Corporate Property Associates 18 - Global Incorporated (WPC) Earnings Call Transcript & Summary

Hello, and welcome to this conference call hosted by W. P. Carey to discuss this morning's announcement. My name is Kevin, and I'll be your operator today. [Operator Instructions] Please note that today's event is being recorded. [Operator Instructions] I will now hand the program over to Peter Sands, Director of Relations. Mr. Sands, please go ahead.

Good morning, everyone, and thank you for joining us. Before we begin, I want to briefly remind everyone that some of the statements made on this call are not historic facts and may be deemed forward-looking statements, including, but not limited to, statements regarding the timing and/or expected impacts of the proposed merger. Factors that may cause actual results to differ materially from W. P. Carey's expectations are described in our Form 10-K filed with the SEC on February 11 of this year, and the Form 8-K announcing the proposed merger filed this morning. An online replay of this conference call will be made available in the Investor Relations section of our website at wpcarey.com, where it will be archived for approximately 1 year. And with that, I'll turn the call over to our Chief Executive Officer, Jason Fox.

Thank you, Peter, and good morning, everyone. I'm excited to discuss this morning's announcement regarding our proposed acquisition of CPA:18, the nontraded REIT we've managed over the past 7 years. Total consideration for the acquisition is $2.7 billion, comprised of stock and cash includes the assumption of CPA:18 debt. A presentation summarizing the proposed transactions, main terms and benefits as well as its key impacts on our portfolio and balance sheet is available in the Investor Relations section of our website and has also been filed in an 8-K. Joining me on this call are John Park, our President; Toni Sanzone, our CFO; and Brooks Gordon, our Head of Asset Management, who are available to answer questions. Let's start with a brief overview of the deal itself. We agreed to acquire CPA:18 for $10.45 per share, consisting of $7.45 per share of stock and $3 per share of cash, with each share of CPA:18 converted to a W. P. Carey share at a fixed exchange ratio of 0.0978x. We expect to fund the cash component mostly through asset dispositions, both pre and post closing, where we also have ample liquidity through our revolving credit facility and amounts available under our existing equity forward to fund the cash consideration without the need to access any new capital. Once the transaction is closed, W. P. Carey shareholders are expected to own approximately 93% of the combined companies' equity and CPA:18 shareholders are expected to own approximately 7%. In terms of timing, we currently expect the transaction to close in the third quarter of 2022, subject to customary closing conditions, including CPA:18's need to obtain shareholder approval. The transaction does not require approval by W. P. Carey shareholders. It has the unanimous support from both W.P. Carey's Board of Directors and CPA:18 Special Committee. No changes to our management or Board will result from the transaction. And in our view, there's effectively no integration risk, having managed the fund since its inception and given our prior successful acquisitions of other CPA funds. For W. P. Carey, the transaction provides a number of compelling benefits. First, we expect it to be immediately accretive to our real estate AFFO per share, about 2% on a full year basis. This accretion is expected to replace over half of the estimated $0.15 per share of income we earned from managing CPA:18 with higher quality lease revenues. The resulting impact on total AFFO per share is, therefore, expected to be about a $0.06 decline. I also want to highlight that this transaction replaces finite life investment management income with stable and recurring real estate revenues. Similar to our acquisition of CPA:17, we believe that by transitioning to higher quality income, we're improving the nature of our earnings that cover our dividend and debt obligations going forward. I'm extremely pleased with the progress we've made in recent years, delivering value to our shareholders as we transitioned away from investment management and focused on growth through acquisitions. While we will achieve cost synergies from combining the 2 companies, primarily from the elimination of public company costs within CPA:18, overall our G&A is expected to modestly increase by about $4 million on an annualized basis, which will no longer be reimbursed by CPA:18 for certain costs. It's also important to note, however, that pro forma for the transaction, our G&A will support a larger owned portfolio and remain in line with some of the most efficient net lease REITs. Another benefit of the transaction is that CPA:18's net lease assets fit well with our current portfolio. Given the similarities in the small size of CPA:18 compared to W. P. Carey, our overall portfolio metrics remain relatively similar pro forma for the transaction. CPA:18's portfolio is also high quality and well diversified by asset type, geography, tenant and tenant industry. Our top 10 tenant concentration will be reduced to approximately 19% as no new tenants being added to our top 10 list. The percentage of annualized base rent, or ABR, we generate from investment-grade tenants will increase, although our weighted average lease term will decrease slightly. Like W.P. Carey, virtually all of CPA:18's ABR comes from leases with built-in rent growth, including over 40% of ABR from CPA:18's net lease portfolio that has rent bumps tied to CPI, ensuring we continue to see potential upside to our same-store growth from inflation. We expect ABR from both office and Europe to remain consistent with our current levels as we've targeted certain CPA:18 European office buildings for disposition to help fund the cash consideration in the transaction. I want to also highlight that CPA:18 assembled a desirable portfolio with operating self-storage assets. These are assets with strong rent growth profiles comprising 65 properties over 5 million square feet, which by comparison is more than twice the size of the operating self-storage portfolio we acquired in our previous merger with CPA:17. The acquired self-storage portfolio gives us lots of optionality going forward and interesting upside potential. One possibility is to convert some or all of these self-storage assets to long-term triple net leases with an established self-storage operator similar to the transaction we did in 2019. In that scenario, our U.S. net lease ABR would increase significantly, and our overall asset mix would be enhanced. We would also expect to see positive impacts on certain key portfolio metrics, including weighted average lease term and the percentage of ABR from investment-grade tenants. Another attractive option would be to sell the operating self-storage assets at tight cap rates, enabling us to accretively fund future net lease investments or potentially reduce debt. Their operating assets that we know well, primarily managed by Extra Space Storage and CubeSmart and we are very comfortable with the existing management agreements and potential near-term growth from these properties. So we have a variety of interesting options to evaluate, and we'll take our time to achieve the optimal outcome for our investors. The final point I want to address this morning is the impact of the transaction on our balance sheet. Given the relatively small size of the fund and its current leverage profile, we don't expect it to meaningfully affect our key balance sheet metrics. While leverage will tick up slightly, we expect to remain within our target leverage ranges, of mid- to high 5s on net debt to EBITDA and low to mid-40s on debt to gross assets. We also expect to remain well within the secured debt limits expected by the rating agencies despite adding mortgage debt with this transaction. Refinancing this debt may, in fact, present an opportunity for additional attrition through interest cost savings, especially if we issued euro bonds, which would also optimize our debt levels for purposes of hedging our European cash flows. Any potential interest savings have not, however, been factored into our AFFO accretion calculations. Importantly, for the balance sheet, we don't expect to have any equity or debt issuance needs associated with the closing of the transaction. Planned asset sales, primarily CPA:18 student housing assets and certain of its European office buildings that we've targeted for disposition will generate net proceeds that cover almost the entire cash component of the deal. In closing, we view the acquisition of CPA:18 as a unique opportunity to acquire a portfolio that we know well with embedded upside while generating real estate AFFO accretion for our shareholders, effectively including our transition to higher quality and more valuable real estate earnings and further increasing our scale. We believe all of this will lead to operational and capital markets benefits, enhancing both our cost of capital and growth profile going forward. And with that, I'll hand the call back to the operator to take questions.

[Operator Instructions] Our first question today is coming from Brad Heffern from RBC Capital Markets.

Congrats on getting over the finish line. Anything you can tell us about the process here? Was it competitive? Were there other bidders?

Yes, sure. So CPA:18, it's around the ninth year from when we began raising the fund. So based on the prospectus, the guidelines in the prospectus, this was timely to consider liquidity options for the fund. It was really the natural time to beginning discussions with the independent directors of CPA:18. So it was actually negotiated between us and CPA:18 in an arm's length process. I think as you know, when we file the S-4, you'll see specific details of the back and forth, but that's basically what we can tell you right now.

Okay. Got it. And then can you talk about what the implied cap rate is here and maybe give the NOI number for the self-storage business?

Yes, sure. So the going in cash cap rate is in and around 6% for the entire portfolio and pro forma for the dispositions and really the main one that moves the needle is the student housing portfolio that we would expect to be sold as part of the change in control with the purchase option that's embedded in a prior transaction that we've talked about. So pro forma for that disposition as well as some other office assets that we expect to sell, it's going to be closer to the mid-6s for the portfolio. So I think from there, you could probably back into generally NOI. I think with regards to self-storage, it's in and around 1/3 of the portfolio. Once you factor in -- or I should say, take out the student housing assets, just to give you kind of a big round number of the relative scale of the storage relative to the rest of the net lease portfolio.

Your next question is coming from John Kim from BMO Capital Markets.

How does this acquisition impact your guidance for the year as far as the acquisition guidance of $1.5 billion to $2 billion?

Yes. We're not updating guidance on this call. I think that we'll wait until the transaction closes, which we would expect to be sometime during the third quarter. And I think at that point in time, we'll update guidance. Obviously, the contribution from the transaction does depend on the timing. So we prefer to wait until that point in time.

And I would just say in relation to investment guidance, this is separate and apart from the range that we gave at the beginning of the year for investment volume.

Yes. So in $1.5 billion to $2 billion. So we're not... That's right. We're not going to update any of the guidance numbers. And sorry, I missed the part on the investment volume. So we're still expecting $1.5 billion to $2 billion, and I think we'll continue to evaluate as the year goes on and updated earnings calls.

So just to clarify, the $1.5 billion to $2 billion, is that additive to CPA:18?

Yes. That was prior to the CPA transaction. So if you want to add that, you would add the $2.7 billion to it, if that makes sense.

And where does leverage go to? I know you're funding this with cash on stock. Where does it go pro forma for this transaction?

Toni, do you want to touch on that?

Yes. I think we largely view the transaction as leverage neutral in relation to kind of our overall target leverage level. We do expect that on a net debt-to-EBITDA basis that the investment management fees are going away. So we would see a temporary tick up, perhaps to the top end of our range, maybe slightly higher. But again, we view that as pretty temporary and something that we would have -- be very manageable for us as we continue growing our real estate earnings. So no major concerns there from a leverage perspective.

And Jason, you mentioned on the self-storage portfolio, you had a few different options. One was to sell it. Another was to convert to a net lease structure. I'm wondering if there were any other options that you're considering that would potentially allow you to capture more upside in the growth of the portfolio?

Well, I mean, certainly, the other option is we can continue to hold it as operating assets. We're comfortable with the managers that we have in place. It's primarily Extra Space and CubeSmart. I think ultimately, long term, we are focused on owning net lease, given we're a net lease REIT but that's certainly an option to consider as we look through other options as well.

Our next question today is coming from Manny Korchman from Citigroup.

Jason, if I flip through the presentation that you put out, you've got a slide on G&A, and you guys still sort of end up middle of the pack there on the slide, at least. How does the end of the investment management business? Maybe alter that, can we expect G&A to come down as a percentage of the portfolio over time? Or is that we're expecting it to be going forward?

Toni, do you want to touch on that a little bit? .

Yes. Thanks, Manny. I think what you're highlighting is really this is the culmination of the end of the investment management platform. So the shift that you're seeing here, which we're saying is the loss of the remaining investment management fees, and that's -- this is the bulk of it. So adding about $4 million of G&A, which we were previously sharing that cost with CPA:18. It's a same-sized platform. It's the same people managing the assets. I think we feel really good, as we've said about no integration risk. But when you really look beneath that and think about that there is no change in the actual platform, we are gaining a lot of operating leverage in that we're spreading that over a significantly higher asset base. And so I think we're happy with the level of G&A where we are now. We continue to look for efficiencies certainly through technology in other areas, but we don't view this transaction as having a material impact in terms of how we operate.

And certainly, Manny, going forward, this is a very scalable business. So at scale, I could expect us to continue to become more efficient based on that metric that you're looking at.

And then I think. [Technical Difficulty]

Manny, please requeue. Our next question is coming from Greg McGinniss from Scotiabank.

So apologize if I missed this one, but -- so was there a bid process for CPA team? And is there other bidding offers? And if not, how did you guys come to this offer price?

Yes. The independent directors did form a special committee, and we don't have a lot of visibility into what they considered. They did retain their own financial and legal advisers, but we'll find out more about the process and what they considered when the S-4 is filed in the kind of coming weeks. And what was the second half of your question?

So how did you determine which price to pay for these assets?

Well, look, we know these assets well. I think that from our perspective, we're buying a high-quality portfolio, well diversified. As we mentioned, it's got a highly desirable self-storage portfolio on top of the net lease. And so we looked at this from different angles, but certainly, importantly, as we've mentioned, the transaction is about 2% accretive to real estate AFFO, and we think that's a good level of accretion given the size of this portfolio.

Okay. Great. And then which percent of the cash portion of this deal do you think will be covered by the purchase option?

It's probably the $3. It's probably in and around, call it, $2.50, and that's from proceeds from the student housing sale as well as we have 4 other assets that we've identified, 3 of which are our European office assets.

And then what will that leave you with?

So it's a marginal amount after that. It's under $100 million of cash requirements after that. So that's something that we could certainly use our revolver or other sources for that matter. We also have some of our equity forwards that have yet to be settled. So it's not a meaningful cash component that's going to be impactful at all.

Okay. And then will there be any office assets left after those office sales?

There will. It's a diversified portfolio. It has all of the major asset classes within it. We are selling. It's probably about 1/3 of the office ABR that we're acquiring as part of our expected dispositions, and I think we would continue to look at others if it makes sense.

And is this kind of similar office to some of the other parts of your portfolio where it's connected to some other assets, other industrial or warehouse type assets?

So are they on master leases or -- I think it's typical of the rest of our portfolio. I mean a lot of it is stand-alone office. The assets that we're looking at in Europe are well located. Some of them are in city centers, strong tenants. So it's consistent with the office that we have in the rest of the portfolio.

Your next question is coming from Anthony Paolone from JPMorgan.

I guess first thing, the $0.15 that you'll be losing from this. What's the bridge just in terms of like dollars? Because I thought the actual base fee was like $12 million or $13 million a year. And then I guess the rest is your pro rata. Just trying to get like the dollar amounts that? And where they go or what's being lost?

Toni, do you want to touch on that?

Yes. So within kind of the Investment Management segment, there's a number of line items. The significant portion of that is our asset management fees and the interest that we receive from our SGP interest, so the cash flow that you're seeing coming through there. So those are the 2 lines we also have ownership -- existing ownership in the AFFO of CPA:18 as well as the G&A reimbursement. So there's a handful of lines, but I think they're spelled out in our supplemental in a fair amount of detail if you kind of refer to the investment management page there.

Okay. We'll take a look at that. And then the -- in terms of the total deal price, so it sounds like about $375 million goes with the student housing and the office stuff. And then you mentioned $1 billion of assumed debt, but what's the bridge against the -- what's a little closer to $1.25 billion of debt for CPA:18 at the end of the year?

Toni, do you have those numbers?

Yes. I think what you're referring to, the differential there is somewhat related to the debt that's encumbering the assets that we would be disposing off in relation to the dispositions that Jason highlighted in his remarks before the closing. So there's debt on those transactions that, again, we would retire as we sell those assets. And so the net amount that you're seeing is really what remains that we would take on.

And just to be clear, the funding of cash to the cash portion of the deal through the dispositions, that's a net proceeds amount after the debt that Toni referenced.

Okay. So that $3 -- that's cash no matter wherever it goes, because it sounds like some debt will go with the student housing and office assets?

That's correct. I was just clarifying if you were thinking about the gross sale value of those student housing assets as well as the office assets that we're targeting to sell. So I want to make sure it was clear. It's not the cash number you mentioned, that's net proceeds. The gross asset value will be higher even if debt is in place.

So then if we're thinking about really that 6% pro forma cash cap rate -- or I'm sorry, the mid-6s, it's really on something closer to like -- yes, [ 2.3 ] and change it sounds like?

It's going to be lower than that because the gross assets are greater than the cash proceeds that we mentioned. Toni, I don't know if you have some backup there to try to understand.

Yes. It's about -- I think the high level that you're trying to get to pro forma for the dispositions, we're taking on about $2 billion of assets at about that mid-6% cap rate that Jason referenced.

$2 billion out of mid-6s?

That's right.

Right. But -- so sorry for the confusion, but like going from the $2.7 billion to the $2 billion, I thought -- so you're saying the roughly $375 million, call it, roughly that's net -- that's the net cash from the dispose, the gross is something closer to like $700 million thereabouts?

That's correct.

Of the various components. Yes, the different dispositions, that's the ballpark, right.

Next question today is coming from Sheila McGrath from Evercore.

Yes. Just high level, Toni, if you could just walk us through -- I think you said G&A will go up $4 million. Just walk us through the numbers that -- to help us model like on how much investment fees go away, et cetera, just -- that would be helpful.

Are you speaking specific to the G&A, you want the different line item?

Well, the different -- well, also the asset management fees, just so we can model like upon closing, what's going away? And NOI, it sounds like we're modeling a 6.5% cap rate on $2 billion of assets, I think we just got to that.

Yes. So I think the starting point when you look at the midpoint of our guidance range that we previously announced, there's $0.15 of investment management earnings in -- at the midpoint of that range. All but about $0.01 of that goes away. We retain kind of 1 smaller fund, our student housing in Europe, which is much smaller. That's that penny that will remain with us. So really kind of wipes out everything on the investment management side of the ledger. And then you're shifting $4 million of G&A over to the real estate platform as we're no longer getting reimbursement. So I think there's definitely a line-by-line kind of pick that you can do there. And as I mentioned, those lines are available in the supplemental. But the easiest way to think about it is $0.14 of the $0.15 of investment management earnings goes away, and we pick up an additional $4 million of G&A expense while adding, again, $2 billion of assets at about a 6.5% cap rate.

Okay. Perfect. And then just on the self-storage piece, can you remind us again how you did convert self-storage assets to a net lease? And what kind of cap rate was that? I forget what that was.

It's a conversion. It wasn't a sale. So it didn't really have a cap rate associated to it like we're going to earn with the CPA:18 assets at -- upon conclusion of the merger. These will be operating assets, we'll earn the NOI. What we did in the prior transaction when we converted it to a net lease, we set a rent level roughly in line with the NOI level, protecting our downside, participating in the upside, and that was really the structure that we had in mind at that point in time. I would imagine if we did something this time around that would follow a similar blueprint.

Our next question is coming from John Massocca from Ladenburg Thalmann.

So I understand it may need to be general ranges, but what are you assuming in terms of cap rates on the office property sales?

Brooks, do you have any color around the disposition cap rates? I mean these are assets that we expect to market, but we have some general ideas.

Yes. I think for competitive reasons, we wouldn't want to get too granular on the cap rates specifically. But as you can see in the overall math that we've just been discussing, we do expect those cap rates on the dispositions as a whole to be inside of the overall CPA acquisition cap rate, thereby enhancing what's left from a cap rate perspective. These are liquid office assets. We think they'll trade very well, but I'd hesitate to specifically predict on an asset-by-asset basis.

John, maybe what you're looking for is that we mentioned the going in cap rate on the whole transaction is around 6% pro forma for both student housing and the other 4 asset dispositions gets us to a mid-6%. So that should give you the high-level math. But -- sorry, you had a follow-on?

Yes. And I guess where do those assets kind of sit, what do you think is in the barbell of the office portfolio in CPA:18?

Brooks, do you want to answer?

Where do they sit -- sure. In terms of the gradient of office assets, these are pretty high-quality assets, 2 in the Netherlands, 1 in Norway. We think they'll trade very attractively. We've had historically interest in these assets from unsolicited from third parties. So I think these are middle to higher end of the pack in terms of overall office assets, but it's a diversified pool.

And part of our focus on these 3 assets, John, is that they are some of the larger ones as well. So from an execution standpoint few removing parts.

Okay. And I know it doesn't really impact the pro forma total company ABR. But I noticed that the CPA:18 had a little bit of short -- shorter lease term assets that are coming due in 2023. I mean can you provide any color around what those are? Is that just because of the operating component in that portfolio? Or just kind of wondering what that was?

Brooks, do you want to give some color on that?

Sure. Yes. So I mean the lease expiration schedule in CPA:18 is pretty light, really nothing in '22, a few in '23 and '24. I think the key is that we don't expect it to materially change our overall lease expiration outlook on a combined company basis. And I think the important point here is that since we acquired and have managed these properties for their entire life cycle, we have really excellent insight into the lease expiration schedule in each tenant specifically. So that's really fully baked into our -- how we underwrote the offer, and we feel very good about the near-term lease expiration outlook. So I'm pretty confident that we'll be able to manage through that very effectively.

[Operator Instructions] Our next question is coming from Chris Lucas from Capital One Securities.

Jason, congratulations on getting this done. A couple of quick questions. Just following up on Tony's question, sort of the delta between the $700 million in gross sales and the proceeds, is that all mortgage debt? Is there cross-ownership issues? What is the sort of -- what is the delta, what caused the [indiscernible] there?

It should be all mortgage debt. But go ahead, Toni, if you have anything to add.

Right. Yes, I think that's in large part there. I mean the student housing assets have some minor ownership -- third-party ownership, but we're talking 1% to 2%. So it's really the mortgage debt that's the biggest differential.

Okay. And then, Toni, while I have you, what's the cross-ownership NOI between CPA:18 and WPC? Is there much of that?

There is -- I don't have the number at my fingertips, but it's pretty -- it's relatively small. Let me see if I can pull that up for you. I think there's a very small handful of assets that we will now own 100%. One of them is in the disposition pool actually that we're looking to dispose of before the acquisition. But beyond that, it's a really small component of our ABR.

Okay. And then on the timing of the dispositions, is that pretty well set in terms of when those are expected? Or is there some lead time where some of this might run into '23?

No, I think what we've talked about for the disposition pipeline related to this transaction, we would expect that we can sell those assets prior to the closing of the merger. But of course, it all depends on the process. And we have a lot of flexibility, but that's our expectation right now, and that's how we've modeled the transaction.

And then the last question just is -- actually, I'll leave it at that. Thank you for your time this morning.

Okay. Welcome, Chris.

We reached the end of our question-and-answer session. I'd like to turn the floor back over to Peter for any further or closing comments.

Thanks, everyone, for your interest in W. P. Carey. If you have additional questions, please call Investor Relations directly on (212) 492-1110. That concludes today's call, and you may now disconnect.

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