Azrieli Group Ltd. (AZRG) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Azrieli Group conference call. [Operator Instructions] This conference call will be accompanied by a slide presentation. It can be found on Azrieli's site, www.azrieligroup.com, on the Investor Relations page under Presentations and the final reports can be found on the website as well. I'd like to remind everyone that forward-looking statements for the respected company's business financial condition and results of its operations are subject to risks and uncertainties that could cause actual results to differ materially from those contemplated. With us on the line today are Mr. Eyal Henkin, CEO; and Ms. Irit Sekler-Pilosof, CFO. Mr. Henkin, would you like to begin?

Thank you. Good afternoon, and thank you for joining Azrieli Group's Third Quarter Conference Call for international investors. We are ending the Q3 2021 period with record results in the operating parameters, whether it's FFO or NOI, occupancy, et cetera. In some of the parameters, the results are the highest that Azrieli Group has presented to date. A couple of things to note. One thing is that it should be kept in mind that our focus throughout COVID was to maintain occupancy rates with tenants that we believe in and to preserve the pre-COVID commercial models. This is one thing we were very focused on. The other thing is that currently, we have full occupancy. We're updating tenant mix and there is a consistent rise in the NOI, which I think, again, COVID is not gone but up until now, I think it provides a proof of the formula that we are working with. I would like to talk about and to reflect some macro indications of the Israel economy. First thing, growth in Israel economy is strong, mainly thanks to the high-tech industry, which affects all of the circles of its service providers. And of course, first and foremost, the employees, which then reflected in the spending and its high spendings, high capital. This is one thing. Second thing, the GDP grew by 5.9% in Israel compared with Q3 2020 and by 2.4% compared with the previous quarter. Personal consumption expenditures grew by 12.7% compared with the previous quarter. And according to the IMF's growth forecast is that the Israel economy will grow by 7.1 percentage, this is from October -- 7.1% is forecasted from October, 7.1% in 2021 compared to OECD countries 5.2%, compared to EU countries 5.1%. And the projections for 2022 in Israel is growth of 3.2% compared to 1.6% in OECD countries and compared to 1.5% in the EU countries. Today, we will review all the segments, but I will begin with the data center segment. Some words about strategy and the market. Data centers market is considered one of the fastest-growing industries in the world. If you look at the U.S. lease prices in the market, they are at all-time high figures. In recent weeks , there were some M&A acquisition globally. CoreSite, CyrusOne; in August, there was QTS, altogether are almost $35 billion worth acquisitions, which is a number. That is for big platforms in which the prices reflect high multipliers. What strengthen our thinking that the prices and the fact that the prices we acquired, both Compass and Green Mountain, which are smaller platforms with a very high growth projection, the prices we paid are really attractive. I think this market is a good fit for Azrieli, and let me demonstrate with a couple of points. One, it's a pure income-producing real estate. We look at it as pure real estate instead of building with workers or R&D people of Amazon, Facebook, Google, whatever, you have servers working in your premises. It's a real estate market with 35% annual growth. It's a high yield on cost in a high development market, I'll reflect it in a minute. It's a market which is driven by the huge growth of the cloud, 5G, streaming, gaming, crypto, AI, autonomous vehicles, HPC storage, et cetera. It's a super strong customers market, particularly Microsoft, Amazon, Google, Oracle, IBM, Salesforce, Netflix, Uber, others. These are challenging customers on the other hand in terms of financial solvency, the #1 market in the world -- customers in the world. It's a very long and very sticky contracts. Once you have this hyperscaler in your premises, they are with you for a long time. It's a market characterized by significant development enterprise from site selection to engineering, zoning, permitting and development with critical time-to-market capabilities, this fits exactly like a glove to us really. I remind you that during COVID-19, we had more than 3 huge projects that we delivered either on time or before time within budget or lower than budget. This is something we know how to cope with and we have the expertise. It's an attractive double digit, as I said before, development margins, which are higher in Europe and EMEA compared to Northern America. It's a capital-intensive market. For a company like ours with such an LTV at such a cost of debt, exactly what we're looking for. And it's a real unique selling point or a unique advantage for us really. Cost of capital is a material factor, as I indicated just now. It's a market where the prominently growing channel is hyperscale and this is what we are focusing on, with an exclusive members club of data centers, which are deemed hyperscaler fit, of which only few signed contracts with more than 1 hyperscaler. Today, we have the 3 major hyperscalers in hand. It's a global market once you talk about hyperscalers, with the same customer and the same teams managed from Seattle to Dublin for all the major markets, same culture, same engineering, same commercial contracts, same approach. If you are located in many places on the globe, you have high synergy and higher compatibility with these markets, with its customers, and they will approach you. We believe in the data center market and it will be -- it will serve as a significant growth engine for the group. As I mentioned, our strategy is to acquire platforms with immense growth potential whether in Tier 1 markets, but maybe with even more potential in the Tier 2 markets and to expand from there into the Tier 1 markets. Some points on our strategy. One thing is time to market. We understand that with all these vast acquisition space if you want to be global, you must go for acquisitions within the coming 18 to 24 months. And we usually don't buy NOI. We develop NOI. In this case, we think there's no choice but to acquire good platforms. This is one. This is on the strategic level. Time to market on the tactical level, we understand that if you are a player there, you must work speculative on the tactical level, which is site select -- good site selection, buying lands speculatively where you know you have the indications from the hyperscalers, build pad-ready and all the infrastructure in advance and be ready to have your merchandise ready once the telephone is coming from these hyperscalers. Just to reflect on how Azrieli works, unlike other entities, Azrieli builds 80% of its real estate speculative. And today, we are 99% occupancy. Anything we've built during COVID-19 is between 90% to 100% full. So we know the space, we know how to manage it, we know how to manage risk and to execute on opportunities. We decided to start in Northern America back in 2018. 2019, we entered into Compass and we bought together with Compass Root. Today, we're 24% hold in Compass. And we chose Northern America because it's a highly, mature sophisticated market with mature suppliers, regulations, facilities, infrastructure and even good common practice with the customers. And after 2.5 years, we think that this was the time to go and make acquisitions in other higher-yield markets and to build some synergy. And we looked for a number of platforms in the European Continent. Up until recently, we bought into Green Mountain, which I will reflect in a minute. In Northern America, we are making strong process with development. And as I said, we started out exactly 2 years ago. And today, we have hyperscaler contracts with almost 5x the NOI we've acquired originally the platform. At the same time, as I indicated, we're looking for more platforms in Europe. Europe is a high-yield and high-growth market with the development yields of 250 to 500 basis points, higher than Northern America. It is a market that the U.S. players are entering aggressively. But still, hyperscalers don't have self-build in this market, and it is an opportunity. It is a market with barriers to entry and local expertise. And this is the reason why we go for M&A on -- when we enter this market afterwards, of course, we go for development. We are aiming to buy additional strong platforms, consolidate them under 1 roof and proceed to expand from there to other territories and maybe for -- with an IPO at some point of time. After the closing of the acquisition of Green Mountain with the current holding in Compass, the segment accounts for around 12% of the group's operations. Bear in mind that we are considering increasing our holding in Compass as well as development investments and possibly other M&As in the next few years. which will lead in the future to the segment being more significant at the Azrieli group. Some points about Green Mountain. We looked at several companies in Europe and deemed Green Mountain an investment in an excellent, high-quality company with hyperscale customers that complement Compass and exceptional development and management capabilities. Investment according to an EV was made on the range of ILS 2.8 billion, including a company debt of ILS 500 million. These days, we are finalizing finance of this deal with almost ILS 1 billion leverage, an additional ILS 700 million as a CapEx facility for future high growth. The transaction was closed in August 2021 and is currently -- and in the current statements, it is already a consolidated company. Irit will expand on the effect of Green Mountain's consolidation on the group statements after myself. Green Mountain will be a springboard for development in European countries from Northern Europe, whether it's Germany, the Dutch, et cetera. Synergy with other holdings in terms of global presence for hyperscaler is essential, and it provides the synergy for customers worldwide. Some advantages of Norway and Nordic countries. TCO, what we call, total cost of ownership is very low because of electricity costs, which are something like between 15% to 25% or 75% to 85% lower compared to the major Tier 1 markets in Europe. Lots of government support, whether it's through taxes, ease of doing business, et cetera. It is close to most of the population in Europe, low latency and high connectivity. And these days, additional 4 subsea cables are being laid between Norway and the U.K. or Europe. An important element, it is the fact that this industry in the Nordics is 100% environmentally friendly energy, which is very important for us really and very important for the customers. Some advantages on top of this from Green Mountain. It's a very -- we found a very good and experienced management. It has a significant experience in marketing and relationship with top hyperscaler customers. It has many years of experience in enterprise design, location and development of land for data centers and the assets are top quality, top quality the assets. Looking at the customers, we are aiming to, you can find the Amazon AWS just to reflect on what happened in the recent quarter. They had 39% growth in Q3, 37% growth in Q2. And their cloud accounts for almost 15% of the revenues, but the entire EBIT line of Q3 is only AWS, which is phenomenon. If you look at Microsoft. Microsoft have their revenues in Azure of $17 billion in Q3, which is a rise of 50% compared to the previous quarter. And Azure today accounts for 38% of the operating income. And again, it's growing within the P&L of Microsoft. So this is something which is worth aiming for real estate, and we are there. Going to other segments offices. Azrieli currently has demand for more than 100,000 square meters, which we cannot -- we don't have a supply for. If we had a vacant space available, we would quickly lease it in a very good prices. I believe that Azrieli is a very strong product, service and customer loyalty. I will reflect it in a minute. The demand in the market is by far the strongest ever. The offices segment continues to perform very well, and was assigning large lease transactions at higher enterprises. One of the main reason is the very strong high-tech industry with significant financing rounds and exits, companies having available capital, some of which flows into the real estate market to create a good work environment for employees in order to attract talent. There's lots of recruitment. I would call it, frantically. It's really -- recruitment of R&D employees in Israel is really on peak levels above any imagination and these companies need space for these employees. Some examples of contracts or transactions in offices that I would like to highlight. For example, in Sarona, we had 1 floor of a startup, which went public back, a couple of billion dollars. There is no room to expand. They left the building. They were paying ILS 120 per square meter. And on the spot, it was rented by -- it was leased by ILS 175. In Azrieli Center, we had just now a customer which were replaced from ILS 93 per square meter to ILS 155. Contract renewal trend continues to be very positive. And I started with products, service and customer loyalty, I will finish with it in offices. First of all, we think the locations of Azrieli are I would say, the hub of each CBD, we are at where there is stability, public transportation and proximity and adjacent to other services. And we earned based on this customer loyalty, for example, Rapyd, which raised $700 million. They were in Sarona. They had some other places that they wanted to expand. They didn't have space in Sarona. They went back to the Azrieli Center, took 10 floors 13,000 square meters in the Triangular Tower, which I remind you Bezeq was the AT&T of Israel, which moved to another building of ours. And they took another 14,000 square meters in the Spiral Tower, which is going to be ready by year 2026. This is one example of loyalty. Another company, SolarEdge, which is the -- which is traded in NASDAQ is the -- in terms of market cap, is the highest company in Israel, $19 billion market cap, the company was with us in the Herzliya Business Park for many years and now it is continuing with new 40,000 square meters campus that they chose us to build and lease to them. So these are good examples of customers staying with us and expanding. Going to the malls. There's a sharp rise in all parameters, occupancy is 99%. Mall footfall and store revenues have been good and growing since reopening on February 21. Considering the fact that half of the Israelis are traveling overseas compared to regular times, lots of liquidity in the market. It turns out that these guys are buying more in Israel and partly because of COVID, which reduces activities and the expenditure to other than malls, et cetera. I would add that in terms of online, and we are online and offline, right? But in terms of online supply chain is difficult and people are going to stores, which is very good for the tenants and for us. February 21 through September 2021 compared with the same period in 2019, which was a regular year, store revenues increased by 2.4%, excluding businesses that are closed or worked partially or irregularly. We are taking intensive measures to adjust the mix in Jerusalem, Modi'in, Tel Aviv and Givatayim. Most of the stores, 16 in total, accounting for about 9% of the NOI will be reopened in Q1 2022 with a very, I would say, good and accurate mix. Going to senior housing. We are on track big time. We have very strong demand. We have dozens of contracts that were signed in all the senior homes, mainly in Lehavim and Modi'in, the new ones, Tel Aviv and Ra'anana maintained close to full occupancy. We have very high resident satisfaction with our management during COVID. And we have the best marketing in town, which is word of mouth. We raised our prices by 8% at the beginning of the year, an additional 5% in the middle of the year, i.e., June 2021. Lehavim, we are finishing stage A much earlier than we planned regardless COVID with a marketing rate of almost 90%. And now we're going into Phase b, which is additional 110 apartments that we're aiming to launch by mid-2022, which is July 1. Modi'in is already 98% taken with 95% occupancy. And as I said, Tel Aviv and Ra'anana, one is 96%, the other one is 100% occupancy. And we're building additional homes that I will reflect in a minute. In terms of development, as you know, Azrieli is about 1.350 million square meters today. And as we speak, we developed additional 1 million square meters to be operative within the coming 5 to 6 years. Projects completed in '22 are fully leased up, whether it's Lehavim, whether it's Modi'in, whether it's Town. Margins in these projects, which are under development or ones that we already finalized, margins are higher than 8%. Our recent buildings were -- we had margin -- double-digit margins, whether it's 10% or 11.5% yield on cost. Debt and leverage, Irit will reflect on this. I'd only indicate that in Q3, we made an exceptional debt raising, almost ILS 3.7 billion in 2 series with long average duration 11.8 years as a total and 1.28% linked to the CPI, which is -- again, it's phenomenal. I would like to finalize this -- my part with ESG. We are in the process of formulating a broad and significant CSR policy. Starting with segment connected and related to real estate, such as green building, the properties we built in recent years are to LEED standard and most LEED Gold or Premium standard. We consider ourselves a nation-leading recycling and waste reduction entity. And we already stated on the largest project in Israel in the Israeli center, which will be expanded to our other properties and aims for a waste reduction target of 50% within the coming 3 years, and we are on it and we invest in this, and we allocate the management and operational and financial resources on this. We're continuing our good corporate governance and ethics policies for which we are already now rated very highly. Employee-related policy. Diverse employment and encouragement of the Israel economy, I would say, through supplier -- even through suppliers. Social initiatives both at the level of the properties, in the local areas and at the HQ level, strengthening and improving volunteering and involvement in the communities in which our properties are located. And of course, for us -- it's, of course, the nation policy. We're improving transparency in information, will lead to higher ratings, improved performance and target setting and we are close to finishing our first ESG corporate social responsibility report, which we expect to release in December of this year. I will now hand over the floor to Irit to review this quarter's financial parameters.

Good afternoon, everyone. The third quarter presents excellent results, as I expressed in all the operating parameters for the quarter. The NOI in the quarter was ILS 428 million compared with ILS 352 million year-over year and ILS 407 million in the same quarter of 2019. The increase of ILS 76 million year-over-year is mainly derived from the retail segment with share of the increased amount to ILS 39 million due to the COVID-19 relief and rent waivers in the same quarter of 2020. Approximately ILS 31 million derived from an increase in the office segment, mainly from the completion of the construction of Azrieli Town in Tel Aviv and Azrieli Hamanor in Holon as well as the hand over of areas to tenants of the Triangular Tower who are replacing Bezeq for highest rent. Approximately ILS 6 million derived from an increase in the Senior Housing segment, mainly due to an increase in the occupancy rate of the homes in Lehavim and Modi'in and a decrease of approximately ILS 1 million in the U.S. Real Estate segment, which was derived in its entirely from the decrease in the U.S. dollar exchange rate. The same property NOI present, a trend similar to the NOI. In fact, the property is not included in the same property NOI for mainly the Hamanor building in Holon, whose construction was completed in October 2020. Azrieli Town, whose construction was completed in December 2020 and which is fully marketed and the new property on Mikveh Israel street in Tel Aviv, which was purchased in February this year. The company's FFO totaled ILS 357 million in the quarter compared with ILS 282 million year-over-year and ILS 321 million in the same quarter of 2019. The increase of ILS 75 million in the FFO year-over-year correlates with the increase in the NOI net of tax expenses, in addition to a significant increase from a senior housing operation, which contributed another ILS 20 million to the FFO disparity between the quarters. At the end of the quarter, the total value of the group's real estate properties was ILS 32 billion. This value includes first-time consolidation of the assets of Green Mountain, a Norwegian data center company in which was acquired full ownership in August 2021. In the quarter, the valuations for the group's real estate properties were not updated and the impairment in the sum of ILS 14 million, mainly derived from purchase tax payments for the purchase of land. From this quarter, the company presents another operating segment in the data center industry. And an annex was added to the financial statements providing an extensive description of all operations. The impact of the results of operations of Green Mountain will be expressed from the first quarter. While Green Mountain's assets and liabilities were included in this report as of September 30, 2021. The company's net debt is ILS 12.6 billion, and it constitutes approximately 32% of the total assets. The said debt includes the bond offering in July 2021 in the sum of ILS 3.6 billion with an average duration of 11.5 years and average interest rate of approximately 1.28%. The company's average effective interest rate after the said debt raising is approximately 1.5% with an average duration of 6.8 years. The company has ILS 27 billion in unencumbered assets which constitute 75% of the company's assets, in addition to deposits and cash balance at the end of the quarter of ILS 2.7 billion. The net profit in the quarter totaled ILS 187 million compared with a profit of ILS 193 million year-over-year. The decrease is mainly derived from an increase in the financing expenses, which derives from the linkage differences due to the rise in the CPI net of increase in the NOI. The positive effect of the CPI on the valuation of the properties is not yet expressed in this quarter. The equity attributed to the shareholders totaled ILS 18.5 billion at the end of the quarter which was after the distribution of a ILS 600 million dividend this year. We will now hold a Q&A session and go ahead.

[Operator Instructions] The first question is from Charles Boissier of UBS.

Thank you very much for the presentation. I just have 2 questions to Irit and Eyal. On the data center discussion, did you mention a potential IPO. I may have misheard, so apologies if that's the case but if you have any plans around that, just to understand maybe a bit more? And second question on the more on the capital allocation more generally. Obviously, your LTV is still very low and you have a very strong access to the financing market. And I just was wondering as you look about the acceleration of your investments into data centers, and the ongoing pipeline also in Israel. How do you think about the funding? Do you want to lever up a bit more from here? Or do you also consider disposals? And where do you anticipate your LTV to be, let's say, in 2, 3 years, just looking at that kind of ongoing pipeline and the data center acceleration.

Two things. One, we think -- I'll start with the second question and then go to the first one. We are considering and checking the possibility of going to the -- extending our growth in this market together with maybe 1 or 2 or maximum 3 institutionalists on a worldwide scale. So we're checking this possibility. It involves structure, governance, capital allocation, et cetera, but this is definitely something we're checking these days. We're being approached by both local and international capital markets and institutional folks who are keen on entering this space specifically with the operational company like ours. So you're on the spot and we're checking it at this point. If we go with this in such a formula, and there's a high probability that we go there, I suppose our LTV will be between on a steady state between 30% to 40%, which we feel comfortable with. And going back to your first question, if somebody or some entities join hands with us, and they want to capitalize or liquidate their investments, so for us, it's an option. It's an option to go public with such a platform or to have the option of going to such a platform. We are not exit people. We invest for long term. But if our partners want to have this vehicle, it's something that we would provide. Having said that, we're thinking of U.S. REIT with the aim of -- with the option of having this executed in New York. So I started with the investment vehicle partners, LTV and going back to the IPO option, which is only an option for somebody who looks for this.

[Operator Instructions] There are no further questions at this time. Before I ask Mr. Henkin to go ahead with his closing statement, I would like to remind participants that a replay of this call will be available later today on the company's website at www.azrieligroup.com in the Investor Relations section. Mr. Henkin, would you like to make your concluding statement?

Yes. Thank you. I would summarize with the fact that we are maintaining and developing first of all, our core business in Israel. The group is making strong progress in all of the current parameters from offices through malls to senior housing in terms of occupancy, NOI, FFO, traffic and store revenues. Our development pipeline is robust with around 1 million square meters under construction, and we keep developing it. We strongly believe in and are intensively promoting the data center segment. We think this is the right time in a development, high-margin market with massive growth in the world's strongest customers in very long and sticky contracts in a technology-driven world which is primarily accelerating the growth. We will continue to grow after the Green Mountain deal with more acquisitions and extensive development with a strong trajectory for M&A growth and development growth on the strategic international level within the coming 24 months. This is, as I said, alongside intensive development at local level, reflecting our hyperscale customers demand. I would like to thank you for listening. Stay healthy, and have a good day. Thank you very much.

Thank you. This concludes the Azrieli Group conference call. Thank you for your participation. You may go ahead and disconnect.