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At the start of the year, I believed that shares of Public Storage (NYSE:PSA) were still valued a bit rich in order to provide a storage of wealth. As one of the larger self-storage REITs, Public Storage has a solid long term track record.
Being observant of these qualities, I feared that momentum has been a bit too strong amidst slower economic growth and a potential reversal of pandemic-induced trends which boosted demand for self-storage.
Back To January
Founded in the 1970s, Public Storage owns and operates thousands of buildings which in total encompasses millions of garages let out to over a million customers across the US. Having nationwide coverage, the company is larger than peers like Extra Space Storage (EXR), and actually much larger than peers like Life Storage (LSI) and CubeSmart (CUBE).
Claiming superior rent and margins, on the back of its scale and positioning, the business is well equipped to effectively handle the many tiny rental contracts, in part through standardization and usage of technology.
The share of the US population which uses such self-storage solutions has increased from just 3% in the 1990s to 10% by the time of the pandemic, providing a huge growth driver on top of population growth and inflationary drivers.
Public Storage posted a 17% increase in 2021 revenues to $3.4 billion, the result of both organic and inorganic growth. The company reports $1.8 billion in expenses, many tied to the actual running of these operations, complemented by depreciation charges and general and administrative expenses, and interest expenses of course. Occupancy rates at 95% look decent, with rents running as high as $20 per square foot in 2021.
The profit and loss account reveals a net profit of $1.73 billion, just a couple of pennies shy of the $10 per share mark. After adding back depreciation charges, and some other items, funds from operations (FFO) came in at $13.36 per share. Reporting $17.4 billion in assets (mostly comprised out of the net value of property assets) the financing is quite conservative, consisting of $9.3 billion in equity. The company guided for strong growth in 2022, with FFO seen just over $15 per share, driven by rental growth to an important extent.
A $200 stock pre-pandemic has seen shares peak around the $400 mark in April 2022, peaking after many other REIT (categories) have seen a pullback already. Shares fell to the $300 mark over the summer, driven by concerns on growth and higher interest rates, as shares fell to $270 in January. This pullback came amidst a solid operating performance as the company hiked the full year outlook, despite a $2.3 billion divestment of its ownership in Public Storage, with receipts paid out as special dividend.
With 176 million shares trading at $270, Public Storage’s equity was valued at $47 billion, a huge premium to a $10 billion book value of the equity at the time. Given this $37 billion premium, on top of a $17 billion asset valuation on the books, that suggest that the market was still valuing these assets (and/or future earnings power/development power) at $54 billion.
Based on funds from operations, the valuation comes down to 17–18 times, as the risk was not related to the activity, leverage, but really centered about a further valuation retreat, at least in my belief. Despite a pullback seen in the share price already, it still felt too early for me to dip my toes into the water.
A Big (Potential) Deal
Since my cautious but largely neutral tone in January, shares of Public Storage have risen more than 10% to $308 per share, driven slightly lower interest rates and hopes of equity markets at large that the worst of the fight on inflation is a thing of the past already.
Early in February, Public Storage announced a big deal, as it proposes to acquire Life Storage in an all-stock deal. Public Storage is willing to exchange 0.4192 of its own shares for each share of Life Storage outstanding, representing a 19% premium to a Life’s stock price based on a 20-day VWAP pricing model.
The deal seems hostile as the company indicated that it made an initial attempt on January 12, but apparently Life Storage is not willing to engage, hence the decision of Public Storage to go public with its intentions. The company believes that investors should benefit from better operating margins (reported at 80% by Public Storage, while Life Storage “only” posts margins at 73%). Higher margins should come from platform costs savings, adoption of technology and generally greater scale.
Life Storage is quite a bit smaller in terms of its size. The company commands an >$9 billion equity valuation at $110 per share, less than a fifth of the valuation of Public Storage. A 20% premium comes down to about a $1.8 billion premium in dollar terms, or about $10 per share in terms of the shares of Platform Storage. Initially, that is pre-market, shares of Public Storage were down by about $10 per share, but shares quickly gained ground and now trade flat for the day.
Perhaps in anticipation of the reaction of its own investors to the apparently hostile deal, Public Storage announced a huge 50% dividend hike, now paying out $3 per share on a quarterly basis. The move is quite large as the payout ratio will jump to over 75% of the anticipated FFO for the year, up from a payout ratio just in excess of 50%. The move is quite large and will significantly impair the potential to deleverage the basis from retained earnings in the meantime.
Concluding Remark
The truth is that the hostile acquisition attempt likely means that more pressure is needed on Life Storage to make a success of the deal, which implies that the offer will likely need to be sweetened. I must say that I like the fact that this is an all-stock deal, which makes that leverage is not the concern, but synergies have the potential to create benefits over time.
Of course, it is mere speculation for a raised offer, as perhaps a higher price will likely weigh on the shares, yet the company has been able and willing to hike the dividend to please investors.
The deal is set to create some uncertainty for a while as the dividend hike certainly is compelling but at the same time limits growth as well. On the other hand, growth opportunities on an organic basis likely come down amidst a softer economic environment and reversal of pandemic induced trends. Amidst all of this, I remain an avid follower of the shares, but see no reason to get involved here sub-$300 again.
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