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Editor's Note: This is another in our series of articles profiling companies in the REIT and publicly traded real estate industry. Portfolio runs profiles like this one on companies that have shown leadership, innovation or resourcefulness that we believe our readers will find of interest.

Super-regional entertainment and value-oriented mega-malls are the hallmark of the Mills Corporation of Arlington, Va.—one of the fastest growing, publicly traded retail REITs in the nation. The company's successful mega-mall format combines manufacturers' outlets, department stores, specialty retail outlets, off-price retailers, category dominant stores and dining and entertainment options, all within about 1.5 million square feet of gross leasable area (gla)—about the size of 31 football fields. Its unique, competitive product continues to generate low-double-digit growth while many other regional mall companies are generating high single-digit growth. Mills occupancy rates, sales productivity and dividend payout ratio are among the highest of the leading regional mall companies.

In February, the company announced the shopping center industry's first-ever naming rights deal: Mills Corporation and Discover Financial Services, a business unit of Morgan Stanley Dean Witter & Co., unveiled an exclusive partnership in Discover Mills, a 1.3 million sq. ft. retail and entertainment center to open in Atlanta in 2001.

Mills' anticipates a physical growth rate of two projects per year over the next few years, with development costs averaging $225 million each. Today, Mills Corporation has ownership or interests in eleven Mills projects, one Block project and 11 community shopping centers, with the Mills and Block projects totaling 18 million sq. ft. of GLA in 14 states, with six projects under development in the United States and one in Toronto. Its activities have attracted joint-venture capital from companies like Kan Am, Simon Property Group, Taubman Centers Inc., Cambridge Shopping Centers Ltd., and Gaylord Entertainment.

The company enjoys a risk rating of "above average" and "Analysts' Select List Choice" ranking from Legg Mason Wood Walker Inc., an "outperform" rating from Morgan Stanley Dean Witter and "buy" ratings from Merrill Lynch and Robertson Stephenson (as of earlier this year).

States Andrew Jones, a principal with Morgan Stanley Dean Witter, "We [give Mills] an 'outperform' rating on the shares and a $21 price target, reflecting our favorable view of the company's growth rate, valuation and strong management team. We have weighed this against the risks associated with development, particularly the problem of finding the capital to fund its development pipeline, as well as e-commerce and the associated transfer sales and deflationary impact on bricks-and-mortar retail. Given the company's current annual dividend of $2.01 and our price target of $21, we believe the shares offer attractive upside into 2001."

Of the company's success, Larry Siegel, Mills' chairman and CEO, remarks, "We are what I call a 'new century' retail entertainment developer: We clearly recognize the balance between bricks and mortar, technology and new age consumerism. Mills has been the first to emerge as a new century developer who understands and delivers this balance in the out-of-home experience. We are trademarking this product in a nationwide network of branded properties with differentiated experiences that help tell our story."

"That's a view from 30,000 feet, but it's what drives us every day," declares Siegel.

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Investment Positives

Analysts agree that Mills' unique assets, committed partners, development expertise, good tenant relationships, strong management team, attractive yield and low payout are among the positive factors steering this company towards continued success. Mills' super-regional entertainment and value-oriented mega-mall presentation is in the early stages of its growth cycle compared to traditional malls, and is a proven product type, with occupancy rates in 1998 and 1999 (about 96 percent each year) among the highest of the leading regional mall companies. It heads the mall universe in its dividend payout ratio (dividend/-FFOPS) of about 83 percent.

Direct competition is limited due to high barriers to entering new markets: The scarcity of viable new sites and difficulties in obtaining local approval for development limit the number of competitors. In addition, Mills' strong relationships with key national retailers (about 74 percent of the company's specialty store tenants are located at more than one Mills project) encourage renewals and expansions, and facilitate leasing at new developments.

The cost to develop a new Mills project is about $200 to $250 million, and initial returns are forecast to average 9–9.5 percent, with stabilized returns approximating 11–11.5 percent, according to Jones. Mills has a $1.4 billion pipeline of projects expected to be completed over the next three years, at the rate of two new developments per year. Among the companies helping to fund this pipeline is Kan Am, a German investment syndicate that has invested over $315 million as a partner in several completed projects and has agreed to invest a total of $750 million over a five-year period. (Three of the 12 Mills Corporation's board members are Kan Am principals.)

For the year ended 1999, Mills' FFO increased to $95.1 million from $85 million for the year ended 1998. For the quarter ended March 31, 2000, FFO increased to $23.6 million from $21.3 million for the same period in 1998. Net income for that quarter increased to $5.2 million from $4.8 million for the same period ending March 31 last year.

Investment Concerns

Potential stumbling blocks include interest rates and development risks, according to Robert Levy, senior real estate analyst for Robertson Stephenson: "About $430 million of Mills' debt is variable rate. We estimate a 50 basis point increase in interest rates could reduce per-share FFO by $0.05 to $0.06 annually.

"In addition, Mills' external growth is tied to the success of its development projects. Risks inherent in real estate development include leasing, attaining government approvals, cost overruns, delays, and more," says Levy.

According to analysts at Legg Mason Wood Walker, although Mills' joint partnerships help limit competition and provide access to capital, they also pose an elevated corporate/shareholder risk profile. In addition, these analysts report that Mills plans to sell its community shopping center assets to help fund its development pipeline may have a dilutive effect on earnings.

Jones of Morgan Stanley claims that if Mills' joint venture equity funding dries up (which is not anticipated), raising cash through increased debt would be difficult since Mills' assets are fully mortgaged and little is available on the company's line of credit.

Another issue, according to Jones, is Mills' newest development concept, "The Block," which is still an unproven product. Opened in the fall of 1998 in Orange, Calif., three miles from Disneyland, this mix of full-price retail stores with heavy emphasis on dining and entertainment "is generating a reasonable (but not exceptional) initial return, and stabilized returns should be in the same category," Jones says. Mark Rivers, Mills' executive vice president and chief strategic officer, has a more positive view: He says Mills is very pleased with the results to date for The Block at Orange, which is home to one of the highest grossing theaters in the U.S. (Last summer the AMC 30-plex was the number-one-grossing movie theater in the nation.) Reports Rivers, "We're planning to add another 60,000 square feet of retail and entertainment to The Block this year, and have received both residential and office development interest, which would bring significant additional bulk to the project." These are all just the initial stages of what Rivers believes will be a long and successful run for The Block at Orange as a retail and entertainment, mixed-use project. Mills is also in the process of pursuing another Block project in midtown Atlanta, planned for 2002.

Brief History

Mills went public in 1994, after it had completed the development of Potomac Mills (in the Virginia suburbs of Washington, D.C.), Franklin Mills (Philadelphia), Sawgrass Mills (near Ft. Lauderdale, Fla.) and Gurnee Mills (Chicago suburbs). After its IPO, and through joint venture partnerships, Mills then developed Ontario Mills (Los Angeles area), Grapevine Mills (Dallas/Fort Worth), Arizona Mills (Phoenix area), The Block at Orange, Concord Mills (Charlotte, N.C., area) and Katy Mills (Houston area). Each is a leading tourist destination in its state. On average, each Mills project has drawn an average of 18 million visitors, 3,000 to 4,000 tour buses and tens of thousands of foreign visitors a year. Each site consists of about 1.5-million sq. ft. of GLA, 15 to 20 retail and entertainment anchor tenants (about 60 percent of total GLA) and 175 to 200 specialty tenants (about 40 percent of GLA).

Discovering New Options

Under the exclusive naming arrangement with Discover Financial Services announced in February, Discover will pay Mills $10 million over 10 years for the right to rename the Sugarloaf Mills project (under development) to Discover Mills. The naming rights represents found money in terms of investment risk, and will have ancillary benefits for both the mall and consumers. Kan Am will fund all of the required equity in this deal.

The Discover Card universe is the largest independent credit card network in the U.S., with more than 3.5 million merchant and cash access locations, and 48 million cardmembers.

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Rivers comments on the arrangement: "This is a terrific partnership for two reasons. First, we expect to explore a number of exciting financial services and other consumer- and merchant-related products in Discover Mills. Second, having a company like Discover willing to pay us for the right to call the project Discover Mills is for us a very innovative and meaningful alternative source of revenue. The deal demonstrates again that we have a powerful brand and asset that can be leveraged to generate other forms of income for our company."

Rivers adds that there is the potential to pursue similar naming rights deals for each of its existing and planned Mills centers.

Other Current Projects

This past May, Mills opened its 1.2 million sq. ft. Opry Mills in Nashville, Tenn., adjacent to the Grand Ol' Opry and the Opryland Hotel and Convention Center. The project is 66.7 percent owned by Mills and 33.3 percent by Gaylord Entertainment. Arundel Mills, at 1.3 million sq. ft., is planned for a November 2000 opening in Baltimore. The project is 37.5 percent owned by Mills, 37.5 percent by Simon Property Group and 25 percent by Kan Am.

Scheduled for a late 2001 opening just north of Toronto, the 1.4 million sq. ft. Vaughn Mills will be the Mills Corporation's first venture outside of the United States. Mills has partnered with Cambridge Shopping Centers, which will own 50 percent of the project and contribute $30 million of equity.

Beyond 2001, Colorado Mills (formerly Denver Mills) is on the drawing board for the Denver market. Mills will partner with The Taubman Centers on the project, but final financial terms have not been disclosed. It is anticipated that Mills will fund 37 percent of the approximately $70 million in required equity. Potential sites for future projects also include midtown Atlanta (The Block), New Jersey (Meadowlands Mills, to include a 1.5 million sq. ft. Mills project, a 1 million sq. ft. office project and a 300-room hotel), Boston, Tampa, St. Louis and Minneapolis.

Candlestick Mills in the San Francisco market, a 1.4 million sq. ft. joint project planned with DeBartolo Entertainment, originally announced in May 1997, is still in the pipeline but temporarily on hold.

Partnership Arrangements

In a typical unconsolidated project, Mills normally contributes a percentage of equity less than, or equal to, that of its partners, but receives an ownership percentage greater than, or equal to, that of its partners. Mills and its partners usually receive a minimum preferred return (generally nine percent) on their respective cash equity contributions.

"We are no different than most REITs in that our stocks have been lower than we wish, making trips to the equity market difficult," admits Rivers. "Our joint venture partnerships have worked exceedingly well, delivering economic advantages as well as accelerating the development pipeline."

At Kan Am, Jim Braithwaite, president of U.S. operations (based in Atlanta), states that his company believes strongly in the Mills concept and likes the returns it gets. "We're capitalists," he says. "Our investors are looking for stable, long-term, above average returns and that's what the Mills projects provide."

Braithwaite says he doesn't think the joint venture poses an elevated risk profile; regardless, the German investor he represents "has to reinvest in the form of a joint venture to obtain the tax benefits he's looking for." He says Kan Am has a "huge stake" in the Mills Corporation and is very supportive of its development activities. Simon Property Group began its joint relationship with Mills in 1995, with an agreement to examine projects in eight markets. To date, Grapevine Mills, Arizona Mills, Ontario Mills and Concord Mills have been jointly developed, with Arundel Mills underway.

The Taubman Centers of Bloomfield Hills, Mich., is a REIT that own, develops, acquires and operates regional and super-regional malls nationwide, with $1 billion of projects under construction today. The company's partnership with Mills, about two years old, is tackling multiple developments in many cities simultaneously, with the goal of seven Mills projects in a ten-year period (by 2008). Reports President and CEO, Robert Taubman, "Our alliance with the Mills organization provides an outstanding opportunity to leverage both companies' core competencies and create incremental growth for our respective shareholders in a more consistent and efficient manner. We believe the Mills orientation to development is most similar to our own, especially with respect to their in-depth understanding of all aspects of the development, merchandising and marketing process."

Cambridge Shopping Centers of Toronto has about 50 percent of the shopping center projects across Canada, 40 percent of which are regional malls. Nothing like a Mills super-regional entertainment and value-oriented mega-mall exists in its portfolio, nor in the country. J. Lorne Braithwaite (no relation), president and CEO of Cambridge, reports that Vaughn Mills is the first of four joint venture partnerships with Mills being planned for Canada, which will include projects in Montreal, Vancouver and Alberta. He says the Montreal project is zoned and should be under construction later this year.

"The Mills concept is at the forefront of the consumer mindset in today's marketplace. It is just the type of retail-driven real estate Canadian consumers are looking for," asserts Braithwaite, adding that Mills was essential in convincing about 100 U.S. tenants currently not in Canada to commit to leaping the border. "It was essential that we partner with someone like Mills to assist with such a large project."

E-commerce

As Mills and its partners aggressively pursue a commanding development pipeline, the phenomenal growth of e-commerce and its potential impact on these projects come to mind.

But Rivers insists e-commerce has not impacted Mill's retail performance, but its motivation to create an even better out-of-home experience, to differentiate itself even more. He says a Mills project is as much about shopping as it is about getting out and being entertained. "People's time is limited. When they do get out, they're looking for a high-quality out-of-home experience that provides recreational, entertaining leisure time for the entire family. The more innovative and successful we are at providing this, the better off we'll be."

Adds Rivers, "The Internet is our friend, not our foe. Smart developers are finding a way to capitalize on its excitement, energy and success to create value and opportunity for their core businesses. That's what we're doing, whether in the area of direct consumer marketing, business-to-business applications or in applying the strengths of Internet technology through our buildings to interface with our merchants and consumers." He says that even the most successful online retailers today are marrying an online and offline presence.

In December 1999, Mills hosted a live, in-person holiday auction during which mall goers bid for the items on eBay, the world's leading person-to-person online trading community. That same month, eBay's website began featuring "Shopping Adventures with The Mills," special featured auctions during which eBay users bid on Mills-related experiences, such as shopping sprees, retail collectibles, trips and more.

"As a result of this relationship with eBay, we discovered that the auction—one of the oldest forms of customer transactions known to man—is a very hip, modern form of location-based entertainment. I believe there is a long-term opportunity for developing auction facilities in our properties," reveals Rivers.

Frontiers

Rivers reports that Mills' growth is linked to the development of new markets and the product itself. "There is still a host of markets—a wide frontier—remaining for Mills projects," he claims.

"We are also finding significant internal growth through the remerchandising and expansion of our existing properties. Once our projects open, they become an attractive nucleus for a wide range of diversified uses," continues Rivers. Under Mills' "Portfolio 2000" initiative, major expansions and renovations to several flagship properties are taking place to bring new and creative uses, and yet another layer of intrigue to each project, says Rivers. "We are going back and insuring that we are maximizing the potential of every property, and have demonstrated that there is a lot of upside remaining among our existing assets."

At the same time, according to Rivers, the company continues to consider other forms of retail-driven product types which capitalize on its creativity, merchant relationships and ability to develop and sustain dynamic, top-performing environments.