A Deal That's Looking Dubiouser And Dubiouser

Frank J. Pasquerilla likes to make a big impression. The $27 million headquarters of his Johnstown (Pa.)-based Crown American Corp. was designed by postmodern architect Michael Graves. It features a massive rotunda and a pyramid housing the executive offices. Soon, the 66-year-old Pasquerilla, patriarch of one of the nation's largest private hotel and shopping center developers, hopes to operate on an even grander scale. He wants to transform Crown American into the largest equity real estate investment trust (REIT) that Wall Street has ever seen. In August, with the help of investment banking firm Kidder, Peabody & Co., Crown American hopes to float an initial public offering that it anticipates will raise at least $400 million, enabling it to reduce its burdensome debt load and assuage nervous lenders.

But Pasquerilla may find the Wall Street environment less welcoming than Johnstown. Although the road show discussing the deal with prospective investors hasn't started and the deal hasn't been priced, several analysts have raised questions about its properties, management, growth prospects, and potential conflicts of interest. "It's a very curious deal, and everyone is scratching their heads and saying, `How is Kidder going to do it?"' says Barry Vinocur, editor of the Realty Stock Review in Shrewsbury, N.J.

BAILOUT? Crown American isn't the only REIT offering that's raised controversy recently. REIT stocks have been highfliers for the past two years. But concern is growing on Wall Street that deals in the pipeline are more akin to bailouts for developers and their creditors than good investment opportunities. If the Crown offering doesn't fly, the company's financial troubles could intensify. The reputation of lead underwriter Kidder Peabody, which hopes to make its mark in the REIT arena with the Crown deal, is also on the line. Kidder and Crown American, citing Securities & Exchange Commission rules barring promoting a deal in registration, declined to comment. But sources close to the deal say the soon-to-commence road show may quell some critics' concerns.

The late 1980s weren't good times for Crown. As a result of overbuilding, overleveraging, and a weak economy, the company lost money the last three fiscal years and went through a debt restructuring with bank creditors in August, 1991. A number of the anchor tenants in its enclosed shopping malls filed for bankruptcy within the past five years. The list of its mall anchors reads like a Who's Who of retailers with financial woes: Ames Department Stores, which recently emerged from bankruptcy, Hills Department Stores, Phar-Mor. Currently an anchor at 15 of the malls, Hess's Department Stores recently left bankruptcy court after completing a debt restructuring with creditors.

Many of the worries about the Crown American offering center on the fact that Crown, which will have a 40% interest in the REIT, owns 100% of Hess's. "Even if Hess's were a healthy retailer, it would probably be a problem," says Vinocur. "It puts Crown American into a position where one of its largest tenants is itself. It's a lot like negotiating with yourself for a pay raise." The company has tried to allay such fears with provisions such as one requiring that "a majority of the REIT's independent trustees unaffiliated with Crown must approve transactions involving Hess's, including new leases," as the deal's prospectus puts it. Skeptics can question how independent the trustees will be. One will be Clifford A. Barton, president of U.S. Bancorp in Johnstown until his retirement in January, 1994. Frank Pasquerilla is a director of U.S. Bancorp and is a beneficial owner of 1% of the company's stock. U.S. Bancorp is also a "co-trustee under certain trusts which hold nonvoting stock of Crown American," notes the prospectus. Barton could not be reached for comment.

ANCHOR QUALITY. Some analysts worry about Crown's business prospects. "The biggest issue isn't the conflict with Hess's but the quality of anchors," says Jon Fosheim, one of two principals at Green Street Advisors, an institutional REIT research firm in Newport Beach, Calif. While the average sales per square foot for Crown's anchors was $138 in 1992, the one Wal-Mart anchor had $349 in sales per square foot. And while Crown has recently begun adding Wal-Mart Stores Inc. anchors to its malls, Wal-Mart is also a strong competitor on Crown's home turf. "A lot of their properties are in Pennsylvania, and Wal-Mart is moving into this area for the first time in a major way," says Vinocur.

Analysts say the outlook for cash flow growth is troubling. "We think on the one hand that the assets are pretty solid, that the company knows what it's doing, but there isn't tremendous growth" in Crown's middle-to-lower-middle market niche in Pennsylvania, says Frederick F. Carr Jr., a principal at the Penobscot Group Inc., a Boston-based real estate research firm. He doesn't expect occupancy rates to rise dramatically. Crown's older malls are now 84% occupied, and those recently constructed are 66% leased. Crown's relatively low occupancy rates may weaken its leverage when it tries to raise the below-average rents of tenants, which is part of its growth plan.

The most crucial element in any REIT is management. "They're pretty good people, and that's where you start," says Michael T. Oliver, portfolio manager for the Chicago-based PRA Real Estate Securities Fund. Analysts question the depth of Crown's management, however, and are somewhat uneasy with Mark E. Pasquerilla, 34, who has been with the company since 1983 and will be president of the REIT. "Whenever you have a dominant family patriarch, succession is always an issue," says Fosheim. "With the Pasquerilla deal, I think management is an issue. Mark never spent the time in the trenches that Frank has." Responds an analyst who has close ties to the company: "Mark is a guy who is on top of everything. He has a tremendous grasp of the issues and the numbers." But,he adds, "people who have seen themanagement think that Frank is more polished and has more vision than Mark."

Management becomes even more critical because Crown's REIT is structured as a partnership. That can lead to a conflict of interest. Under the tax laws, it may be in the REIT partners' interest to avoid selling its properties, thus incurring substantial taxes. Yet it may well be in the interest of REIT shareholders to unload poorly producing properties.

Crown's road show, scheduled to begin July 19, may alleviate some anxieties. But selling $400 million worth of stock to what appears to be a growing band of skeptical institutional buyers won't be easy. Pulling it off would indeed be a crowning achievement.

      SHAKY TENANTS Several of Crown American's mall anchors, including Hess's 
      Department Stores, are experiencing financial difficulty. Four chains with 10 
      anchor stores have filed for bankruptcy over the past 5 years.
      POTENTIAL CONFLICT OF INTEREST Crown owns Hess's, which will be one of the real 
      estate investment trust's largest tenants. Analysts worry that could influence 
      leasing decisions.
      CONTROVERSIAL DEAL STRUCTURE The REIT's managers contributed all of its 
      properties in return for interests in the REIT. For tax reasons, the managers 
      might be loath to sell properties even though that might benefit investors.
      DEPTH OF MANAGEMENT Crown CEO Frank Pasquerilla, 66, is a longtime developer, 
      but analysts say son and heir apparent Mark Pasquerilla, 34, lacks hands-on 
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