AMB’s headquarters complex,
Pier 1 in San Francisco
The expectation is that the combined customer relationships, land banks, and financial resources will give the combined ProLogis and AMB a leg up on a lot of its competition as it endeavors to expand its building portfolio.
It might not be the biggest real estate investment trust (REIT) merger ever, but as combinations of publicly traded industrial real estate owner/operators go, the deal joining global powerhouses ProLogis and AMB Property Corporation is quite a doozy.
The $5.7 billion all-stock, tax-free transaction expected to close in the second quarter creates a true warehouse behemoth, as would be expected when the two biggest public industrial real estate players join forces. If the merger goes through as planned—and there is little doubt it will—the combined portfolio of the New York Stock Exchange–traded companies will approach 600 million square feet (56 million sq m) of floor space spanning 22 countries on four continents.
The gross value of assets owned and managed by the combined company, including private equity funds it will manage, amounts to roughly $46 billion. And as ProLogis CEO Walt Rakowich and his AMB counterpart Hamid Moghadam noted in announcing the merger agreement in late January, the company—which will retain the ProLogis name and PLD stock symbol—will have operations in markets representing about 78 percent of global gross domestic product.
“As global demand picks up and trade activity returns to more robust levels, we believe our combined footprint and capabilities will allow us to better meet the real estate needs of our global customers and drive future growth,” Rakowich commented in the post-announcement conference call.
The rationale behind creation of such a global giant appears to be far-reaching as well. Analysts who follow the companies and their industries are mostly quick to acknowledge that combining forces at this point in the global real estate and economic cycles seems to be a sound strategy. Occupancy in the domestic industrial property sector appears to have started growing again sometime last summer after nearly three years of negative net absorption, and Colliers International projects positive net absorption averaging 50 million square feet (4.6 million sq m) per quarter this year.
Cargo trade—a critical factor underlying demand for ProLogis and AMB properties—is likewise rebounding at a decent clip. While 2010 was not exactly a stellar year for the global economy, container volume at the Port of New York and New Jersey rose 16 percent from 2009’s slump. And the rebound was even stronger on the Pacific Coast, with volume at the twin ports of Los Angeles and Long Beach up nearly 20 percent.
Therefore, the combined ProLogis and AMB portfolios seem well-positioned to increase “same-store” operating incomes as occupancies recover, presumably followed by strengthening of effective rental rates. The expectation is that the combined customer relationships, land banks, and financial resources will give the new ProLogis a leg up on a lot of its competition as it endeavors to expand its building portfolio as well.
The combined geographic footprint likewise appears to complete the respective strategic ambitions of each management team. San Francisco–based AMB is already active in Brazil and China, where ProLogis cannot yet meet client needs, and Denver-based ProLogis has holdings all over eastern Europe, where AMB had long planned to expand when conditions were right. Factor in significant cost-saving administrative synergies expected under a single corporate umbrella, and the result should be an efficient and formidable cash flow machine within two to three years.
“This appears to be the rare merger where one plus one equals more than two,” concludes the industrial REIT research group at Green Street Advisors in Newport Beach, California.
Both CEOs are enthusiastic about development opportunities ahead and about ongoing income-generating prospects of the combined company’s large and diverse fund management operations. “We will be in a great position to offer our private capital partners a wide range of industrial funds, both geographically and from a risk/return perspective,” Rakowich says. The combined advisory operations manage assets valued at $25.7 billion through 19 co-investment ventures.
But Rakowich, Moghadam, and associates are particularly optimistic about near-term opportunities to boost same-store net operating income by filling currently vacant space. “Everything really pales in comparison to the opportunities to grow rents in the operating portfolio,” Moghadam says. In fact, occupancies in both companies’ portfolios are already on an upswing, with each improving by roughly 100 basis points during the fourth quarter; AMB’s overall revenues were up nearly 2.5 percent last year.
Increasing the combined current portfolios’ overall occupancy rate by another 300 basis points over the course of a recovery would likely boost rental revenues by perhaps another $15 million or so—every month. Moghadam estimates that as space demand recovers, the company likely will invest about $2.5 billion annually in expanding the portfolio through new build-to-suit (in particular) and speculative developments.
The merged company will be exceptionally well-positioned to capture build-to-suit development projects in key markets, including high-growth emerging markets China and Brazil, suggests Steven Frankel, Green Street industrial research manager. “Development will become more important in the future, and in the global big-box development business, bigger is indeed better.”
The CEOs also emphasize that eliminating duplicative operations and offices will soon pare the current combined annual overhead figures by about $80 million—and that may well be a conservative estimate. Frankel, in fact, says he would not be surprised if the management team is ultimately able to achieve $100 million in annual overhead efficiencies, “although it will likely take a couple of years to realize the full potential,” he says. Green Street’s research identifies opportunities to combine 22 duplicative ProLogis and AMB offices. “That’s a lot of overlap,” Frankel says.
Whether the transaction is really a merger of equals, as both management teams insist, is more a matter of debate. Ross Smotrich and his analyst colleagues at Barclays Capital in New York City, for various reasons, tend to view the deal as an AMB acquisition of ProLogis, notwithstanding the fact that ProLogis shareholders at closing will own 60 percent of the combined company.
AMB CFO Tom Olinger
The planned management team certainly appears to reflect those sentiments. Moghadam will take over as sole CEO when Rakowich retires as co–chief executive at the end of 2012. Likewise, AMB’s Tom Olinger will become sole chief financial officer when his current ProLogis counterpart Bill Sullivan retires at the same time. AMB’s veteran institutional investment manager Guy Jacquier will oversee the combined fund management operation.
Moghadam plans to continue running the show from a standard cubicle at the current AMB bayfront headquarters atop San Francisco’s redeveloped Pier 1. Strategically located Denver will serve as operations headquarters for the combined business.
Although ProLogis has a far larger portfolio than AMB—435 million versus 160 million square feet (40 million versus 15 million sq m)—and equity capitalization of $8.22 billion versus $5.65 billion for AMB as of mid-March, AMB for now is more efficient at churning out funds from operations. For 2010, AMB generated $1.22 per share in core funds from operations (FFO) on revenues of $633.5 million, compared with 57 cents a share on $909.2 million in revenues for ProLogis.
AMB’s strong-performing advisory group has also been far more active in raising new equity for its latest Mexico, Brazil, and China investment funds, securing $1.4 billion in commitments last year, followed by another $1 billion in the first quarter alone.
Barclays projects that AMB would likely be nearly twice as profitable on a per-share basis than ProLogis again this year if the two companies remained separate—$1.31 per share of core FFO and another 9 cents in net development profits, versus 64 cents plus 13 cents in development profits for ProLogis.
One obvious reason for the difference is that AMB’s portfolio-wide occupancy rate bests ProLogis’s by 270 basis points—93.7 percent to 91.0 percent. Taken together, it is no surprise that Wall Street sees greater value in AMB’s income stream: its shares have been trading in the mid-$30s lately, compared with the midteens for ProLogis.
In addition to challenges inherent in integrating large merging companies and corporate cultures, Frankel also cautions that the combined operations initially will carry more debt than Wall Street has traditionally recommended for REITs. He cites the companies’ blended leverage ratio of 56 percent—meaningfully higher than the 47 percent REIT average.
While Moghadam and Olinger expect leverage to decline gradually as FFO gains and development projects become operating properties, Frankel suggests that meanwhile ProLogis will not be able to borrow at interest rates quite as low as those obtained by certain REITs with the best-positioned balance sheets.
ProLogis and AMB properties in Japan sustained only modest damage in the recent earthquake and tsunami, Frankel notes, but says the better news is that their generally strong performance will tend to attract tenants from Japan’s many outdated structures. “Replacing obsolete stock is a major opportunity driver there, which the tragedy will only accelerate,” he says. “Inevitably trade will continue; goods will still need to be stored.”
Frankel likewise observes that while ProLogis will stand out as a huge player, its market share is not that relevant in a warehouse/distribution real estate sector that remains highly fragmented. He notes that the combined AMB and ProLogis operations will not control even a 5 percent share of any major U.S. market.
Moghadam is quick to acknowledge the limits of ProLogis’s future scale. “We’re not kidding ourselves; we’re not going to be dominant in anything,” he said during the conference call. “We’re still going to have to be quick and scrappy, work hard, and fight for every piece of customer business we can get. It’s not about being big. It’s about being the best, being agile, making decisions quickly, and moving forward to take advantage of the tremendous opportunities this market offers us at this inflection point.”