Corrected and Updated: Feb. 17, 2010, 8:32 A.M. Major holder corrected from Barclays Capital to BlackRock Global Investors. Link to General Growth's response added.

Simon Property Group Inc. dropped a bombshell in announcing this morning that it has made a $10 billion offer to acquire General Growth Properties Inc.

Simon, the Indianapolis-based REIT with the largest portfolio of malls in the U.S., issued a detailed release early Tuesday morning saying that it had made a written offer to acquire Chicago-based General Growth Properties Inc. in a fully financed transaction valued at more than $10 billion, including approximately $9 billion in cash. The firm sent a letter to General Growth on February 8, to which it got no response, along with a follow-up letter dated today. (The full texts of both letters can be viewed at this post.)

Simon’s offer would guarantee General Growth’s unsecured bondholders a “100 percent cash recovery of par value plus accrued interest and dividends.” Simon estimates this consideration to be worth approximately $7 billion. In addition, General Growth’s shareholders would receive more than $9.00 per share, consisting of $6.00 per share in cash and a distribution of General Growth’s ownership interest in the Master Planned Community assets valued by General Growth at more than $3.00 per share. Simon is also prepared to offer Simon common equity instead of the cash consideration, in whole or in part, as payment to those General Growth shareholders or creditors who would prefer to participate in the upside of owning stock in Simon. Under Simon’s offer, the existing secured debt on General Growth’s portfolio of assets would remain in place.

Simon executives declined to comment on the offer directly, referring inquiries to the press release.

According to Simon’s release, “The Official Committee of General Growth’s Unsecured Creditors has advised Simon that it supports the Simon offer, and encourages General Growth to engage with Simon promptly to allow the proposed transaction to be considered by General Growth’s creditors and shareholders as soon as possible.”

“Simon is in the unique position of being able to offer General Growth creditors and shareholders full, fair and immediate value. Our offer provides much-needed certainty to conclude General Growth’s protracted reorganization process. We are confident it is the best option for all General Growth constituencies and far superior to any other third-party proposal or stand-alone plan that could be completed,” Simon Chairman and CEO David Simon said in a statement.

Tuesday night, General Growth responded to Simon with a letter of its own. The letter explained that General Growth is still exploring its options in maximizing value from shareholders.

According to the letter, General Growth is "about to commence a process to explore several potential options for the Company’s emergence from Chapter 11, including a sale of the entire Company." It plans to finalize the information memorandum and to send materials to participants in the process by the beginning of March.

Simon would not pursue the transaction alone. In its statement, the firm said the transaction would be financed through cash on hand and through equity co-investments in the acquisition by strategic institutional investors, with the balance coming from Simon’s existing credit facilities. It also has told analysts that it would partner with an institutional investor in any deal that takes place.

The deal would be a huge coup for Simon and leave it with a mall portfolio vastly overshadowing any other player in the U.S. Absorbing General Growth wholesale would leave Simon Property Group controlling more than 400 million square feet of retail real estate in the U.S.—more than twice as much as the second largest firm and more than four times as much space as the next largest mall owner.

“Anytime you can add malls to a portfolio you create more leverage with the tenants,” says Rich Moore, a REIT analyst with RBC Capital Markets. “This would be a big deal for Simon—a chance to add high-quality assets to their already high-quality portfolio.”

Industry observers, however, think a deal is unlikely to proceed on the terms Simon has outlined. Instead, many believe Simon is trying to pressure General Growth into accepting an acquisition offer that does not accurately reflect the REIT’s value. Since in a bankruptcy proceeding unsecured creditors generally get paid before common shareholders, creditors who are afraid they might lose their investment can sometimes force a bankrupt company to accept a bid that undervalues its stock, notes Todd Sullivan, a Massachusetts-based investor and author of the Value Plays blog. General Growth’s unsecured creditors, however, face no such danger in his opinion.

“I think the chance of a sale based on this offer is zero,” Sullivan says. “It values the equity at about 30 percent below its [market] price on Friday. I think Simon is just throwing an offer out there and seeing if it sticks because I can’t fathom a scenario in which management seriously considers it.”

If General Growth does reject the offer, there is a possibility it might bring in a joint venture partner to help it pay for the acquisition, says Bernard J. Haddigan, senior vice president and managing director of the national retail group with Marcus & Millichap Real Estate Investment Services. He notes that any number of Simon’s largest shareholders, which include investment firm Vanguard Group Inc. and BlackRock Global Investors, might be willing to help Simon buy General Growth.

“They’ve got a deep bench of investors who are very, very invested in Simon and have an interest in seeing their portfolio grow,” he notes.

General Growth’s stock (GGWPQ), closed trading Friday at $9.40 per share on the over-the-counter market. In addition, in the wake of Simon’s announcement, the stock has shot up to nearly $12 per share. William Ackman, founder and CEO of hedge fund Pershing Square Capital Management, owns a big stake in General Growth and sits on the company’s board and in December issued a presentation that argued that General Growth should be valued at between $24 per share and $43 per share.

In addition, although General Growth’s unsecured debt holders would be made whole in this deal, they may not feel pressured to green light just any offer. Simon itself owns an undisclosed amount of unsecured debt. Moreover, Canadian asset manager Brookfield Asset Management Inc. owns about $1 billion and Bruce Berkowitz, president of securities investment firm Fairholme, purchased $500 million of the company’s unsecured debt, including $394 million in convertible bonds, a $110 million tranche loan and $94 million in Rouse bonds.

The $6 billion in unsecured debt on its books is a critical component in General Growth’s continued restructuring. The firm recently brought in Swiss investment bank UBS as a new financial advisor and asked the bankruptcy court for a six-month extension in presenting its reorganization plan. The moves appear to be aimed at increasing the company’s chances of raising enough equity from traditional real estate investors to forgo a large debt-for-equity swap. And that would enable the REIT to avoid outside takeover bids and exit Chapter 11 bankruptcy protection as an independent entity.

To date, General Growth has completed the restructuring of 74 secured mortgages totaling $9.4 billion. Coupled with previously completed transactions, General Growth has dealt with almost all of its secured debt. It has just 16 loans totaling $2.1 billion that still need to be restructured: a process that, according to the company, will be done in the next few weeks.

Lazard Ltd., J.P. Morgan and Morgan Stanley are acting as financial advisors to Simon and Wachtell, Lipton, Rosen & Katz is serving as legal advisor.

–David Bodamer & Elaine Misonzhnik