MERLIN Properties SOCIMI, S.A. (MRL) Earnings Call Transcript & Summary

Good afternoon, ladies and gentlemen. Thank you for joining 9 months '23 [indiscernible] update conference call. As we always do on quarterly results, our CEO, Ismael Clemente will provide you with the main highlights of the period and will thereafter open the lines for Q&A. [Operator Instructions] With no further delay, I pass the floor to Ismael. Thank you.

Thank you, Ines. Good afternoon, everyone. Well, we are here today to report on another solid set of results of MERLIN Properties in up to the third quarter of 2023. Many of you might remember that during the full year results presentation 2022, we commented that our expectation for the year was a relatively strong first half on significant inertia from the positive 2022 and a slightly softer second half. Probably what we didn't have the opportunity to comment was the order of magnitude of that predicted softening which has clearly been lower in impact than we expected. While in 2022 as of today, we had renewed 74% of our contracts with a 6.2% inflation average. This year, it's been 70% of the contracts with 5.7% inflation average. This is why the second half is slightly a little tad softer than the first, but clearly well above our expectations. Particularly, offices where our asset management team has made a great effort in keeping occupancy stable and obtaining not only full pass-through on the rents on the inflation, but also in terms of achieving modest release spreads in the renewals. Likewise, our logistics team covered a fantastic quarter. Occupancy is now reaching 99%, which is an all-time high for us. And it continues to underline the strength of the logistics business in Spain, for which we can subsequently comment during the Q&A. In shopping centers, we are amazed by the strength of consumer demand in Spain, both like-for-like and real spreads have been significantly high and we continue to see good performance through the Black Friday campaign and the Christmas campaign if nothing goes wrong, specifically at a local level. Occupancy overall of the company has reached a new high at 96%, which is remarkable because it is no longer positively affected by the 100% occupancy of the BDA portfolio. So it is -- that is important to note. Regarding our data center program, we have delivered our three data centers on time on the 30th of September in Madrid, Barcelona and Bilbao to the anchor client and are currently working on a number of initiatives in order to continue furthering our pioneering effort in that line of business. Our NTA per share with no revaluations in the period stands at 15.49, whatever it means nowadays. But this is our NPA at present. Without further comment I am happy to take your questions.

[Operator Instructions] And we already have a question. Its from the line of Mariano Miguel from Banco Santander.

I have a few questions on the mega plant and then one on offices.

Mariano, sorry, but we cannot hear you very well.

Now it's better. Now?

Much better, thank you.

I've got a few on the mega plan and being one on offices. So first, we've seen recently different articles talking about a potential acceleration of the whole plan pointing towards different options involving in some of the corporate transactions. So I was wondering if you could give us a bit of color on this. And then in the 9-months release, you revised upwards the expected given cost on the first 58 [indiscernible] of the plan. So on one side, it would be interesting to understand the reasons behind, one side, the higher CapEx on the other -- the much higher rental income for [ SIM ]. And also, how should we think about the next phase of the plan in terms of potential returns. And finally, on [offices], sorry for that long. It seems that the year will finish better than expected. We've been able to renew an important contract mattering in 2024. So -- if you could provide a little bit of color and expectations for the next exercise and also on the release rate on that contract, that will be welcome.

Okay. Look, well, first, regarding the press article on how we are planning to act on data centers, but I can comment is that we have, as commented, finished and delivered on time or fee structures with -- fitted with 3 megawatts each, so for a total of 9 megawatts. Clearly, we have been mistaken in the estimate of the demand that we will find in the market. We have been too prudent. In the General Shareholders' Meeting, we already hinted to shareholders in April that the first phase of technology demonstration of our data centers that we intended -- in which we intended to reach 12 megawatts commercialized and 3 data centers opened by end of 2024, was to be construed as 15 to 18 megawatts by end of 2024. Then in our results presentation in July pertaining to the first half -- we already commented that we were placing orders of equipment in light of the demand in order to reach approximately 33 megawatts equipped by end of 2024. That's why when you see in our presentation, the CapEx breakdown, you will see that there is CapEx till end of 2024 and then there is a little CapEx also to be incurred during 2025 in order to reach the 58-megawatt capacity, which is total in our three existing facilities. What I can share with you now is that we have activated an acceleration of orders so that those 33 megawatts can be fitted in our facilities up to 30th of June. So we will probably be already [endowed] with 36 megawatts as sort of end of June. And we will continue fitting during the rest of the year and throughout 2025, up to reaching the maximum capacity of 58 megawatts, although that might or will accelerate depending on how we see not even demand, how we see the installation of our clients within our facilities, which, as you know, by nature in this world of data centers is relatively staggered. At present, our order book more than covers all of our available capacity. So now we are embarked in basically a next step, which is addition of capacity. This problem is further slightly aggravated by the fact that we have had some problems with the staggered delivery of capacity in Madrid, but it will be significantly compensated with the fact that we might probably repower to a superior power in Barcelona. So we are doing things basically keeping track with our many times revised business plan. The demand we are encountering in the market, it is important to highlight that we have devised a business plan that was mainly intended for cloud services. The truth is that the reality we are finding is that we are signing between 10% and 20% of our capacity with cloud services, 80% or more with generative AI operators. So the game changer clearly has been generative AI, which is also helpful because it brings cash flows slightly closer to moment 0, which is good. And you can achieve slightly better pricing than you can achieve in cloud. Hence, why we have now shown our most recently recalculated yields on cost growth, of course, then there is a gross to net that you need to take into account, which in data centers can be significant. The other nuances that generative AI bring to the table are bigger orders in caretaking, but those bigger orders come at the price of a much more significant scrutiny on the technical due diligence. Because, of course, they need to be fully operational on day 1, and they check every aspect of your technical operation. And that simply delays a little bit the moment between reservation and signature of contracts. On our side, there is also the need for a more thorough credit analysis because we are talking about significant order -- I mean, significant backlogs, and we need to check that those backlogs are good enough. And the contract negotiation, however, could be slightly easier, always taking into account that converting an American work order made by e-mail into a Spanish lease law, 180-page contract is never easy. It is exactly the same, but you need to convince your counterparty that it is exactly the same. So there is always some time lag in the middle. Hence, why we have decided basically to go the route of playing statistics and covering our order book more than one so that we can have replacement in case somebody finally falls in the last minute. Next steps, which are important for our business is, well, first, sign all leases and fill up to the maximum or of our capacity. As soon as this is achieved, start the second building in [Arasur], which will be good for 48 megawatts IT power, that is [Arasur] is past country, which is, you might remember is the landing station for Maria and for Grace Hopper and at the end of next year '24, we will be also welcoming Anjana, the biggest subsea cable from the U.S., which is being laid out by Meta as we speak. The other next step, which is important for us is obtaining the license in Lisbon because we are seeing significant demand for that 100-megawatt generative AI campus. The location -- the lease 1 location is extremely attractive for engineers across the pond. So this is basically where we are in terms of development of our mega plan. And you have also your explanation of iron cost and next phases. Regarding speculation in the media about capital increases, et cetera. First, let's do a recap of where this need comes from. Basically, we devised for our Board of Directors a business plan that encompassed readying between 58 megawatts and 70 megawatts, whatever was good to reach approximately EUR 75 million of income by end of 2027. That meant basically 5 years. The cost for this oscillated between EUR 520 million and EUR 640 million, more or less year. We are good for those figures. But those figures were spread in 5 years. And what we have found is that we would probably need to incur in such CapEx in less than 2 years. While this means a certain stress to our P&L, it is not a stress that we cannot cope with. So clearly, we are good and we can more or less easily cover that kind of CapEx. The problem lies with the remainder of the 178 megawatts of IT capacity that we have in our billing, which in our original business plan, if you look at what we explained to you during the analyst presentation, the Capital Markets Day in Barcelona, those 178 megawatts spread to 2035 and beyond. If -- because of the market strength we need to bring those 178 megawatts to something closer, meaning 26, 27, that means the plus, we are not holding our horses. I mean we continue working on a series of new projects in Spain and Portugal, trying to secure power in our existing land or buildings of hours plus also looking at third-party assets. So if we need to bring all that expense closer, that means we need something between EUR 1.6 billion to EUR 2 billion CapEx in order to build the remainder, EUR 170 million all at once. And that, although you might think this is a luxury problem. Of course, it is a luxury problem. But from a managerial standpoint, it is a problem. So we need to tackle it. We need to have a course of action decided beforehand in the company in order to tackle that difference in -- difference, numerical difference and acceleration of CapEx. The possibilities are wide. There will be one possibility, which is simply to deleverage the company. Many of you say, okay, you can do it because it's bottom of the cycle and interest rates will go down and you can do it safely. Yes. But I don't think a company like this with EUR 11 billion in assets, which should go to the casino and play all of it on the 27 [indiscernible]. I believe we have to act a little bit more prudently than that. And I'm sure that Miguel Ollero, who is by my side, our CFO, will slip better if we do things on a more prudent way than simply deleveraging to the bonds. The other possibility clearly is bringing in capital and that capital can be brought in downstairs, I mean, at the data center subsidiary level or upstarts. We have engaged in preliminary discussions with our BOB, which have meant also a number of checks with some Spanish-based investment banks. And we have been looking at the different options that we have in front of us and able to need to raise capital for that, let's say, accelerated expansion in data centers. As you know, 70% of the employees of this company are shareholders. So rest assured, as we have commented in many occasions that we are not stupid, and we are not going to provoke a capital raising at the top co level at current share prices, even if they have significantly improved and will probably continue improving as compared to the moment in which we started discussions with the DoD regarding this possibility. However, we have calculated returns for investors and we believe pretty interesting returns can be achieved by an investor at certain levels of entity price that will reflect a fair valuation of the company, hence, a significant premium compared to current trading levels. What will end up happening, we don't know. We will try to act in the best interest of existing shareholders because we are existing shareholders and all the R&D of this company towards having the promising data center activity that we are having today has been born since 2019 by the existing shareholders. Therefore, our respect to the existing shareholder base is maximum, and we will do whatever we believe is best for the interest of shareholders. Of course, this is a two-way process. There will be a counterpart in front of us which we'll argue in terms of pricing, and we will try to do our best to achieve a good solution for all parties involved, recognizing that if we want to accelerate the data center expansion business plan, which is in the best interest of everybody, including existing shareholders, we will need to engage in such discussions with the capital provider. So that is all I can comment as of today on data centers, next?

There was a second question. Mariano can you remind us [indiscernible] ?

It was simply -- sorry, because I mean it took very long. It's simply about color and expectations of offices and the lease spread on the contract within your [indiscernible]

Okay. Look, Mariano, on the release spreads, I wish I had an idea. What I can tell you -- [indiscernible] the specific contract information we cannot provide to you. But I can tell you that the A1 has positive release spread, okay? So despite all the mid and relations we have achieved positive lease spread on A1 contracts, which is not only Indra, there are some others, but Indra, let's say, big. Expectations for 2024. Look, I wish I had a crystal ball. I don't have it. Clearly, as we have commented in many cases, there is I would say, communication between CPI pass-through and [risk] spread. So it is obvious that in an environment of high inflation, you are always eating and eating on your reversionary potential vis-a-vis the market. And the clients that accept a full investing CPI pass-through sometimes protect a significant release spread and vice versa. If they accept a release a hybrid spread, they want you to have at least the first year of inflation. So it is up to our office team to negotiate the best solution possible for the company, knowing that both ingredients go aay into like-for-like. So whether it is full pass-through [indiscernible] for the company, knowing that both ingredients go way into like-for-like. So whether it is full pass-through or it is release spread, they all go in offices. Providing more color on the market, I can tell you that so far, the fears that come from the other side of the Atlantic, are not pretty much at present, applicable to our market. As commented in other calls, one equals behavior that we are seeing in our clients is that they normally mistakenly calculate their needs for space. We have recently had an anecdotical evidence with a very big client that contracted with us a number of square meters. We thought they were approximately 20% short of what they really needed and told them openly that they were wrong. But they, of course, told us that their bosses in the U.S. expected them to reduce square meters for the sake of reducing. The end result has been that we have finally ended up signing a contract with a 100% owned subsidiary that takes us exactly to the same situation that we indicated to them at the very beginning. This is repeated all across the portfolio. We have other clients in also recently inaugurated buildings in Castellana, which initially left one or two floors empty that we knew they would end up occupying. So what we did is temporarily, we occupied them with new co-working spaces. And at the end, they have been reclaimed back by the clients. So I see people swimming in uncertainty as probably everybody else in the world. But I don't see a significant weakening of the office demand. And if there is some weakening is, again, more owing to uncertainty than it is to a softened economic activity, which at some point, might come. But for the moment, employment in Spain remains good, and economic activity remains good. So we would expect normally pretty reasonable 2024. I cannot tell you whether a super good year, super bad year, but I would expect a reasonable 2024.

We have another question from Fernando Abril coming from Alantra.

I have a few questions. One feedback from Mariano [indiscernible]. So it's about offices again. So I don't know if you can comment on your current reversionary potential on your office portfolio regarding prices. Then second is on sub-ncentives. So trends continue super strong. But my question is on renewables again. Still a few renewables year-to-date, but you face a big amount in 2024. So I was wondering if you can comment on your expectations based on the conversations you may be having with tenants? And if you expect neutral or positive release spreads in 2024? And third, data centers. I don't know because you comment a lot on this topic. Just on your CapEx expectations and your rental expectations for the next 2 to 3 years. I don't know if -- how this would change if you start working on the Lisbon data center?

Okay. Look, on offices, reversionary potential I don't have it handy with me, the one that we internally calculate, but I tell you for sure, it is now lower than 10%, okay? So let's leave it there. Although it is important to note that the market continues going up. So note that every lease we have been signing in [indiscernible] has been at a higher rate than the previous one. And that trend is continuing. And we know of particularly small leases, which are being signed by some of the boutique specialists in the Madrid market like Muto, et cetera, at rents starting with [ 500 ], okay? So that is very, very interesting and provides us with a very interesting comparable for our lease-up activity. So we don't really see a significant softening as is evident in some other places in the world, particularly in the U.S. and well, and a little bit also in London, which is where those fears are coming from basically. At some point, if there is an economic softening, everything is possible, but not for the moment. Some interesting themes, which we are seeing in the market, are as follows. One is new supply has never been a problem in Madrid and Lisbon. But what I can tell you is that at present is zero, means nonexistent. I mean nobody is really now building anything in offices because that -- the wave of negativity on the asset class, which is coming from across the pond has reached the capital sources and the debt sources, and it is not easy to finance or fund an office project. The second thing which is important is that we are starting to see the first signs of some stock distraction as a consequence of office to resi conversions. We are protagonists in a number of them here and there, small things, but everything counts. But we are seeing that as a widespread trend in the market, which has also helped by the more pro business regulation, which is starting to be applied in a number of Spanish cities barring probably Barcelona. Okay? So that is what we see. And this will, of course, contribute to the market finding new balance and really liquidifying itself at some point in the future. Because at present, as commented on many occasions, the investment market is mainly now down to transactions with family offices in the 30 to 60 million ticket maximum, and there is at present no institutional capital chasing office assets in the market. Regarding shopping centers and our expectations for renewals in 2024, I can tell you that at present, our stance is positive. I have here with me [indiscernible], who is the Head of Retail and Logistics in the company, and he's giving me his thumbs up. So basically, that means that the role of renewals that you are eventually seeing in our presentations, you need to know that a significant part of it is the 1-year revolving renewals pertaining to one or two big clients, namely one big client, which always operates on a 1-year revolving basis. But as you might know, that big client has left us completely aside from the significant closure program that they have conducted in the past. Well, so -- and the rest is, I would say, ordinary renewals that will be tackled in due time with no specific concern about whether the clients will renew or not. Of course, I can provide more color during the full year results depending on how we see the Black Friday and Christmas campaign. And if we start seeing something different, we will be the first to comment differently. So -- but at present, this is the -- what we see. Regarding data centers and the lease on artificial intelligence campus, yes, the lease on campus brings a slightly different CapEx, higher CapEx because it sits on a river bank on a highly seismic territory. So that means basically that you need to provide for a number of construction solutions which make the CapEx a little heavier than in other assets. However, rent also look significantly better than in other locations, given the desirability of a lease on [indiscernible] to American engineers. So we are, I mean, happy with the numbers, and we will, of course, provide reprojected numbers as soon as we start and have evidence on the real costs when we have costed and priced correctly the project.

So the next question comes from the line of Florent Laroche from ODDO.

Thank you for all this information. Maybe I would have a question maybe on your disposal plan and valuation of assets. I noted that you have a budget for this year, maybe to dispose between EUR 80 million to EUR 100 million. So I don't know if you have any discussion in progress as of today? And I don't know if you could give us any comments on the current campaign for the valuation of assets? And maybe another question on logistics. Could you please remember us what is the pace expected for the development of the [indiscernible] how is this in your portfolio?

Okay. Well, regarding the disposal program, we have a budget for the year of EUR 80 million and EUR 100 million. We are perfectly on track to make a cruise. The only difference could be timing because there could be 1 or 2 transactions that might slip into the beginning of '24. Because everything now is a little bit more difficult in terms of signature or let's say, between head of terms to due diligence on signature, it takes a little bit more time used to take in the past. That budget is perfectly good. Probably to be exceeded because we are the first partly interested, of course, in providing as much a recycling of capital as possible to feed our data center program. Valuations on those disposals at present, all of them above gross asset value. I know might look impossible, but it is the situation at present. I mean, of course, we have no problem if we need to dispose an asset at or slightly below books, we will have no problem at all doing so. But at present, this is not the case overall on our disposal program. Regarding valuations as of 31st December, at present, we don't have visibility yet because we haven't had yet the preliminary meetings with the [indiscernible]. But I can tell you that you should expect lower valuations. Why? Because of not expanding cap rates. So let's be frank about it. Everybody knows. There is no point in acting in denial of that. And by the way, with NTA at 1,550 and being trading at 9, there should be no special problem in bringing that NTA down a little bit so that the NTA and the reality approach little by little, which I hope will end up closing the gap by both things, reducing the NTA and increasing the share price. The -- important to say also that at present, the gross variation in valuation is still to be significantly offset by a better operational performance. This company continues creating alpha plus CPI continues helping us for the moment. So as you have seen in the past, shopping centers in gross terms have probably adjusted close to 30% since before COVID. However, when you look at net, the difference is not that big because part of that difference in cap rate expansion has been absorbed by better-than-expected performance, operating performance. Same is true for offices and logistics in which, in some cases, we have gone even positive, like in the first half of the year. That is all on logistics. You made a question of at which moment we are starting the 180,000 square meters. They will be started between end of this year and beginning of next with the idea to have them ready if at all possible on before year-end or beginning of '25. So we are progressing with that logistics program business as usual.

Next question comes from the line of Jonathan Kownator from Goldman Sachs.

One, just to finish on the logistics theme. So can you comment on how much you intend to spend CapEx? I know you had also land reserves. So you to put these plans on the hold given the data center requirements? Or are you continuing to plan for that? And second question, just on the data center very quickly, would you consider to spin off that business given the significant CapEx requirement or do you want to keep it on the Merlin?And let's start by these two and then we can talk about the office pipeline afterwards.

Okay. Look, on logistics, well, you have a reconciliation of what we are starting and what remains in our billing on Page 4 of the presentation. There, you will see that the 180 square meters that we are about to start involve CapEx of around EUR 109 million for an expected gross rental income of EUR 10.4 million and therefore, a yield on cost in the region of EUR 7.4 million. Regarding the remainder, the 425,000 square meters that we keep in our balance sheet. Our present cost estimate is in the region of 233 , okay? And the expected gross rental income is close to EUR 25 million for a yield on cost at or above 7%. The reason why if you divide gross rental income by pending CapEx, you get to 10%. And we say the yield is 7%, is cost of land. I mean, basically, it is land that we already own because we bought it in '16, '17, '18, and we are keeping it basically at cost in our balance sheet. So that is on logistics and land reserve. Then on the DCs, you made a question regarding the possibility of a spinoff. Jonathan, can you repeat the question?

Yes. Just to consider, obviously, I mean, if you keep -- because obviously, one of the options in terms of funding, I know you can raise IP at the [indiscernible], you could raise funding at the sort of subsidiary level or just a data center, but you could also consider spinning off the data center to raise equity directly from the market in the data centers. Just wondering that whether that was an option on that.

My thoughts on this, they are very preliminary, but my thoughts on these are as follows: it is going to be mainly a mathematical decision. So wherever we can achieve better pricing for the shareholders of the company, we will carry out the transaction. So we are relatively -- we are going to be relatively agnostic on where to execute it. However, one thing that I can tell you out of experience is that the type of people, which is approaching us for an investment at the DC subsidiary level tend to be higher cost of capital than the people approaching us for a top co investment. So we will need to play with that peculiarity when doing our calculations because it makes a big difference. And the second thing which is important is SOCIMI regime. I mean, spinning off -- I mean, playing with boxes, M&A style in a company which is subject to a very strict legal regime, is not that easy. So we need to double check what can be done and how this can be achieved, plus there is a problem regarding staffing. Do you take stuff from the top and send the downstairs, not easy. So we need to check the different alternatives. We need to check the different characteristics of the different business plans which are offered to us and take the decision, which is in the best interest of our shareholders.

Okay. Very clear. Just a last question. So on the office pipeline. I mean, obviously, you mentioned in your disclosure that you've got a number of projects in offices as well. I don't think there was details as of Q3. So I just wanted to understand what is the status of the main projects, plus AristiCassle, Ateca 1, PLZFA, what is the status of these projects?

Look, on the office pipeline, [indiscernible] is about to be delivered to the first client on the first of December. So remaining CapEx in that building is only the, let's say, the payments to the construction company, which normally go a number of days or months after the works are executed, and they have been verified by our project management people. Regarding other office projects, we are not doing anything big or which can really move the needle in terms of the company. We are doing some refurbishment of buildings in [indiscernible] with 100% occupancy, and we are going a little by little. So as we are emptying one building, we are pre-letting the next. And we are little by little, refurbishing all that location. There is a Lisbon Liberdade building, which at present, we are in the middle of the licensing project. So until we don't achieve license, it is a little bit premature to comment on that project. And what basically this is -- at present, this building is 100% occupied, I mean by Novo Banco. So we we're in no rush to start at that reconversion. So on offices, we will continue doing business as usual. We are a company offices have not disappeared from our balance sheet. So whether you like it more or you like it less we need to continue doing some investment in offices because we need to upkeep our portfolio state-of-the-art because this is what is giving us a 24% market share in terms of letting when we are only 4% market share in terms of space in Madrid or Barcelona or Lisbon for argument's sake.

Just -- I mean if it's possible, I mean, that can be taken off line, but it'd be good to have a big disclosure of how much CapEx do you expect for that for the project, the empty buildings, the R&T or not, and the size of these buildings? That would be helpful because we're kind of losing track a bit of what's becoming vacant for rest.

I recommend Jonathan you call [indiscernible], and they will provide you with all the details you need in terms of the CapEx in offices.

So a, there are no further questions. We thank you all for joining today's call. And as I said, we remain at your disposal for any further questions or comments. As always, you can reach as back for more e-mail. So that's all. Thank you very much, and have a great weekend. Good-bye.