centre in Nanaimo, B.C., and Montreal's Place Vertu.