Analysis: signs point to an 'M&A binge' in the wings of the logistics arena

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It is easy to speculate that a flurry of deals worth billions of dollars – perhaps $30bn or more – could be waiting in the wings of the logistics arena.

This is a simple conclusion, drawing from recent deal-making activity in a sub-segment that, in late 2017, I defined as the first level of “downstream logistics” and which involves providers of distribution facilities, logistics properties and services.

Background

At the end of April, San Francisco-based Prologis announced it had agreed to merge with domestic rival DCT Industrial Trust, retaining a controlling stake of about 85% in a combined entity whose customers are some of the biggest companies in the transport industry.

Source: Prologis

The $8.4bn all-stock deal, which is expected to close in the third quarter, was promptly followed in early May by the purchase of Gramercy Property Trust (GPT) by Blackstone. The private equity powerhouse shelled out $27.50 a share to secure the ownership of a real estate trust that mainly deals with industrial properties.

The buyout valued the target at a whopping $7.6bn, which is even more remarkable because the PE firm went solo for it, with closing due in the second half of this year. Blackstone’s move was clearly opportunistic, given the depressed share price of the target when the offer was made, as well as the implied premium offered to snap up GPT.

If you are unfamiliar with the sector, GPT’s weakness was rather unusual, given the skyrocketing levels of the shares of other companies in the sector.

Source: Morningstar

No surprise

Rapidly rising M&A activity in the space concerns different players in terms of business model, end markets, geographical mix, clients and operations. It is a function of new clients’ needs: surely, an M&A binge in the second half of the year could be the natural continuation of last year’s trends.

We highlighted the takeover battle for Singapore-based Global Logistic Properties (GLP) in December, labelling the deal as the star performer in supply chain M&A activity in 2017.

These events won’t be surprising for The Loadstar readers. At the end of last year, I wrote that some of the smaller deals announced in the fourth quarter were “nothing compared to what is about to come in the fight for infrastructure and warehouse space, with private equity in the driving seat”.

Latest capex stats and trends from the US are also impressive.

Source: The Economist

It’s very easy to identify palatable targets, assuming another wave of deal-making comes soon in a sector where only a few players have a generational gap problem. But several public companies have free floats close to 100%, rendering consolidation at a fast clip an easy suggestion to make.

UK appeal

Just above the $7.6bn-$8.4bn Blackstone/GPT-Prologis/DCT range, the UK’s Segro, with equity currently worth almost $9m, is a less likely takeover candidate for private equity – unless its valuation falters under competitive pressures, or debt is redeemed, and leverage drops a bit – than for large trade buyers from the US.

But the takeover allure for those in the latter category is obvious if its shares fall from current levels.

A takeover is one possibility, but this logistics property developer could also act as a consolidator, both domestically and internationally, using a richly valued stock to finance transformational M&A, given where its shares trade in terms of multiples. Also, it has options, as it turns over about 70% of its sales in Britain, so it might continue to grow organically in neighbouring countries, for example.

Its latest trading update speaks volumes not only about its growth prospects, but also testifies to a wise capital allocation and an appropriate amount of leverage to pursue rapidly rising returns for its shareholders.

About a decade ago, it was a rumoured takeover target for British Land, but I suspect now the most likely scenario with BL would be one where Segro is in the driving seat, if it ever returns to the negotiating table.

As I wrote earlier this year for Transport Intelligence (“Ever-present demand rings the till for Brexit-bulletproof Segro“; log-in required), the supply of new warehousing remains stable, and is particularly constrained in urban markets where competition from higher value uses (such as residential) is a significant barrier to entry for industrial developers without land on which to build.

Segro looks so promising that its stock trades at almost 27x forward sales against its enterprise value, and its adjusted operating cash flow multiples are among the highest in the world, considering mature businesses in all sectors (20% premium vs Amazon’s).

Another highly valued stock is the UK’s Big Yellow Group, but it is much smaller than Segro in terms of market value ($2bn) and revenues (£117m vs Segro’s £273m). As with Segro, net leverage is meaningful, but it is sustainable only if it continues to grow. Its stock similarly trades at rich multiples (15x forward revenues and 23x Ebitda).

Another rising star you might have missed in the UK is Safestore Holdings ($1.6bn market cap, £130m of sales), which acquired Stork Self Storage for £56m last year. It is leveraged, too, but its stock trades at a discount to Segro and Big Yellow, based on most headline metrics.

US higher up

Valuations remain crazy on both sides of the Atlantic, I admit, yet if recent macro and micro trends – from changing consumer habits, to the e-commerce boost, via investments in available space and infrastructure by large corporations, digitisation, inflation and other macro metrics – are confirmed… then I reckon the downside could be limited, although aggregate net leverage projections should raise eyebrows, whether a bubble here is about to burst or not.

Ranking above Segro, as gauged by equity values, three US behemoths stand out: Public Storage ($37bn market cap), Extra Space Storage ($12.4bn market cap) and Duke Realty Corp ($10.2bn market cap).

(Let me spell it out: about $60bn of aggregate market cap for these three “giants” equals just about $4.7bn of aggregate trailing sales.)

Given the hype, these companies are just as likely to be consolidators as targets, of course, and M&A of any kind “is unquestionably an option for all three”, a US banker from New York told me recently.

Similarly, Ascendas REIT could turn acquisitive this year, continuing to pursue its M&A-led strategy. Analysts are particularly bullish on its growth prospects, with reports suggesting that it “remains a prime beneficiary of the expected turnaround in Singapore’s industrial sector but looking ahead, the A-REIT is also seeking to tap into the US and Europe markets for potential acquisitions.”

Thanks to market appetite, the size of recent deals and market values and multiples of Extra Space Storage, Duke Realty and Ascendas REIT alone, the M&A volumes surge could be impressive if these three attract interest either from private equity or strategic infrastructure investors.

If these three were poised for a change of ownership, even excluding the three previously mentioned UK-based players, and just assuming a small premium in line with the take-private deal of GPT, we could reach more than $30bn of deals in a flash – and that is before mentioning a slew of other potential targets.

Others

As the South China Morning Post reported last week: “Warburg Pincus, the US private equity firm that failed in the 2017 buyout of the world’s largest warehouse operator, has set its sight on China’s No 2 manager of logistics space [China Logistics Property Holdings], as it jostles to enlarge its footprint in the country’s booming e-commerce industry.”

And how about Australia’s Goodman ($13bn market cap)? If consolidation speeds up, it could hit the M&A trail overnight. It is no stranger to M&A; earlier this year it agreed to sell its portfolio of European logistics properties for €600m to a dedicated fund owned by Blackstone.

Finally, the smaller players are either weakening or growing stronger: “that is our bread and butter growing healthy”, another banker in the US remarked this week.

Life Storage has reached agreement with activist investor Jonathan Litt that “could make the storage-facilities owner a takeover target as rents in the business come under pressure”, Bloomberg reported earlier this year.

Elsewhere, the future of Industrial Logistics Properties Trust (ILP, $1.4bn), following its fall in value since its IPO, is also worth a mention. Analysts at Bank of America Merrill Lynch have suggested they expect $200m of deals this year, but will ILP expand its free float or welcome new investors?  

And there’s more to come, aside from M&A. Terreno Realty has been described by the press as being on an “acquisition spree” – organically, this time, as it keeps acquiring new properties – while the pace of growth associated to property deal-making has accelerated since the chief executive of STAG Industrial said last year that cost of capital improvement and new opportunities could not be overlooked, hence more property purchases.

If this is a bubble, it is not very well concealed.