Elsewhere: How a Glitzy Mall Developer Built Its Way Into Big Trouble

Larry Siegel, its 52-year-old chief executive, was credited with injecting new life into the nation's tired mall industry. His "shoppertainment" retailing formula offered customers more than just stores. There was glow-in-the-dark miniature golf, simulated Nascar driving and dining in faux rain forests. His staid competitors took notice.

But now Mills, a real-estate investment trust based in Arlington, Va., is drawing attention for different reasons. Its recent developments have largely been flops. One in five employees has left or been laid off, including its development director, raising doubts about whether it can finish the projects it hasn't already abandoned. Last month, the Securities and Exchange Commission launched an investigation into its accounting practices. Its stock has plummeted 55% over the past eight months. On Wednesday, its lenders forced it to slash dividend payouts and to submit biweekly financial reports while it readies itself for a likely sale.

Mr. Siegel stumbled during one of the hottest real-estate markets in years by pushing into markets that were either too small or too competitive to support the company's mammoth malls. Mills compounded its problems, say investors and analysts, by focusing more on development than on managing its existing properties. Its current struggles raise questions about whether its unique and expensive approach to retailing can survive.

"I think their projects are the most creative of any developer out there," says Warren Weiner, executive vice president of Philadelphia-based Deb Shops Inc., which has 340 teen fashion stores nationwide and six in Mills properties. "The question is: Is it possible to be that creative and be financially successful?"

Mills, which has 42 malls in the U.S. and abroad, has said it is exploring "strategic alternatives," but declines to elaborate on disclosures it has already made about its current financial troubles. Mr. Siegel declined to be interviewed for this article.

In recent years, mall companies have performed well as consumers continued to spend despite recession, terrorism and the war in Iraq. The nation's major mall developers -- now big public companies mostly run by the scions of the original mall magnates -- expanded primarily by buying other mall companies.

Mr. Siegel decided to expand by building new properties. A balding, gregarious Philadelphia native, he got his start in retailing as a leasing agent for a predecessor company of Mills, and ascended to the chief executive position shortly after Mills went public in 1994.

Mr. Siegel saw most malls as ho-hum rectangles with four large anchor stores. The outlet malls that came in the 1980s and '90s, which carried name brands at discount prices, often offered no place to eat or sit down. Mr. Siegel decided to marry two concepts: to build full-service malls with food courts and even massage zones and skateboard parks, then fill them with outlet retailers.

He wasn't the only mall developer to explore ways to combine retailing and entertainment. The Simon family of Indianapolis and Sheldon Gordon of Greenwich, Conn., were also moving in that direction. But Mr. Siegel became one of its most enthusiastic proponents.

He pursued retailers not typically found in malls, such as Bass Pro Shops, which offers a 60,000-gallon aquarium and an archery range along with its outdoor supplies. Mills was one of the first mall companies to offer prominent space to IMAX theaters instead of sticking movie theatres in an unused corner of the parking lot, says Paco Underhill, who runs a New York-based retail consulting firm, Envirosell Inc., and has written about the mall industry.

Shoppers flocked to Mills's early projects, such as Potomac Mills near Washington, D.C., and Sawgrass Mills outside Fort Lauderdale. So Mr. Siegel picked up the development pace. After building just four large malls between 1985 and 1995, over the next decade Mills built 13 malls and converted two more to its shoppertainment formula.

Mr. Siegel planned on an especially large scale. Mills's properties typically sprawl over about 1.5 million square feet, compared with about 1 million square feet for other major regional malls. At its enormous Xanadu project now under construction in the New Jersey Meadowlands, the company spent some $120 million or more before it even won the right to develop the site, analysts estimate. Mills promised an indoor ski slope, a roller coaster and a 300-foot-tall Ferris wheel.

More Vulnerable

While a typical large mall draws customers from a 10- to 20-mile radius, many Mills malls are so big they need to draw from a larger area to attract enough customers. As a result, Mills became more vulnerable to new competitors, including outlet centers, discount stores and the hot new model -- open-air "lifestyle centers," which adhere to a "Main Street" approach, with stores opening onto a street, says Steven H. Gartner, president of Metro Commercial Real Estate Inc., a Conshohocken, Penn., retail consultant. And high gas prices made shoppers less willing to drive long distances for a deal on a pair of blue jeans.

To stand out from the crowd and draw traffic, Mills began adding more entertainment components. But the entertainment offerings took away valuable retail space, pushing down average sales per square foot at the properties.

All along, Mills had been attempting to lure more shoppers by allotting more space than a typical mall does to anchor tenants, which usually pay lower rent than smaller specialty stores and post lower sales per square foot. As a result, Mills's properties brought in an average of about $370 of annual sales per square foot in 2004, below the average for regional mall REITs.

Its aggressive development mentality rendered the management of its existing properties a second priority, analysts say. "They focused more on the next great development and less on continuing to run the properties they had and [getting] the full values out of those properties," says Rich Moore, an analyst with New York-based RBC Capital Markets.

Mills took on projects in Singapore, Madrid and Scotland in an effort to become a global REIT. In the U.S., it was becoming difficult to find large new markets where the Mills concept would still be novel. Mills pushed into the outskirts of the Pittsburgh and St. Louis markets, which already had quality malls and didn't have enough demand to support newcomers. Last year, in Pittsburgh, Mills resorted to its first-ever "soft opening," starting operations without a big marketing campaign due to a low number of retail tenants.

Mills's growth plans began to outpace its ability to finance new projects, forcing the company to borrow more and enter into joint ventures that gave its partners preferred returns. Mills had little margin for error in its developments. The company's ratio of debt to market capitalization reached 72%, compared with 53% for the average regional mall REIT, according to Harris Nesbitt, the U.S. research and investment-banking subsidiary of Toronto-based BMO Financial Group.

Newer projects struggled. In Lakewood, Colo., Mills had projected Colorado Mills to have annual sales of about $300 million. The mall, which opened in late 2002, so far has generated average annual sales of $215 million, says city spokeswoman Stacie Oulton. The expected $4.5 million in annual sales taxes from the mall has averaged only $3.2 million, she says. Malls in St. Louis and Cincinnati also fell short of company projections.

Over the past decade or so, malls built by Mills have earned the company about 20% less than it projected, estimates Greg Andrews of Green Street Advisors, a Newport Beach, Calif., real-estate research firm.

Some investors and analysts became skeptical of Mr. Siegel's promises. "Larry, he is a salesman," says Dionisio Meneses, an investment manager with Global Real Analytics LLC in San Francisco, which holds an undisclosed number of Mills shares. "You have to discount some percentage of what he says."

The SEC investigation begun in March has added to the uneasiness of investors. Company filings indicate about a dozen areas of accounting are under review, including revenue recognition, lease accounting and cost capitalization. Mills capitalized its pre-development costs to spread them over several years, for instance, rather than expensing them all at once like most real estate companies do. Mills says it may have to restate six years of financial results.

Investors and analysts have also expressed frustration over company disclosure about joint-venture deals with partners, saying a lack of details makes it difficult to accurately value the company's assets.

As its problems mounted, Mills faced increasing competition from other companies pursuing similar strategies for merging retail and entertainment. Rajendra Sisodia, a professor of marketing at Bentley College in Waltham, Mass., notes that there are now IMAX theaters in a chain of furniture stores in the Boston area.

New Formulas

Moreover, new retail formulas are gaining popularity. Mr. Gartner, president of Metro Commercial, a Philadelphia-based retail consultant, contends that "the behemoth mall is clearly giving way to more manageable, accessible and open-air centers."

"It isn't that the huge center doesn't have a future. It's just that it's no longer a slam-dunk proposition that it used to be," says Mr. Underhill, the retail consultant. "The shopping malls that are being built in the U.S. now are being built basically to steal other people's markets."

The pact Mills struck with its lenders earlier this week makes it likely that the company will be sold, analysts and investors say. Some assets are expected to be coveted by competitors. The bank deal included a refinancing of Sawgrass Mills that valued that property alone at $780 million. "Sawgrass is 10% of the value of this company," says David Fick, an analyst with St. Louis-based Stifel Nicolaus who was once Mills's chief financial officer. "It's worth more than all their bad stuff combined, times three."

Many of its competitors, including Simon Property Group Inc. of Indianapolis and Vornado Realty Trust of New York, are taking a look at the company, which owns 51 million square feet of property in the U.S. and abroad.

"The issue that somebody's going to have to decide is: Does the model work or not?" says David Lichtenstein, owner of Lightstone Group, Lakewood, N.J., one of the largest private owners of real estate in the U.S., who says he intends to bid. "I think the buyer is going to have to be convinced that Larry Siegel's dream can become reality and not a nightmare. He's an absolute visionary. But very often the first visionary isn't successful."