Alexandria Real Estate Equities, Inc. (ARE) Earnings Call Transcript & Summary

I'm in here with Manny Korchman. We're pleased to have with us Alexandria co-CEOs. And I always get confused of like who is going to take it. Is it going to be Peter, Steve, maybe each word.

Peter is still the most important one. It's who you need to...

Or is Joel on the webcast somewhere? He's going to start sending questions through LiveQA, Citi2020. So Peter, I guess, I'll turn it over to you to introduce Alexandria and the management team that's here and provide 3 reasons why investors should buy your stock today. And I'd like to thank you as well as being the unique office West Coast REIT who did attend said conference.

Sure. So good afternoon, everybody. I guess it might still be morning. Peter Moglia, co-CEO and Co-CIO of Alexandria Real Estate Equities. I'm with Steve Richardson, who's also co-CEO with me; Dean Shigenaga, our CFO and Co-President; and Catherine Pagliarulo.

Yes.

Thank God, I'm Italian. I better get that right. Who is a member of our science and tech team. And we're all very pleased to be here today. I'll go ahead and start with the 3 reasons you should buy our stock. I think the coronavirus is a great reminder of the value of the life science industry and the many challenges to human health that exist today and that will appear in the future. We're still at the very early stages of the biology revolution. And what is going on today really underscores the importance of this. And we're in the best position or Alexandra is in the best position today to benefit from the demand for space that is going to come from problems such as the coronavirus and other things that will come in the future and obviously, things like cancer and Alzheimer's disease and whatnot. There's certainly a number of things that need to be done, and we're best positioned as anybody to solve that. We're also a better alternative to many real estate sectors. We have a strong underlying industry that's propagating demand. We have a low CapEx profile. We have a lack of exposure to WeWork. We so far have not experienced any densification trends that would be tough for our business. And we have some of the best located real estate in the centers of the knowledge economy, which is really where everything is going. The markets that we're in are the leading edge markets for this stuff, and we have the best locations for those companies. And then last, our business model has proven to consistently grow earnings, and it's also very resilient in hard times. We have a great credit tenant profile. We have long-term leases and we have a very high tenant retention ratio. So if things indeed do turn tough, Alexandria is very resilient as well as a great growth story. So with that, maybe Steve can open up our remarks.

Sure. And thank you, again, Michael and Manny. Again, congratulations to you and your team for hosting an exceptional investor event, especially under trying circumstances. And just do want to note that the playlist keeps getting better and better, so kudos to you, Michael. Look, Alexandria has a unique mega-campus platform and a brand position in our key clusters. Our exceptional performance, evidenced by the highest annual leasing volume in its history of 5.1 million square feet this past year and the highest leasing spreads during the past 10 years of 32% on a GAAP basis, is the result of this unique mega-campus platform and the brand position of the company. The life science industry, which Peter referenced, is one in which the Alexandria team is recognized as a long-term partner, not merely a commodity supplier at all. The industry continues its breakthroughs in biology so that therapies now not only include small molecule, recombinant protein and antibodies, but also gene therapy, DNA and RNA therapeutics, bio-engineered vaccines and gene-modified cell therapy. The mission-critical nature of this work, as evidenced by what's going on now around the world, is undertaken by scientists at these enterprises. They require a combination of Class A facilities, highly curated and amenitized facilities and campuses, adjacent to the world-class research institutions and teams with deep operational knowledge and skills. Our pioneering efforts initiated nearly 25 years ago now have created an absolutely unique brand, and we're honored and proud to be working collaboratively with leaders in all facets of the life science ecosystem. This well-earned reputation, not only to the life science ecosystem stakeholders, but also with key city officials and multigenerational research institutions, continues to drive our disciplined and balanced growth. The core operating portfolio is strong, as noted above, and we have significantly mitigated the risk of our high-quality development pipeline as a percentage of gross investments with 6% under construction and that 6% is 2/3 leased or in negotiations. Another 5% of the growth pipeline has income produced as a covered land play, and we have just 2% in raw land. With that, I'll hand it back to Peter for further comments on the recent highlights of adding to our mega-campuses and unique brand.

Thanks, Steve. So as mentioned, our stellar performance is due in part to this mega-campus strategy that has accelerated in recent years but goes back to 2006. It's definitely not new. Back in 2006, we bought a 1.2 million square foot Tech Square campus in Cambridge. Shortly thereafter, we bought the Illumina campus in San Diego. At the time we bought it, it was 346,000 square feet. Today, it's nearly 800,000 square feet, and we've got another 450,000 square feet to build. Right after we bought the Illumina campus, also in 2010, we bought Campus Pointe. That was 450,000 square feet at inception. It's 1.4 million square feet today. And it will eventually grow to be 2.1 million square feet. So we saw the synergies of these mega-campuses being realized in the form of higher rents and efficient operations and have expanded the strategy to widen this moat that we have to further differentiate ourselves against others that are currently dabbling in our space. And in order to continue to widen this moat, over the past few months, we've announced even more mega-campuses, starting with the Mercer Mega Block, which was awarded to us by the City of Seattle due to their confidence in our execution and our compelling vision for the property. The Mega campus is -- or the Mega Block itself is 800,000 square feet, but we're going to pair it with 2 other acquisitions we did at 601 Dexter and 701 Dexter, which will give us a 1.2 million square foot campus at the doorstep of South Lake Union in Seattle. I'm sure there are many people that would love to be in that position. We have a joint venture at the San Diego Tech Center in Sorrento Mesa. It's historically been the premier tech campus in San Diego. It is sorely in need of repositioning, and we're just the team to do it. In addition to adding some modern amenities, we are going to be adding life science to that campus. It provides us really an extraordinary opportunity to significantly densify and enliven one of the largest campus footprints in San Diego, which today sits at 600,000 square feet. And by the time we're done with it, it will be 1.7 million. Arsenal on the Charles was acquired recently in Greater Boston, and it provides us a way to expand the borders of Cambridge within a very historic and beautiful setting. We're going to transform a current set of 11 buildings that comprise about 680,000 square feet into a mega-campus which will total 1 million square feet and will create enduring value for our stockholders and tenants through that effort. Finally, our joint venture with Boston Properties recently announced affords us an opportunity to transform a 29-acre location in South San Francisco, within walking distance to the Caltrain station, from an existing 11 million -- I'm sorry, 1.1 million square foot vintage campus into a Class A mega-campus which is going to feature 1.7 million square feet, which includes NetZero conferencing and dining facility. I'm leaving out One Kendall Square. I'm leaving out the Alexandria District in San Carlos and our mega-campus in Shady Grove in Maryland and others so we can get on with questions. But hopefully through this illustration of what we've been doing in the past and the present, you get the picture that we are clearly the leader in life science real estate, and our unique brand and strategy continues to create significant value for our tenants and shareholders. So with that, we can go ahead and open it up for questions.

Thanks for that, Peter. One of the things you started off with was talking about coronavirus and how that demonstrates how much your tenant base, which is in the research and development and the creation of drugs to fight so many diseases that we currently know about and forget about the ones that we don't know about and how that's the enduring factor of Alexandria. Does this sort of episode tell you that maybe doing any of the tech stuff and the tech tenancy, which is active in the markets that you're in, that maybe the full focus on life sciences is better than a dual? And when I say dual, I recognize still the majority of your company is life sciences. But do you want to monetize those sorts of things rather than keeping them in the company?

Yes. Certainly, the tech portfolio, which serendipitously was created as we held these great locations in these innovation centers that were highly coveted by those organizations, is something that we talk about all the time when we're talking about asset sales and how to -- and what to monetize. We still think that there's room in our portfolio for that if we had a rollover and we had a great life science opportunity to take its place. Life science has better margins than tech office. And indeed, we would consider it for sure. I don't know if this particular event changes our thinking on having tech as part of our portfolio, but it is inventory down the road to become future lab space.

So the current coronavirus situation has gotten the entire world thinking about sort of drug development or at least the news is talking about drug development. I assume there's multiple of your tenants that are trying to hit the same finish line, which is find a drug that either treats, prevents, eliminates, however it is. Is there a -- sort of is the outcome bifurcated and one is going to benefit and sort of when? Is there one drug that comes to market that hits that goal line? Or -- and if that's the case, what happens to all of the other staffing, knowledge, investment that's gone in by the other tenants? And so for you guys, is that sort of a net negative longer term where you have a ton of energy going towards this sort of goal, it will be realized over the next whatever number of years, call it, but then the rest of it goes away?

Yes, Manny, let me just start while I hand it over to Catherine, part of our science and tech team. Look, the intellectual capital that will be generated from this endeavor will have value. It will spread throughout the entire life science ecosystem. So we don't think there's any downside to additional research by a number of different companies. And Catherine will talk more in detail about exactly what's happening.

Yes. So just, I guess, a little bit more broadly in the life sciences. There's rarely a winner-take-all strategy where one drug gets developed and everybody else gets pushed out. In the case of coronavirus, as you mentioned, there are really 2 approaches. There's the vaccine approach and the treatment approach, and those can be entirely complementary. I think the key point to make here is, we do have several tenants working on this. None of them were working on nothing until coronavirus came up and then put all their eggs in the coronavirus basket. In fact, many of the programs that are in development are actually slightly repurposed from treating things like the MERS and SARS outbreak. So as Steve mentioned, it will be pretty rare that they would have like massive layoffs if somebody else beats them to market in things like coronavirus. The other thing to mention is, many of our tenants are working on these platform approaches where there are lessons to be learned from any sort of development that occurs with their farthest along programs. And they're able to take a relatively modular approach, if you will, to their learnings and then implement them into future programs down the road, which allows them to work on sometimes smaller markets, often in the infectious disease markets, and then expand them into broader opportunities.

Any other questions on corona in the room before we go on to other topics? No? Okay. We've got this ESG question we've been asking all of the management teams. And it's, ESG is of increasing importance for all company stakeholders. What's one thing your company is doing to improve your overall ESG score over the next 12 months?

So Manny, I'll take that question. Thank you. Really think it's more of a dual approach because ESG is a much broader topic than just environmental. I'd say, first, we're trying to minimize the impact we have on the environment as well as mitigating the risk around climate risk. But maybe fundamentally, it's all about a significant reduction in our carbon footprint. We've got 2025 goals that have been established, which go beyond carbon, but carbon reduction is a component, minimizing or reducing our water consumption, energy usage or consumption as well as waste diversion. But as you heard in the lunch discussion yesterday, we're also focused on embodied carbon, which is effectively the other half of your carbon footprint. You have operations of the building which produces a carbon footprint, but you also have the carbon footprint from the construction as well as delivery of materials to your site. And there are alternatives, for example, steel, you can use timber, which you saw in yesterday's lunch presentation. We have 2 buildings that are being designed to replace the steel with timber. And NetZero is an important component of our environmental goals as well. We have our first building that's almost completed. But it's a complicated goal to achieve with what's available in the market today. And I think we're trying to do it with as much on-site benefits than pulling stuff from off-site locations. But the reality is, we're not quite there today with technology. The other piece is really having a positive impact on people. And I use the word more broadly than just employees. I think it's referencing our tenants. It's referencing our supply chain, vendors, et cetera, but it's focused on the health and wellness. It's focused on safe work environments and diversity and inclusion as well. So I think we're trying to be a very thoughtful leader in these areas, and I think it's going to be an evolution, not just for Alexandria, but for a lot of companies here today.

Maybe we just run through sort of the -- you spoke about the mega-campuses that you had, just the trends that you're seeing in those? Any updates you have specifically on what's getting more positive or potentially negative in any of the large-cluster markets you're in?

Well, maybe to address the trends, I mean, where we see the value in the mega-campuses is the ability for our tenants to grow. So life science companies tend to start out in 5,000 to 10,000 square feet and the successful ones can quickly grow to 50,000 in 2 years. And when they're a 50,000 square foot company, they think they're a 300,000 square foot company, and they don't always get there, of course. But if, as a landlord, you can point to that path to, yes, okay, I get it if you continue to build your business and it goes the way you think it goes, we can fit you into these places without massive disruption to your business. And where that helps differentiate us from others that are trying to do this is that we have those huge campuses. Others that -- there's no secret. In every meeting, people are asking us about, what do you think of this company and that company doing life science? And I think it's great because it can distract the investors from the poor performance of their other business. So go and try to do it. But at the end of the day, we've been doing this for 30 years. And we've got the right approach because we understand the industry and how it needs to be served. And so that's why this mega-campus strategy is really going to help us overcome any competitive pressure.

Yes. I think to add to that, Manny, is this subjective factor of the collaborative nature of the industry as well. So we end up looking very closely at the tenant roster and working hand-in-hand with the science and tech team really curate that tenant roster so that you have a mix of institutions, early-stage companies, mid-stage companies and large pharma as well. So we look at that very closely in a way that you just couldn't if you had a commodity mid-rise office building.

There are some questions that came through here on LiveQA, one just dealing with the election. And let's look at the Democratic side first. And it says, in the event that Bernie wins or that Biden moves more progressive to unify the Democrats, do you believe there'll be a slowdown in R&D leasing either ahead of the election or afterwards?

Yes, I think when you look at this broadly, and we had convened a group of leaders in Washington in December for a health care policy summit. You look at a number of initiatives, the Grassley bill in the Senate probably has the most bipartisan support, and it's really focused on co-pays and deductibles, which is where the real pain point is in the health care system now. Certainly, the price increases in drugs is also a consideration. And as far as specific candidates, I think certainly, Bernie would have a more dramatic approach, but actually moving policy in that direction, we think, is very unlikely. There's really not a broad bipartisan support, certainly in the Senate, especially for anything greater than a continue to enhance and repair what is in place today as evidenced by the Grassley bill.

I think the Democratic platform itself is widely split on the universal health care issue. Many do not support it. And I think anything that could be passed that could disincentivize innovation and thus, maybe even shrink the industry would go against states like California and Massachusetts, which are big supporters of the Democratic Party because it's such a major part of the economy. I mean we would really be killing the goose that lays the golden eggs if we tried to hurt this industry, which is one of our best and that has maintained its presence onshore.

Right. Other questions on election at all in the room? Maybe shifting to competitive landscape for life sciences. Obviously, it's not a secret anymore of the business at how profitable it's been. Is there a risk of increased supply as more competitors get into the marketplace? And how are you sort of seeing the competitive landscape overall? And then does that also diminish your development returns as maybe others are willing to accept a lower return on the business?

Yes. There certainly have been more parties that have expressed interest in life science. We've seen it mostly manifest itself in a lot of construction in South San Francisco. And I think the good news out of that is Healthpeak has done a terrific job with their development and it's been fully leased. BMR/Blackstone's doing the same thing. They've got, I believe, a huge lease with AbbVie and another one about to be signed up, and that's going to be resolved fairly quickly. Kilroy signed a really big deal with Stripe, bringing tech to South San Francisco for the first time. So that could have been something a couple of years ago when you saw all the cranes going up, could have been, say, well, here you go, here's an example of life science being overbuilt. And it turned out it wasn't true because there was so much demand for it. There's -- the other area in the country that others are focused -- have been focused on is the Greater Boston area. Cambridge in itself has been completely full. We have a project ourselves, 325 Binney, which we're very excited about. In fact, just received approval to upzone it to 400,000 square feet. So that's something we're really excited about. And beyond that, BMR has a project that they're trying to entitle and then there's the Volpe site, which is controlled by MIT, which is 3 or 4 years away from moving dirt. So others have kind of started to surround Cambridge with potential projects in the Seaport and other areas. Nothing has been built on spec that we know of. Things that have been built have been leased. So even if there is some risky behavior and spec building that might necessarily be needed, it does appear that our industry is strong enough to support it at least for a while.

There's another supply-related question in the queue here. How much life science square footage does the U.S. need?

As much as Alexandria can build.

Plus all the competitors equals supply.

That's a hard question to answer. Do you have a thought?

I don't have a thought on the square footage. But if you think about -- sometimes the other question we get is, well, aren't all the diseases in the world already cured, so do we even need any more research? And obviously, the answer is no. You may have heard us say before, there are over 10,000 diseases, only about 500 of those are addressed with treatments. And so then, we still have a long way to go. So if you'd look at it from that perspective, we really see no limit to the -- other than sort of capital restraints in sort of where this industry could go.

Let's think about the question differently. How much more employment could be generated by the space? And then you'll get to the square footage. So I guess the question is, how many people are employed in the life science industry and how much does that get to? And that's probably something you guys have looked at, isn't it?

Yes. I think, Manny, there's a number of facets to this. And as we talked about earlier, there's a number of new modalities that are expanding the depth and breadth of the industry in a significant way, cell therapy, gene therapy, just to name a couple. There is also an intersection of science and technology. We now have a 650,000 square foot life science facility with Verily, Alphabet's life science initiative. You have companies that are using artificial intelligence, machine learning to enhance the drug discovery and therapeutic process. So there really is not only a renaissance in science, but an intersection in science and technology that was just not happening a few years ago. So the industry is expanding significantly.

I think we've roughly doubled our square footage in size over the last 5 to 7 years. And as those of you who recall our Investor Day presentation a couple of years ago, we thought we could double again our revenue potentially just with things on our balance sheet. And I think we've started to make a pretty good dent in that goal. So we're at about 22 million square feet in operation today. Could that be 40 million in 5 to 10 years? It's possible.

What happens if VC funding dries up? Everything is cyclical.

Well, certainly, VC funding is an important part of the capital stack that supports the creation of new companies. And there's no doubt that those companies end up becoming larger companies or M&A targets for others. And we do serve those companies. I think our public biotech pie slice is about -- I'm sorry, our private biotech pie slice is about 8% or 9% of our total occupancy or total tenant base. So if there was a couple of years where it dried up, it would lag. The effect would lag, but it would mean less demand probably in the next 2 to 3 years. But again, not to diminish its importance, but it's less than 10% of our business. And we would feel -- probably quickly recover because, as we just talked about, there are so many things to work on. It would be really unbelievable if all of a sudden people weren't investing in life science. I mean they're not going to buy bonds.

The other thing to keep in mind is that even -- if you look back over time, the biotech industry has been well served by venture capital. The stability of capital raising and investing into the biotech industry has been pretty consistent. The tech VC funding and investing tends to be quite volatile at times. And venture capital, as an example, is roughly a little less than 20% of annual R&D investing. So roughly $350 billion was invested last year, $214 billion from big bio and pharma, but you've got NIH and other government pools of capital, a little over $40 billion, and another $40 billion from philanthropy. So you've got pretty large pools that are really stable. I think back to the financial crisis '08, there was no hiccup in venture funding partly because the R&D investment's 10 years or more for a new drug. So they're looking for the long term and they've got to fund it through cycles.

So Dean, your funding puzzle for the year had an equity component to it, sort of flexed through the year as you went. Given some of the shocks to the public equity markets over the last few days or weeks, does that change at all your funding plans for 2020?

Actually, it's an interesting topic to put in perspective. We've been making decisions about growing the business. If you look back over the last 4 quarters, take the fourth quarter of -- take 2019 as an example, we were making a lot of decisions on growing the business based on our stock price through the year. We had a nice run-up along with a number of other REITs in 2020, but we're relatively back where we were about year end. Cost of capital is attractive then. It got even more attractive in '20. So I think long way saying, I think we're in a good spot. Long-term debt has only gotten cheaper. We think the equity markets will settle down. And there's an opportunity for our cost of capital to improve even further. So we're comfortable where we are today.

In the last few minutes here, can we get a quick update on what's happening in New York, where the entitlements for the North Tower are?

Yes. So we're negotiating the ground lease for the North Tower with the city right now. We expect to have that done by the end of summer. Concurrently, we're in design. And we'd expect sometime by the end of the year we would be able to have a foundation permit in hand and we could start construction sometime then or after -- soon after if market conditions warranted it.

Questions in the room? Everyone wants to go to lunch. We'll do our rapid fire questions. Will the office sector have more or fewer public companies 1 year from now?

Fewer.

What will same-store NOI growth be for the office sector overall in 2021?

3%.

I think you're looking at the scientist. What will the 10-year Treasury yield be 1 year from today?

1.8%.

That's 1-8. And what year will the U.S. enter a recession? Come on, Moglia, give us a number.

I'm -- got an algorithm in my head, I'm going to say 2023.

Thank you.