PSA - Life Storage Equity Holders Should Expect A Higher Offer From Public Storage

Summary

• With PSA's most recent moves, including the increased dividend, LSI's management team will have to engage in M&A discussions.
• We believe that any discussions will lead to a higher valuation for LSI, especially as the deal is all-equity and taxable to LSI shareholders.
• The combined company would be a monster in a fragmented industry, which would provide significant cost savings and further growth opportunities.
• This would be PSA's largest acquisition ever; double the size of 2006's Shurgard Storage Centers purchase for $5.5 billion.

In what is normally a pretty quiet and boring area of the REIT world, Public Storage ( PSA ) just made things very interesting by going public with their unsolicited takeover offer for Life Storage ( LSI ). In this area of the market it is rare to see the publicly traded self-storage REITs merge as their sights are usually on smaller players within specific geographies or the larger private regional players. We have seen some mergers between the publicly traded REITs over the years, but due to so few of them being listed, the vast majority of the M&A activity occurs with the publicly listed REITs being the acquirers of the smaller players who are not publicly traded.

Deal Parameters

Public Storage is offering to acquire Life Storage in an all-stock transaction where "holders of Life Storage shares and units would receive 0.4192 shares of Public Storage common stock for each Life Storage share or unit they own," according to the press release . Based on Public Storage's closing price on Friday of $308.47, this breaks down to about $129.31/share which is roughly 16.9% above the Friday close for Life Storage.

Also of interest for Life Storage holders is that Public Storage announced a 50% increase to their quarterly common dividend , which will increase the quarterly rate from $2/share to $3/share and increase the annual common dividend from $8/share to $12/share. This is important as it now makes the Public Storage dividend more attractive than Life Storage's - which they raised about a month ago . Public Storage's management team is betting that a richer payout than what Life Storage shareholders are currently receiving, coupled with a premium (although via equity swap) will be enticing enough to force Life Storage to the bargaining table.

One important note: the deal is structured so that the combined company would get a step-up in the tax basis of the acquired Life Storage assets because the transaction would be taxable for Life Storage equity holders.

Our Take

It is important to also note that Public Storage previously attempted to engage Life Storage in M&A discussions (starting in late 2022) and were rebuffed. The company included letters in their press release highlighting this. While Public Storage did not sweeten the deal from those prior discussions (as the ratio of Public Storage shares Life Storage holders would receive remained the same throughout the provided communications), it is our opinion that this is an opening volley. There is little reason to negotiate against yourself, especially when the other side is not engaging. However, with the parameters and construct of the deal, Public Storage might need to offer a cash component to the deal to take it to around $140/share or increase the equity offer so that Life Storage shareholders receive approximately 0.4539 shares of Public Storage - which would also take the deal value to about $140/share based off of Friday closing prices.

We do agree with Public Storage that a merger would be beneficial for shareholders of Life Storage as Public Storage has an inhouse development team that not only redevelops older properties but builds new facilities from the ground up. That opens up new markets and opportunities for Life Storage, which has focused on purchasing already built facilities and leasing them up or redevelopment.

In short, we think this is a deal that can create value but we do think that Public Storage is going to have to increase their offer in order to push this over the finish line, especially after calling out Life Storage's management in the press release.

One Item To Watch

Public Storage controls about 10% of the self-storage market and is the largest owner of self-storage as measured by square footage. Life Storage is the 4th largest player, and has a 4.2% market share. The industry is highly fragmented, so although Public Storage and Life Storage are top-5 players, the combined company would have just under 15% market share.

Due to the size of the transaction and how it would alter the market, a merger might catch the eye of Washington with the Department of Justice paying particular attention to mergers that consolidate industries and have the ability to impact consumers and other competitors. This transaction might fit the bill as the combined company would be nearly 2x as large as the next largest competitor, Extra Space Storage ( EXR ), and over 3x larger than the other large, publicly traded self-storage names. Add in that both Public Storage and Life Storage have 3rd party management platforms, there are joint ventures present and both are quite active in the market for purchasing smaller owner/operators (or newly developed facilities in lease-up) and one can see that Washington might want to take a closer look at this transaction.

We are not saying that they will, but the current administration has been focused on preventing major consolidation within industries and even scrutinizing deals that did not consolidate market share but had the potential to increase prices for vendors and consumers.

Final Thoughts

This deal makes a lot of sense for both parties, which is why we think that it will get done so long as the DOJ does not take an interest into the market or the transaction itself. If interest rates are to remain elevated moving forward, the combined entity would benefit from the higher credit ratings and more robust balance sheet. The all equity offer also maintains current leverage rather than adding to debt, and that is key, as we believe it could provide the combined company with additional financial flexibility for acquisitions or balance sheet optimization moving forward.

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