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Edited Transcript of TCO earnings conference call or presentation 26-Jul-19 3:00pm GMT

Q2 2019 Taubman Centers Inc Earnings Call

Bloomfield Hills Oct 3, 2019 (Thomson StreetEvents) -- Edited Transcript of Taubman Centers Inc earnings conference call or presentation Friday, July 26, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Robert S. Taubman

Taubman Centers, Inc. - Chairman, CEO & President

* Ryan T. Hurren

Taubman Centers, Inc. - Director of IR & Interim CAO

* Simon J. Leopold

Taubman Centers, Inc. - Executive VP, CFO & Treasurer

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Conference Call Participants

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* Alexander David Goldfarb

Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research & Senior REIT Analyst

* Caitlin Burrows

Goldman Sachs Group Inc., Research Division - Research Analyst

* Christine Mary McElroy Tulloch

Citigroup Inc, Research Division - Director & Senior Analyst

* Craig Richard Schmidt

BofA Merrill Lynch, Research Division - Director

* Greg Michael McGinniss

Scotiabank Global Banking and Markets, Research Division - Analyst

* Michael Bilerman

Citigroup Inc, Research Division - MD and Head of the US Real Estate and Lodging Research

* Michael William Mueller

JP Morgan Chase & Co, Research Division - Senior Analyst

* Richard Hill

Morgan Stanley, Research Division - Head of U.S. REIT Equity & Commercial Real Estate Debt Research and Head of U.S. CMBS

* Shivani A. Sood

Deutsche Bank AG, Research Division - Research Associate

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Presentation

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Operator [1]

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Thank you for holding, and welcome to the Taubman Centers' Second Quarter 2019 Earnings Conference Call. (Operator Instructions) On the call today will be Robert Taubman, Taubman Centers' Chairman, President and Chief Executive Officer; Simon Leopold, Chief Financial Officer; and Ryan Hurren, Vice President, Investor Relations, Interim Chief Accounting Officer.

Now I will turn the call over to Ryan for opening remarks.

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Ryan T. Hurren, Taubman Centers, Inc. - Director of IR & Interim CAO [2]

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Thank you, operator, and welcome everyone to our second quarter conference call. As you know, during this conference call, we'll make forward-looking statements within the meaning of federal securities laws. These statements reflect our current views with respect to future events and financial performance, although actual results may differ materially. Please see yesterday's earnings release and our SEC filings, including our latest 10-K and subsequent reports, for a discussion of various risks and uncertainties underlying our forward-looking statements. In addition, a replay of this call will be provided through a link on the Investor Relations section of our website.

During this call, we'll also discuss non-GAAP financial measures as defined by SEC Regulation G. Reconciliations to these non-GAAP financial measures to the comparable GAAP financial measures are included, when possible, in our earnings release, our supplemental information and our historical SEC filings. Non-GAAP measures referenced on this call may include estimates of future EBITDA, NOI, after-tax NOI and/or FFO performance of our investment properties. Such forward-looking non-GAAP measures may differ significantly from the corresponding GAAP measured net income due to depreciation and amortization, tax expense and/or interest expense, some or all of which management has not quantified for the future periods. Following today's prepared remarks, we will open the call up for questions. (Operator Instructions)

Now let me turn the call over to Bobby.

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Robert S. Taubman, Taubman Centers, Inc. - Chairman, CEO & President [3]

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Thanks, Ryan, and good morning, everyone. Yesterday, we released our second quarter results. We produced solid earnings growth with adjusted FFO of $0.94, up 8% over last year. The primary drivers of this growth were better rents, recoveries, lease cancellation income and higher-than-anticipated insurance proceeds in San Juan standalone. Comp center NOI growth, excluding lease cancellation income, was up 30 basis points, in line with our expectation. Excluding the impact of currency, NOI growth was 1.4%.

Our pro rata share of total portfolio NOI continues to grow at a significantly faster pace, up 4.6% in the quarter and 5.1% year-to-date. This is on top of 4.7% growth in 2018. At a time when the ability of mallers to grow NOI is in question, we are producing solid numbers.

Last year, the stabilization of our Asia Developments and International Market Place NOI drove our pro rata growth rate. This year, growth in our best assets that are 100% owned as well as our noncomparable centers San Juan and Beverly Center along with the addition of The Gardens Mall in Palm Beach are the primary factors. Average rent per square foot was up 2.1% this quarter.

On an NOI-weighted basis, it was up 4.6%. In our U.S. comp centers, average rent per square foot was $62.94, up 1.4%. On an NOI-weighted basis, our U.S. comp was $81.35, up 3.4%. At June 30, comp center occupancy was 92.2%, slightly lower than last year, primarily due to frictional vacancy at our 2 China assets.

In the first half of the year, we proactively recaptured between 4% and 5% of the GLA, including 2 large Forever 21 stores at CityOn. Xi'an and CityOn. Zhengzhou, both of which are 100% leased. Great international brands like Sephora, Nike 750, Opel, Bose, APM Monaco and Victoria's Secret will be opening at these centers in the Forever 21 spaces in the second half of this year. These tenants will be accretive to merchandising, and we expect will add meaningfully to the sales per square foot in NOI of both centers.

Lease space in comp centers was above 95%, which is in line with last year and recent history for this time of year.

Turning to sales. In the U.S., comparable centers' trailing 12-month sales were $940 per square foot, up 12.2%. Including Asia, trailing 12-month sales were $848, up 10.8%. On an NOI-weighted basis, sales were $988, up about 10%. For the quarter, sales per square foot increased 8.8% for all comparable centers. Tenant sales in our portfolio have now increased 12 quarters in a row.

Once again, a few factors impacted sales growth. First, Tesla's vehicle deliveries were added, but to a lesser extent than last quarter, also late Easter benefited April's results. These were partially offset by unfavorable foreign exchange rates, which reduced sales growth at our Asia centers by about 7%.

Taking these considerations into account, our tenants still produced good growth against a strong comp from a year ago. In the U.S., excluding Tesla, we were up 4.5%. Key categories like shoes and electronics and importantly apparel, which was up for the seventh consecutive quarter continued to perform well. The best individual performers included H&M, Fabletics, Jimmy Choo, Louis Vuitton, Abercrombie & Fitch, Coach, Express, Apple, Microsoft, Ferragamo, Aerie, Lululemon, Zara, Vans and American Eagle.

Nevertheless, disruption in the retail industry continues with store closings and tenant bankruptcies persisting. Last quarter, we identified 50 locations that could be impacted by bankruptcies this year. Of those, we expected about 20 stores to close, representing 70 basis points of occupancy. There has been very little additional bankruptcy since, and we now expect 55 locations could be impacted.

In addition, Charming Charlie's, Dressbarn and 602 have announced chain-wide closures. We have 6 locations with these 3 tenants. In total, we now expect about 30 stores to close, representing approximately 100 basis points of occupancy, of which we believe roughly 60 basis points will be backfilled by year-end. This is all consistent with our expectations and occupancy guidance for the year.

As we (inaudible) space, the merchandising of our centers continues to evolve and improve with the new and more productive concepts. Digitally native brands, luxury, coworking and food remain growing sources of demand for space. Recent names include Gucci and Bottega Venata at El Paseo, Louis Vuitton at City Creek, Gucci at Green Hills and Golden Goose at Short Hills and Green Hills as well as Casper, Aerie, Fabletics and Palatine and at a number of centers. In fact, we now have over 2 dozen digitally native brands in our centers.

In May, upscale coworking operator industries signed a lease to join Country Club Plaza in Kansas City after committing to Short Hills last quarter. At Great Lakes Crossing here in suburban Detroit, we just announced Nordstrom's Rack will open a 34,000-square-foot store next spring. At Beverly Center, Angler, a new seafood-driven concept from Chef Josh's team, the founder of the three-Michelin-starred Saison in San Francisco opened with great reviews last month. This will be a tremendous addition to our collection of unique restaurants on Beverly's first floor. We encourage you to visit the center when you're in LA for Nareit this fall.

So with that, I'll turn the call over to Simon.

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Simon J. Leopold, Taubman Centers, Inc. - Executive VP, CFO & Treasurer [4]

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Thank you, Bobby, and good morning, everybody. I'll begin by reviewing the year-over-year FFO variances for the second quarter that are listed on Page 9 of the supplemental. FFO per share for the quarter was $0.78, this result includes $0.135 of costs related to shareholder activism and $0.025 of deal costs associated with the pending Blackstone transaction. Adjusting for these 2 items, AFFO per share was $0.94, up $0.07 compared to last year.

Our year-over-year AFFO variances include the following: minimum rents up $0.025 due to higher average rents per square foot; net recoveries were up $0.02; lease canceled income was up $0.05. We had minimal termination income in the second quarter of last year, whereas this quarter, we received large termination payments from a single restaurant location at a national footwear concept.

Other operating expenses were unfavorable by $0.015, largely due to the change in lease accounting. Interest expense was unfavorable $0.055 due to higher rates and borrowings as well as reduced capitalized interest on developments and redevelopments.

Next, our noncomparable centers, which include Beverly, the Gardens Mall in Palm Beach and The Mall of San Juan were an aggregate of $0.065. Though all 3 centers were positive contributors, the largest component of this variance was business interruption proceeds at The Mall of San Juan as we highlighted in the earnings release.

Lastly, nonoperating income was $0.015 unfavorable, largely due to the fact that we're no longer receiving dividend income from the Simon Property Group shares following our liquidation in the first quarter.

Next, I'd like to quickly touch on the impact of foreign currency exchange rates on our results. Every quarter, the results of our Asia centers are translated at the average exchange rate for that period in accordance with GAAP. Quarterly results are not restated, so year-over-year fluctuations in exchange rates have an impact.

In 2018, favorable FX rates added 30 basis points to our comp center NOI growth. That trend has reversed this year and has negatively impacted our comp center NOI growth by 110 basis points this quarter and 90 basis points year-to-date. While currency has had a big effect on the NOI growth rate this year, the impact on FFO has been negligible as the unfavorable NOI impact is offset by the favorable effect on corporate expenses, taxes and interest expense related to our Asia business.

Further, on average, we own about 45% of these centers, while our comp center NOI is stated at 100%. As a reminder, we disclosed the impact of foreign exchange rates quarterly in our NOI reconciliations on Page 24 and 25 of our supplemental.

Now an update on guidance, which can be found on Page 6 of the supplemental. This guidance continues to exclude the impact of the Blackstone transactions and the remaining associated refinancings. We now expect adjusted FFO per share to be in the range of $3.64 to $3.74, an increase of $0.02 to the bottom of the range. We continue to expect our comp center NOI growth to be about 2%.

Year-to-date, our comp center NOI growth, excluding the impact of FX, has been 2.2%. Our original guidance contemplated an unfavorable impact of 10 basis points from FX, but as we said, the year-to-date impact has been 90 basis points bringing our year-to-date growth rate to 1.3%.

If this trend continues, our NOI growth guidance could be at risk. We have similar reserves in place for adverse tenant outcomes as we had at this time last year, and we believe that these will be sufficient for the remainder of the year given what we know today. Finally, we're also assuming current tenant sales trends will continue.

Before turning the call back over to Bobby, I want to briefly comment on the price of our stock today. For a number of years now, there has been a recognition in the investment community that our NAV is significantly greater than our share price.

On our earnings call on November 2, 2017, with our share price at about $47, we said, and this is a quote, "our share of fewer than 10 assets, applying cap rates that analysts have used for our portfolio as a whole, represents at least as much value as our total market cap today, including debt and preferred stock. That means that at today's share price, investors are getting the rest of the assets for free as well as a dividend yield in excess of 5%." That's the end of that quote.

So in preparing for today's call, we updated and built upon this analysis. Today, the NAV of just 2 of our assets using estimates of market cap rates and allocating an appropriate level of debt is roughly equivalent to today's $40 share price, which means that you get the rest of the company for free, which includes interest in 22 assets, many of which are amongst the very best assets anywhere with growing sales and NOI. You're also getting a dividend above 6.5%, a dividend that has never been reduced and has increased 22x in the last 24 years.

Finally, lease on average are trading at a premium to NAV today and have an AFFO multiple above 21x, which is nearly double our current multiple, which is at about 11x.

With that, I'll turn it back to Bobby.

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Robert S. Taubman, Taubman Centers, Inc. - Chairman, CEO & President [5]

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Thanks, Simon. We had another very productive quarter. Our high-quality assets are allowing us to grow in a volatile environment and continue to meet our earnings expectations. We've completed the acquisition of another great asset in the Gardens Mall in Palm Beach, Florida. We opened our expansion wing at Green Hills in Nashville, elevating the quality of the best mall in one of the fastest-growing markets in the U.S. In Asia, we're progressing well with our new development enhanced on South Korea, which is on schedule to open late next year. And also in Asia, we remain on track to close all components of the joint venture with Blackstone during the second half of this year. We continue to make the decisions necessary to improve our portfolio, strengthen our balance sheet and grow our company.

Now we're happy to take your questions. (Operator Instructions) Jerome, are you there?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Greg McGinniss from Scotiabank.

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Greg Michael McGinniss, Scotiabank Global Banking and Markets, Research Division - Analyst [2]

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Simon, I'm just trying to zero-in on exactly what's going on with the adjusted FFO guidance, all the moving pieces there. You've got the higher-than-expected business interruption insurance and some details on that would be appreciated as well versus the comments last quarter. Then you've also got that reversal of uncollectible rent. So I'm just trying to figure out how much of that -- what was the impact from that? How much has that changed the full year impact FFO from that line item -- from those 2 line items?

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Simon J. Leopold, Taubman Centers, Inc. - Executive VP, CFO & Treasurer [3]

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Well, maybe before we jump into the sort of the bigger picture, let's talk about the business interruption insurance proceeds. We put $5 million of expected proceeds into our guidance. We got $4 million of that in the first quarter of this year, which would have left $1 million for the remainder of the year. We actually received about $3.5 million in the second quarter. So $7.5 million in total versus that $5 million. We don't expect any more, but the way I would think about it is, you had about $2.5 million of outperformance versus our guidance and that goes right into the AFFO. I'd say, in general, we had good half of the year in terms of our expectations. We had $1.89 in total in the first half, that's better than we expected. The stand-alone proceeds were clearly a part of that. That in general, would have allowed us to take up the bottom end of the range and raise our midpoint to $3.69 per share, which means that we're looking at $1.80 per share on the second half. And that's lower than last year when we reported $1.92 in the second half. The predominant difference there is from the lease accounting, the change there which hurts AFFO by about $3 million and higher interest expense in '19 versus '18. In the back half of the year, we see some positives that could push us to the higher end of the range, but there are also some potential negatives that we felt like we needed to be incorporated as well. The potential negatives really all pertain to the volatile retail environment. Tenant sales in our portfolio are pretty good right now. We're assuming that it's going to stay that way. We believe we have appropriate reserves in place to address negative outcomes in tenant health, but we'll have to see about that. We're also assuming $12 million in lease cancel income at our share for the year, but we're not there right now, I think we're at about $6.5 million right now. So it's not clear we're going to get all of that. It's not the worst problem in the world to have, but it could be a drag on our AFFO. In terms of the bad debt reversal, it's not a huge piece of the pie as it relates to where we are right now and where we expect to be.

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Ryan T. Hurren, Taubman Centers, Inc. - Director of IR & Interim CAO [4]

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Yes. Greg, this is Ryan. Real quick on -- a little bit more on that. Under the old bad debt methodology and the new collectability assessment methodology, there is a potential for the sign to flip in any given period. That happened this quarter. It was not unexpected. The flip was primarily due to the resolution of the insurance claim at San Juan. We had several accounts and some past due balances that upon the finalization of the receded business interruption insurance, that were cleaned up. So no -- it's not a surprise to us.

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Greg Michael McGinniss, Scotiabank Global Banking and Markets, Research Division - Analyst [5]

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Okay. Appreciate that. And then just a follow-up question here. You mentioned in the release and a little bit on the call talking about a small number of short-term deals, I think it was 3% of the trailing 12-month total, just driving rent split down 500 basis points. So I'm just kind of curious, do you expect more of these deals over the next year? Could be heading into negative territory? Or what exactly were these deals related to?

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Simon J. Leopold, Taubman Centers, Inc. - Executive VP, CFO & Treasurer [6]

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Well, we said it before, but it's important to reiterate. We manage our centers for NOI, for occupancy and for the quality of merchandising, all which are improving and we're going to continue to make that -- make those choices. Spreads for us really are an output, especially in a relatively small portfolio, in any given quarter, they can have volatility. We continue to point people to average rent, and average rent growth is a more important stat. That said, you have to think about this. A small number of deals, really less than 3% or about 3% hurt the stat, which means that 97% of the leases that we signed -- that we opened rather are producing 8% spreads. If you then NOI weight that, you're at about 11%. So it's healthy. We're still doing some short-term deals, and we're doing them generally in the centers that are not the strongest in the portfolio. It's helping us with NOI, it's helping us with merchandising. So we're going to continue to do that. Exactly when spreads start to go up, it's hard to say small portfolio with all those factors. But if you look at it, it is a relatively small number of these short-term deals that really are weighing down that stat.

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Operator [7]

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Your next question comes from the line of Christy McElroy with Citi.

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Christine Mary McElroy Tulloch, Citigroup Inc, Research Division - Director & Senior Analyst [8]

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Simon, just wanted to follow up on Greg's question, but more specifically related to the same-store NOI growth. You had previously talked about obviously the 10 or 20 basis point FX impact, but now you're saying sort of if that's greater, the 2% could be at risk, but you are reiterating the 2%. So I just wanted to kind of reconcile that. Are you saying that ex-FX that could be higher that the sort of core growth rate could be higher? Or that the 2% is no longer attainable because it seems like the FX impact for the full year is going to be greater than the 10 bps?

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Simon J. Leopold, Taubman Centers, Inc. - Executive VP, CFO & Treasurer [9]

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Well, we're really not saying either one of those things, Christy. Let me sort of take in pieces though. We are right where we expected to be on NOI comp for the year, excluding FX. Our guidance for the year was about 2% -- it is about 2%. Excluding FX, we're actually at 2.2% for the first half. And we do see some big positives in the second half, including the opening of new tenants in the Green Hills expansion and a number of tenants rolling in a much higher rents in Xi'an and Zhengzhou in the back half of the year. Those potential positives could be offset by a number of factors, the FX is definitely one of them. And if we don't see -- start to see a stronger dollar -- I'm sorry, if we don't see a weaker dollar, you'll end up potentially having a drag on the 2%. We did incorporate about 10 basis points of drag into our guidance, but we're at 90 basis points for the half year. If we continue at these levels, it would be about a 50 basis point drag on the number. So there is a risk there. We have other factors that you got to consider as well, including the sales environment, which is always important because we get a lot -- most of our overs run in the fourth quarter. We're assuming sales environment continues to be generally positive. We also have at least one large tenant that could create some drag in the second half depending on what happens. We do have reserves in place that are similar to the reserves that we had at this time last year, and we believe it will be sufficient to address that drag, but we're going to have to see. It's also important to remind everybody it's still a relatively small portfolio and our comp center pool is even smaller than a portfolio as a whole. It's $7.5 million on the year is 1% of comp center NOI growth. So it doesn't take a lot to change the volatility.

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Robert S. Taubman, Taubman Centers, Inc. - Chairman, CEO & President [10]

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But the bottom line, Christy, is that we think we can make 2% even in the context of currency. If currency continues to be this difficult and even goes worse, then it will be very hard for us to actually make 2%. But even with a big dose of currency hit, more than the 10 basis points we originally planned, we still think we can get to the 2%, but there is a lot of stuff out there. There is a lot of noise about tenants, there is sales issues, there is all kinds of stuff. But we still think we have a very good shot at about 2% that we talked about.

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Christine Mary McElroy Tulloch, Citigroup Inc, Research Division - Director & Senior Analyst [11]

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And just related to that, I mean, with regard to Forever 21 specifically, it's a pretty big exposure for you. You talked about the China asset, but given that they've hired advisers, can you maybe give us a sense for what's going on behind the scenes? Are they actively looking for rent adjustments? Are they talking about closing more stores? And either should we expect any impact from that in '19 or '20 resulting from what they're doing? Is this a variable that we should be thinking about sort of near term?

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Robert S. Taubman, Taubman Centers, Inc. - Chairman, CEO & President [12]

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Well, let me say, Christy, that we generally don't comment on specific tenants in our portfolio. We do recognize that Forever 21 is our largest tenant. So maybe I can make a few points. The majority of the stores in our portfolio are performing well. There certainly are lots of published reports that speculate that their challenges are related to things they did in Europe and Asia, and they are very large format stores. We did mention the 2 China stores that we really proactively worked on, and we have -- it has allowed us frankly to backfill much better merchandising and we expect much, much higher rent. Now of our 17 U.S. locations, including a brand-new store that opened -- a 10,000-square-foot store that opened at The Mall of Green Hills in the last couple of weeks, we don't have any former Mervyn boxes as an example. We do have 7 stores out of the 17 that are between 30,000 and 50,000 square feet. So yes, there is a lot of uncertainty. We do believe that our NOI and our FFO guidance ranges incorporate, well, say, a reasonable range of outcomes for this tenant -- for all our tenants, but we'll have to see and it is a very fluid situation.

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Operator [13]

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Your next question comes from the line of Rich Hill with Morgan Stanley.

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Richard Hill, Morgan Stanley, Research Division - Head of U.S. REIT Equity & Commercial Real Estate Debt Research and Head of U.S. CMBS [14]

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Wanted to just follow up on the discussion about rents. One of the things that we were noticing was it looked like based rent growth for the consolidated asset was down year-over-year for the quarter about 1.17% -- about 1.7%. So I'm wondering what's driving that, maybe it's short-term leases, but also if you could maybe give us any insights into the NOI growth between the U.S. assets and international assets?

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Ryan T. Hurren, Taubman Centers, Inc. - Director of IR & Interim CAO [15]

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Rich, it's Ryan. Yes. One of the things -- one of our consolidated centers is San Juan. As a result of kind of a situation we explained in the press release, where we did have some tenant credits issued in the quarter, really we are paid for that through business interruption proceeds, but the offset for the tenant credits ran through the rental revenues line items. So they have the effect of lowering the consolidated rent per square foot. And so that's really the biggest thing you're seeing in that line item in the year-over-year decline, for consolidated specifically.

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Richard Hill, Morgan Stanley, Research Division - Head of U.S. REIT Equity & Commercial Real Estate Debt Research and Head of U.S. CMBS [16]

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Got it. And so we shouldn't be thinking that, that negative 1.7% is reflective of the entire U.S. portfolio. It sounds like it's just driven by the large Mall of San Juan. Is that fair, Ryan?

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Ryan T. Hurren, Taubman Centers, Inc. - Director of IR & Interim CAO [17]

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I think so.

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Simon J. Leopold, Taubman Centers, Inc. - Executive VP, CFO & Treasurer [18]

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Yes, I think it's fair. The way to look at it, Rich, is it really is an anomaly related to what's happening in the center right now.

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Richard Hill, Morgan Stanley, Research Division - Head of U.S. REIT Equity & Commercial Real Estate Debt Research and Head of U.S. CMBS [19]

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Got it. And then guys maybe a little bit technical of a question, but I think we saw a $2.1 million cost related to the Blackstone transaction, including about $1.6 million related to income tax expense. Is that right? And what's driving that? Because I didn't think the Blackstone transaction had closed yet?

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Simon J. Leopold, Taubman Centers, Inc. - Executive VP, CFO & Treasurer [20]

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Yes. So Rich, it's Simon. The $2.1 million charge in the second quarter essentially consists of 2 separate items, both are related to the Blackstone transaction. We really -- we view both of them really as deal costs and we're required to recognize them under GAAP now even though the transactions have not closed. The first is about $0.5 million charge for professional fees, I think that's the relatively simple part. The second charge is more complicated, but the simplified version is that it's $1.6 million accrual for a deferred tax expense related to the sale of the China asset specifically. We expect that a relatively small amount of withholding tax would need to be paid upon the closing of those deals. If the deal closed at a single point in time, they would have been part of really a vast number of accounting and tax items for a deal of this nature. Because the deal is closing serially over a number of quarters, we're required to record this item in second quarter ahead of the closings. It's really sort of a timing issue at the end of the day, and it really is a deal cost.

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Operator [21]

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Your next question comes from Craig Schmidt with Bank of America.

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Craig Richard Schmidt, BofA Merrill Lynch, Research Division - Director [22]

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I was wondering if you are seeing any impact on the level of international travel shoppers?

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Robert S. Taubman, Taubman Centers, Inc. - Chairman, CEO & President [23]

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If you're talking about really the Chinese shopper in the U.S., given all the tariff issues and all the regulations as it were about the -- China are putting in place on travel, we are seeing some of that, mainly in Los Angeles, but a little bit in Hawaii even though tourism generally in Hawaii is up. We're not seeing that issue in Florida, and I would say that tourism generally in San Juan has not yet returned. So there are all kinds of well-publicized issues around San Juan, but we're hoping that as we get to this holiday season and go into this tourist season for Puerto Rico in the first half of next year, then we will begin to see the return of the tourists there.

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Craig Richard Schmidt, BofA Merrill Lynch, Research Division - Director [24]

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Great. And then I hear your caution on the state of retail, but do you think store closings will be less in the next year relative to this year or similar?

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Robert S. Taubman, Taubman Centers, Inc. - Chairman, CEO & President [25]

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Well, it's a complete guess, and my guess would be less. There has been an awful lot of sorting out really in the last 3 to 4 years now. This is 4 years of big headwinds. And I think the narrative has really shifted. Great brick and mortar is where all the new tenants want to be and all the legacy guys that are focusing on their footprints, again they want to be very selectively in the best stuff. Omni-channel retailing has come forward and it should be really understood, and the need and desire of have brick and mortar is so clear. And it's all these digital guys that said they'd never have to store, all of them are raising capital in order to build stores, but their footprints aren't going to be in 1,000 locations. In very rare instances will they be like that. So my gut is that we've seen the worst, but it's been 3 or 4 years.

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Operator [26]

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Your next question comes from the line of Alexander Goldfarb with Sandler O'Neill.

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Alexander David Goldfarb, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research & Senior REIT Analyst [27]

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So 2 questions. First, with land and buildings. You guys -- obviously, you put out an announcement, there was a settlement, you paid some -- you telegraphed that there'll be some continued expenses for the balance of the year, but then it seem like you guys had settled like a cease-fire, but then they relaunched what seems to be a campaign for next year. So maybe if you could just highlight sort of: one, are they -- they got to bounce with their new approach? And then, two, just level of expense, because clearly getting involved with an activist, it's great for the lawyers, but obviously, it's a cost to the shareholders. So just sort of curious what you're budgeting? And what your thoughts are for the balance of the year? And is this something that we should expect for next year to impact numbers?

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Simon J. Leopold, Taubman Centers, Inc. - Executive VP, CFO & Treasurer [28]

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Alex, let's take the expense piece first. So we had a $12 million charge this quarter, and that included a $5 million settlement payment for cost reimbursement to land and building. As I know, you know, we knew about that payment when we had our first quarter call, we highlighted it to the investment community and we included it in our proxy. It's our -- it's GAAP requires us to take these expenses in the quarter in which they are incurred, which is why we didn't take it in the last quarter. So in addition to the $5 million payment, we incurred $7 million of expenses for professional fees and the like. That's on top of a $4 million charge in the first quarter. So you add those 2 together, taking out the $5 million settlement, we've incurred $11 million of expense to date. That compares to an annual average of $13.5 million in 2017 and in 2018 when we were in the midst of a proxy contest. We do expect a little bit of additional cost in the back of the year as some retention awards amortized and we finalized some payments to the advisers. But on the year, we don't expect the overall expense to be higher than in previous years. In fact, we think it'll be a bit lower. We don't guide on these expenses because they tend to be fluid, but remember we didn't proactively choose to have these expenses either. I can tell you that the total to date, since this really started in 2016, is $46 million, we think we'll likely end up at $47 million to $48 million.

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Robert S. Taubman, Taubman Centers, Inc. - Chairman, CEO & President [29]

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So, Alex, let me add. It is a huge amount of money, huge. And I can't make any comment about what land and buildings plans will be. So -- but we agree with you. It's a gigantic amount of money.

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Alexander David Goldfarb, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research & Senior REIT Analyst [30]

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Okay. And then second question. Simon, you talked about the NAV, you talk about where the stock is. Bobby, obviously, you know a lot of people in the industry, Forbes and others, with where the stock is. And Kimco in their call yesterday mentioned that there is money coming back in for portfolios. What are the thoughts of just going private or seeking to find people you sold to half of Asia, but looking at the company because clearly you could pay something probably inside of NAV and people get a bunch of malls for free and given where the market is, the market doesn't seem to be hearing any of the stuff that you guys are talking about as far as the upside. The market only seems to hear the negative. But from your tone and your guidance for the year, it sounds like you guys are very comfortable with the retail landscape potential closings and your ability to deliver on numbers. So what are your thoughts on maybe doing something privately?

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Simon J. Leopold, Taubman Centers, Inc. - Executive VP, CFO & Treasurer [31]

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Maybe I'll jump in first, Alex. Look, we've had a really good run as a public company over the last 27 years, call it, about 11% CAGR. It's clearly an excellent run. The last few years though, they clearly have been a challenge for retail landlord. There's no doubt about that. There are advantages just to be in public. I mean if you think about the Palm Beach, Gardens deal, we were able to buy an interest in an excellent asset what we think is a good price really because we have liquid partnership units and that was a key to getting that done. So that said, clearly there is an NAV gap. We talked about it in the prepared remarks. We're very focused on our share price here, we're very focused on strengthening the balance sheet, improving portfolio of quality and growing NOI in earnings. And we made a bunch of decisions recently that I think proved that, including the Blackstone deal on Asia and the acquisition of Palm Beach, which you just talked about. We're also growing our NOI nicely at about 5% a year and about the same thus far this year. Over time, we believe good decisions. These good decisions will have a positive effect on the share price and help close that NAV gap. The example that I used in the prepared remarks is really meant to highlight the deep discount in our trading price today as compared to the value of our assets. We think it's important that everybody knows about it. We think it's important to highlight that at this price with a yield of more than 6.5%, investors are being compensated away for a broader recognition of that value in the investment community. I think it's reality, but right now it seems to us that the widespread uncertainty about retail, in general, is winning over the specific reality of how we're doing with our performance and the quality of our portfolio. It's true today, but we don't think it's going to be true forever. And so that's sort of the context in which we think about going private. We do think there's some real advantage that we've been able to highlight. We're really fighting the good fight to grow the company and make the portfolio better and help fix the balance sheet.

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Operator [32]

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Your next question comes from the line of Shivani Sood with Deutsche Bank.

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Shivani A. Sood, Deutsche Bank AG, Research Division - Research Associate [33]

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We recognize that you guys have the highest quality portfolio in the U.S. Just given occupancy and where it is, can you give us a sense of if the vacancies may be impacting leasing conversations in terms of what tenants are willing to pay or even in terms of how these negotiations are progressing?

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Robert S. Taubman, Taubman Centers, Inc. - Chairman, CEO & President [34]

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Well, the occupancies are actually pretty good, and we're in a range of 95% our expectation for year-end and that's pretty good occupancy. And as I said, there is really strong demand that is in our portfolio, especially in our best asset. And we're seeing that demand that I talked about from the digitally native guys, the coworking industry now wants to be in our shopping centers. The luxury guys are doing very, very well, I mean, excellent across-the-board for luxury. Food is very strong and food continues -- the best food guys want to continue to expand their footprint. So -- we're at this point of the year, we're 96% finished on our budgeted leasing. It's complete. So we're very happy with where we are. When you look at bankruptcies, they were low in this quarter. When you think year-to-date, roughly 1.8% of our tenants went into bankruptcy. If you extrapolate that out, it would be about 3% for the year now -- 3% is a lot of tenants. And answering to Craig's question earlier, I do think that we've seen the worst of it. But 3% is not the worst we've ever seen. We've been keeping the statistic for 30 years, and it's been anywhere from 50 basis points up to 4.5%. So we said in the comments, we expect about 30-store closures out of the bankruptcies, which is about 100 basis points of occupancy, but we think we're going to backfill about 60% of that. So I feel like we're -- there is good demand and we're seeing it. And we are seeing average rent growth in the portfolio, which really is the key thing that we look at. It's really, is cash flow going to grow. And if your average rent grows then typically you're going to see good cash flow growth over time. So Shivani, I think we feel better than what you suggested.

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Shivani A. Sood, Deutsche Bank AG, Research Division - Research Associate [35]

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Okay.

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Robert S. Taubman, Taubman Centers, Inc. - Chairman, CEO & President [36]

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Shivani, another question?

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Shivani A. Sood, Deutsche Bank AG, Research Division - Research Associate [37]

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Oh, sorry. Yes. And then just with switching talks a bit, in terms of the Brookfield GGP Center expected to open at the end of this year, can you just comment on how that might impact your long-term thinking with regards to the hold of that center? Or just how you envision that going forward?

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Robert S. Taubman, Taubman Centers, Inc. - Chairman, CEO & President [38]

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Well, as we expected, we are facing challenges as SoNo does near its opening. We clearly expect that and performance is lagging the rest of the portfolio. If we took -- the center is less than 1% of the NOI. Our share of the income is less than 1%. But if we excluded it from comp center NOI growth, our overall NOI growth would have been 60 basis points better, just taking that one center out. So it is a situation that we're very focused on.

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Operator [39]

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Your next question comes from the line of Caitlin Burrows with Goldman Sachs.

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Caitlin Burrows, Goldman Sachs Group Inc., Research Division - Research Analyst [40]

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Simon, earlier in your prepared remarks, you mentioned the dividend and the dividend yield. So I was just wondering on this topic, how does management think about the dividend payout ratio in 2019? And what it should be going forward? And does that leave room for continued dividend increases?

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Simon J. Leopold, Taubman Centers, Inc. - Executive VP, CFO & Treasurer [41]

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Well, you never want to get in front of your Board when you talk about dividends, but I would say, in general, we're comfortable with the current level given our liquidity and given what we think are our upcoming capital needs. We're at our midpoint right now for the year, I think we're at about 73%. You'll remember that we were lower than that before we sold 7 centers to Starwood few years back, and we always expect that we will kind of grow into the payout ratio. So the ratio is a little bit higher this year because we did raise our dividend earlier and with slightly lower FFO, big piece of that was the new lease accounting standard, so really just accounting at the end of the day. Remind everybody again, we've increased our dividend 22x. We've never cut it. And like I said, you don't want to get in front of your Board. So we are comfortable at the level that we're at today.

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Caitlin Burrows, Goldman Sachs Group Inc., Research Division - Research Analyst [42]

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I guess so when you think about it in 2019 on a post -- do you think about it on a post-CapEx basis? And if so, I guess, how much do you think that increases from the 73% point?

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Simon J. Leopold, Taubman Centers, Inc. - Executive VP, CFO & Treasurer [43]

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Yes. I mean you're really getting the free cash flow in that point. We've said a couple of times that we expect free cash flow to be pretty sparse in 2019 and potentially in 2020. As we finish the Anseong development, we finish Green Hills this year and our tenant allowances are definitely up from what they've been in the past. But we do feel like we have ample liquidity to pay the dividend that we're paying today and to deal with capital going forward. We do expect that free cash flow will start to increase in 2020 and beyond and that, that payout ratio will come down as our AFFO grows really as a result at the end of the day of our ability to grow ransom, and we spend a lot of capital, which is starting to pay, no pun intended, dividends as well in terms of repair and grow our cash flows.

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Robert S. Taubman, Taubman Centers, Inc. - Chairman, CEO & President [44]

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And remember the Blackstone transaction is meant to reduce debt, and we've talked a long time that we would like to be under 8x and be in the 7s. And our stated policy is somewhere between 6 and 8x debt to EBITDA. So we're very focused on that. At the same time, the Board felt very confident to increase the dividend as it just did in the last quarter.

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Caitlin Burrows, Goldman Sachs Group Inc., Research Division - Research Analyst [45]

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Okay. And then maybe just on the occupancy side, you gave some good detail in Asia, how you had some, I think, pretty backfills coming in the second half of that Forever 21 space and similar for, I think, the U.S. space. You were talking about some backfills coming later this year. So I was just wondering if you could give some examples of who's refilling that U.S. in line space. And how you expect their rents to compare to those previous users?

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Robert S. Taubman, Taubman Centers, Inc. - Chairman, CEO & President [46]

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Well, I mean, it's really across-the-board. I mean it's a lot of -- I don't have ready examples, but I mentioned Fabletics, I mentioned some of the digital guys. I mean they're going into these spaces. These are the guys that want to take space right now. And so we -- I mean we mentioned a whole slew of tenants that are doing well right now. H&M is one example who is doing fantastic right now. So we're -- I mean, we can give you some more specifics offline, but we're very comfortable that we're going to backfill a bunch of the space that we've gotten back through the bankruptcies this year.

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Operator [47]

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Your next question comes from the line of Michael Mueller with JPMorgan.

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Michael William Mueller, JP Morgan Chase & Co, Research Division - Senior Analyst [48]

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So you have Anseong underway, you finished Green Hills. Curious how many new development starts or sizable expansions do you think you could announce over the next, call it, 5 years or so?

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Simon J. Leopold, Taubman Centers, Inc. - Executive VP, CFO & Treasurer [49]

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Mike, it's Simon here. It's very difficult to say what we can and can't start. I will say, it's important to emphasize, we are focused on the balance sheet. And we're clearly looking for ways to strengthen and opportunistically, the Blackstone transaction clearly does a lot. It helps by about half a turn on debt to EBITDA, gets us down in the low 8s and we want to get that down below 8, much more -- much closer to 7, if we can. After Anseong and as Green Hills is done, we are bringing Nordstrom's into Country Club Plaza. That's not a huge check, but we are doing that. We are still looking for developments that meet our very high hurdle rates in Asia as to how many we can identify and how many we can execute, it's really hard to say right now. In terms of other places, we'll allocate capital. We really are looking at our centers. We're looking at places where we might get a department store or 2 back where we can figure out ways to put accretive tenants in place. I think it's important to note on department store boxes that there are a lot of different ways to address those, some of which is -- in some cases, we will use our capital to do that. In some cases, it'll be capital that will end up being put in place by partners who are experts in some of the adaptive reuse side things like hotels, office, gyms or whatever ends up going in there. So there's a lot of options that we have for those going forward, but in terms of very specific new development starts, Asia really would be the focus and it's very hard right now to say what, if any, we identify they can meet our hurdle.

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Michael William Mueller, JP Morgan Chase & Co, Research Division - Senior Analyst [50]

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Got it. And then in your intro comments on the buy 2 assets, get 22 for free. Were you using the -- in that analysis, the actual debt on the assets as well as so it's more of an NAV of those 2 assets versus the overall enterprise value?

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Robert S. Taubman, Taubman Centers, Inc. - Chairman, CEO & President [51]

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Yes. There would -- in one case, there is mortgage. In other case, we're allocating a portion of the unsecured debt on a pro rata basis to it. So yes, there would be -- that would be the NAV after the debt, that's appropriate for those 2 assets.

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Michael William Mueller, JP Morgan Chase & Co, Research Division - Senior Analyst [52]

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Got it. And then any shot you could provide the combined 2018 NOI for those 2 assets since they are unidentified?

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Robert S. Taubman, Taubman Centers, Inc. - Chairman, CEO & President [53]

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No shot of providing that, but what I will say is that it's meaningfully less than half of our portfolio NOI in our share, meaningfully less. So in other words, you get a lot more NOI left over if you took those 2 out.

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Operator [54]

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(Operator Instructions) We do have a follow-up question from Christine McElroy with Citi.

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Michael Bilerman, Citigroup Inc, Research Division - MD and Head of the US Real Estate and Lodging Research [55]

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It's Michael Bilerman here with Christy. Simon, I was wondering if you can just spend a little bit more time just sort of unpacking this NAV differential relative to November '17? And I think you said, it went from 10 assets to 2 assets. Now the shift is only $600 million of effectively equity in that math, which, I guess, surprises me just from the standpoint of either of those top 2 assets have improved dramatically or much lower cap rates over those 18 months or something else happened with the other 8 because effectively 10 assets would have been at $47, 87 million shares, $4.1 billion of equity of NAV and at $40, it's $3.5 billion. So can you just help reconcile those 2 things?

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Simon J. Leopold, Taubman Centers, Inc. - Executive VP, CFO & Treasurer [56]

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Well, they are slightly different concepts. When we talked about it going back to November, we basically said, you would put a cap rate on 10 assets, take out all of the liabilities. So all the debt, all the preferred and then all you would have is pure NOI from the remaining assets as the value you're getting for free. Today's example was saying, take out the NOI of 2 assets, take out the debt related to those 2 assets and cap them, the NAV that remains is equivalent to today's share price. So you would then have the interest in 22 assets left with the liabilities that remain with those as well. And depending on what cap rate you put on those assets, they then have a remaining NAV that is very substantial to extremely substantial.

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Michael Bilerman, Citigroup Inc, Research Division - MD and Head of the US Real Estate and Lodging Research [57]

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Right. And I guess, consensus NAV is $80 or NAV is lower than that, but if we just look at consensus for a moment, right, $80, stock is at $40, so half off. Effectively what you're implying is 2 assets here are worth at a minimum half the company and if people think NAV is lower than the consensus NAV, those 2 assets are worth greater than 50% of the company.

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Simon J. Leopold, Taubman Centers, Inc. - Executive VP, CFO & Treasurer [58]

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I think what you just said is right. I agree with you. I will say that we've got at least a recent indication of what others think of as NAV when we did the -- when we acquired Palm Beach Gardens when the seller there accepted $83 as the NAV. I think today's consensus, however, you look at it is about $81 -- or $80 or $81 something like that. But, yes, I think everybody's got to determine what they think the right cap rates are for these assets in order to get there. But, yes, we are saying at least those 2 assets, the NAV on those are worth approximately the trading price today.

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Michael Bilerman, Citigroup Inc, Research Division - MD and Head of the US Real Estate and Lodging Research [59]

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So -- and I appreciate the color that you gave to Alex in terms of going private, and I respect the idea of being public and the benefits that provides you as you talked about the Palm Beach Gardens. So other than just telling potential investors or current investors, hey, we are cheap, and let me give you all the metrics and how you went through them. I guess, what else are you as a management team and this new Board thinking about from trying to narrow that gap? I know you did the Asia transaction, which was positive. You brought in Palm Beach Gardens, but what else are you going to try to do? And is the discussion of saying okay, 2 22 for free an indication that you are at least thinking about maybe some sort of split of the company sale of interest in certain assets to further delever and maybe buy back your stock at that point? I'm just -- I want to know, I guess, where is this current Board? And you've done a remarkable job at replenishing the Board of Directors. I recognize it was in part driven by some activism, but you've put a lot new people on. What are you -- what should investors expect as they go forward?

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Simon J. Leopold, Taubman Centers, Inc. - Executive VP, CFO & Treasurer [60]

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Michael, I'll take it first and then Bobby may want to jump in as well. We have been engaged with previous Board, but obviously with the newer version of the Board as well, very engaged with them. I'm thinking of ways that we can create value in the portfolio, ways that we can delever, ways that we can continue to grow cash flow, that's what we're focused on. We think we made a lot of good choices as we already highlighted that should over time close that NAV gap, and we're still looking. We're -- that's a conversation that we have on a regular basis with the Board about places where we continue to think that we can do things, make the right decisions, to try to get our share price closer to the intrinsic value of what we own. And we're going to be opportunistic about it and programmatic about it as well. We're going to look at places where if we have the opportunity to sell an asset that makes sense for us to sell, we will. If we think that there is a way that we can raise capital in a way that is -- that doesn't hurt us strategically and make sense for us, we will. Specifics around that, we won't -- I don't want to get in front of those -- any decision that the Board ultimately will be making. So we can't -- I don't think we can really talk specifically about it, but it is a huge focal point for us and we're going to keep doing what we're doing, trying to grow those cash flows, make the balance sheet better and make the portfolio better like we did with Palm Beach Gardens.

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Robert S. Taubman, Taubman Centers, Inc. - Chairman, CEO & President [61]

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So let me add, Michael, that the analysis was meant to inform investors. How we view the value of the company. There is an $80 range NAV consensus on us today. So obviously, people can look at that. We're in essence reaffirming what is being said about that NAV consensus that with very reasonable assumptions, very much in today's market, we believe that there is a lot of value in this company. It is about making good decisions. Blackstone was a good decision. Palm Beach Garden was a good decision. It may be a good decision to find a joint venture partner some place out. We certainly think that we will make that kind of a decision in Anseong once the center is built by bringing Blackstone in, it gave us the flexibility to allow to own the 49% of Anseong through the development period in a project that we believe very strongly, and at that point, recognize value with retail, not in wholesale. So we're going to keep trying to make those decisions. We're very engaged with our Board. We're thrilled with the Board that we have with us today. So again, it's an analysis, it's meant to inform and show how we are thinking about the NAV and its importance.

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Michael Bilerman, Citigroup Inc, Research Division - MD and Head of the US Real Estate and Lodging Research [62]

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Right. And I think if you were to go back to some of these what-if scenarios, if you hadn't sold those assets to Starwood, right, the pricing you ended up getting relative to where those assets probably would have been priced today would have been a lot different, right? So in hindsight even though at the time the market hadn't appreciated the true cap rate of those assets, are you being higher for where your stock was trading, you end up being a very positive transaction, especially looking back on it today. So I asked that the question in relation to -- as you think about the 22 asset portfolio, is there ways -- is there a financial engineering of splitting the company in 2 that makes sense? Or is that just a very low probability? Or it sounds like maybe doing a joint venture or selling assets is more the route that you would go versus trying to hive off different parts of the 22 asset portfolio today?

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Robert S. Taubman, Taubman Centers, Inc. - Chairman, CEO & President [63]

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First of all, I'd like to say that we were criticized at the time that we made the Starwood transaction that we didn't do well enough with it. And so I appreciate you bringing up that the market's view at that time was skeptical of what we were doing. We do look at everything, right, and the idea of sort of splitting the company, it would be very complicated. But having said that, we look at everything. And as I said, with the analysis was meant to inform and we are focused on trying to find ways to bridge this gap.

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Michael Bilerman, Citigroup Inc, Research Division - MD and Head of the US Real Estate and Lodging Research [64]

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And I appreciate all those comments. Just last question. When you did the agreement with land and buildings to pay off the cost, was there not a non-disparagement agreement that was part of that to sort of have a little bit of truce for a period of time?

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Simon J. Leopold, Taubman Centers, Inc. - Executive VP, CFO & Treasurer [65]

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We really have said, what we're comfortable saying in the proxy and publicly at this point, Michael. So I don't think we're really going to comment further than that.

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Michael Bilerman, Citigroup Inc, Research Division - MD and Head of the US Real Estate and Lodging Research [66]

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So you did not have that as part of your agreement? It's typically you would -- typically, in those settlements as usually at least 6 months, 9 months, 1 year sort of don't go just -- bare just in the public market sort of let us do -- we just put this together in this Board. We're doing all these things, give it a break type of thing.

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Simon J. Leopold, Taubman Centers, Inc. - Executive VP, CFO & Treasurer [67]

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I think we said what we're going to say, Michael.

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Michael Bilerman, Citigroup Inc, Research Division - MD and Head of the US Real Estate and Lodging Research [68]

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Is that part of the extralegal costs in the quarter, this $12 million versus the $5 million?

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Simon J. Leopold, Taubman Centers, Inc. - Executive VP, CFO & Treasurer [69]

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It was a $5 million payment to land and buildings as part of reimbursing them for their costs. That was part of the $12 million total for the quarter.

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Michael Bilerman, Citigroup Inc, Research Division - MD and Head of the US Real Estate and Lodging Research [70]

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And the $7 million relates to what then?

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Simon J. Leopold, Taubman Centers, Inc. - Executive VP, CFO & Treasurer [71]

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Professional fees, advisers, a lot of different things, but typical in an active situation, particularly with the proxy contest with the threat of one.

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Robert S. Taubman, Taubman Centers, Inc. - Chairman, CEO & President [72]

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And, Michael, as we said earlier, it's pretty consistent with the last 3 years in terms of what the spend is taking the $5 million out. And frankly, this year will probably be slightly less than it was last year or the year before.

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Michael Bilerman, Citigroup Inc, Research Division - MD and Head of the US Real Estate and Lodging Research [73]

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That's $0.50, $0.60 of NAV, unfortunately?

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Robert S. Taubman, Taubman Centers, Inc. - Chairman, CEO & President [74]

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It's a huge amount of money, and it is not with impunity that these battles occur that sometimes get encouraged by others.

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Operator [75]

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At this time, I'm not showing any further questions. You may continue for any closing remarks.

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Robert S. Taubman, Taubman Centers, Inc. - Chairman, CEO & President [76]

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Thank you very much, all. We look forward to seeing you and go look at Beverly Center when you get out to LA in the fall. Thank you, everyone. Bye-bye.

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Operator [77]

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Thank you for joining the Taubman Centers' Second Quarter Earnings Conference Call. Have a great day. You may now disconnect.