2023-07-03 12:31:17 ET
Summary
- Extra Space Storage is acquiring Life Storage in an all-stock deal valued at approximately $47 billion, which is expected to close in the second half of 2023.
- The acquisition will create the largest self-storage REIT in the US, with over 3,500 locations serving more than 2 million customers, and is expected to be transformative for the industry.
- The deal is seen as a win-win for both companies, with potential benefits including improved cost structure, increased occupancy rates, and enhanced pricing power.
Extra Space Storage Inc ( EXR ) is in the process of acquiring Life Storage Inc ( LSI ) through an all-stock transaction valued at ~$47 billion by enterprise value. The deal was announced back in April 2023 and is expected to close by the second half of this year. For every share of Life Storage investors own, they will get 0.895 share of Extra Space Storage. Post-transaction, Extra Space Storage’s equity holders will own ~65% of the new entity and Life Storage’s equity holders will own the remaining ~35%. This deal makes perfect sense as there is a need for consolidation in the US self-storage industry to prevent overcapacity ruining the economics of these properties (a problem seen during part of the 2010s decade). I’m a big fan of the tie-up as it will generate material synergies while creating the largest self-storage REIT in the US, making it transformative for the industry at-large.
The broader US self-storage REIT industry has a promising long-term growth outlook underpinned by secular tailwinds, namely the desire for US households to economically maximize their living space in the face of booming housing prices seen nationwide since 2010. One of the reasons why I’m a big fan of the self-storage property space in the US (with a long-term time horizon) is due to the immense pricing power these entities have.
Part of the industry’s pricing power comes from the logistical difficulties facing households as it concerns moving the stuff they have in self-storage to another location if they balk at rental rate increases, especially for those are utilizing these services over the long haul. Put another way, if households want to keep that stuff stored outside of their home, generally speaking they need to accept the rental rate price hikes due to a lack of options short of throwing that stuff away. Another aspect of the industry’s pricing power comes from the high occupancy rates self-storage properties in the US have historically experienced, supported by population growth and rising housing prices. As self-storage monthly rental costs are usually just a sliver of the average US household’s budget, it's easier to push through meaningful rental rate increases as compared to say, home rental rates.
Overview of Life Storage
Life Storage manages approximately 1,200 properties across 37 US states and the District of Columbia. That includes ~760 properties wholly owned by the REIT, ~140 properties that it manages via joint-venture arrangements, and ~300 third-party properties that it manages but has no economic interest in. Its asset base is geographically diverse, and Life Storage is a stellar cash flow generator. During the first quarter of 2023 , Life Storage generated $121 million in net operating cash flow and spent $30 million on its capital expenditures (‘improvements, equipment additions, and construction in progress’ plus ‘investment in unconsolidated joint ventures’), allowing for $91 million in free cash flows. However, that fell short of its $104 million in total payout obligations (‘dividends paid - common stock’ plus ‘distributions to noncontrolling interest holders’) paid out during this period.
At the end of March 2023, Life Storage had a modest amount of cash and cash equivalents on hand versus a total debt load of $3.4 billion. Extra Space Storage is taking on a sizable net debt load as part of this deal, which is likely why management opted to structure the deal as an all-stock transaction. On the plus side, Life Storage’s same-store net operating income (‘NOI’) has been trending in the right direction of late, aided by material rental rate increases, which supports its cash flow growth outlook.
Life Storage reported that its net operating income (‘NOI’) from its “stabilized stores” (meaning wholly owned properties since the end of 2021) rose by 12.8% in the first quarter of 2023 on a year-over-year basis. Stabilized store revenues rose by 10.5% year-over-year in the first quarter of this year after Life Storage pushed through 13.6% in rental rate hikes, which was partially offset by a 5.2% increase in its stabilized store operating expenses (due to higher property taxes and labor costs). However, Life Storage saw its weighted average quarterly occupancy from its stabilized store base decline from 93.5% in the first quarter of 2022 to 90.7% in the first quarter of 2023, due in part to additional capacity coming online across the industry.
Concerns over recent additions to domestic self-storage capacity are not unique to Life Storage, with Public Storage ( PSA ) commenting on the issue during a June 2023 investor conference. However, in my view these issues are temporary and should dissipate over time given the secular tailwinds driving up demand for such offerings. Additionally, industry consolidation (such as Extra Space Storage acquiring Life Storage) should help rationalize future development activity going forward.
This year, Life Storage expects its adjusted funds from operations ('FFO') per share will grow by ~5% annually at the midpoint of guidance, rising to $6.75-$6.95 versus $6.51 in 2022 . Life Storage forecasts that its same-store NOI will grow by 3.75%-5.25% annually in 2023, aided by same-store revenue growth (forecasted at 4%-5.5%) offsetting same-store operating expense growth (forecasted at 4%-5%). Its growth trajectory is bright.
Joining Forces
When the transaction is completed, Extra Space Storage will have a self-storage portfolio that consists of over 3,500 locations serving more than 2 million customers as its store count is expected to grow by more than 50%, highlighting the transformative nature of this deal. Acquiring Life Storage will add 88 million square feet to Extra Space Storage’s asset base, bringing it up to 264 million square feet. Within the first year of closing, Extra Space Storage expects the deal will be accretive to its non-GAAP core FFO per share. It’s targeting $100 million in run-rate annual operating synergies via G&A and property operating expense savings, along with revenue enhancements (such as being able to better sell tenants insurance plans).
Extra Space Storage is also a stellar cash flow generator. During the first quarter of 2023 , the REIT generated $282 million in net operating cash flow and spent $38 million on its capital expenditures (‘development and redevelopment of real estate assets’ plus ‘investment in unconsolidated real estate entities’), allowing for $244 million in free cash flow. That fully covered its total payout obligations during this period which stood at $234 million (‘dividends paid on common stock’ plus ‘distributions to noncontrolling interests’). However, like Life Storage, Extra Space Storage has a large net debt load on the books. At the end of March 2023, it had a negligible amount of cash and cash equivalents on hand versus $7.3 billion in total debt.
In June 2023 , Extra Space Storage was able to issue out $450 million in 5.5% senior notes due 2030, highlighting its ability to tap debt markets at reasonable rates as these senior notes were priced at 98.878% of the principal amount. Additionally, Extra Space Storage has revolving credit lines it can tap as needed to raise funds to meet its near-term financing requirements (as does Life Storage). For reference, Extra Space Storage had economic interests in ~1,460 self-storage properties and managed ~930 third-party properties at the end of March 2023, with those assets spread out across 41 US states and the District of Columbia.
Overview of Extra Space Storage
During the first quarter of 2023, Extra Space Storage posted $2.02 in core FFO per share, up marginally on a year-over-year basis. Adding Life Storage’s assets to its operations should significantly enhance Extra Space Storage growth trajectory. Extra Space Storage saw its same-store revenues rise by 7.4% year-over-year in the first quarter of this year, which more than offset a 3.5% increase in its same-store operating costs, allowing for 8.7% same-store NOI growth. However, its same-store occupancy rate on a square foot basis fell from 94.3% at the end of March 2022 to 93.5% at the end of March 2023. As noted previously, consolidation and secular tailwinds driving up domestic demand for self-storage offerings should help bolster occupancy rates across the industry over the coming years.
Looking ahead, Extra Space Storage aims to generate $8.30-$8.60 in core FFO per share this year versus $8.44 per share in 2022 , representing marginal year-over-year growth at the midpoint of guidance. The REIT modestly adjusted its full-year guidance in May 2023 versus guidance issued out in February 2023, though it left its core FFO per share forecast the same. Extra Space Storage aims to generate 3.75%-5.25% same store revenue growth, 5%-6% same store operating expense growth, and 3%-5.5% same store NOI growth this year on an annual basis (none of these forecasts were adjusted in May 2023).
In May 2023, Extra Space Storage had some good news to share within its first quarter earnings report regarding its credit rating provided by S&P Global Inc. ( SPGI ):
Subsequent to quarter end, on April 4, 2023, S&P Global placed all of its ratings on the Company, including its BBB issuer rating, to CreditWatch with positive implications, stating that the CreditWatch placement reflects S&P Global's view that the pending merger with Life Storage will enhance the Company's credit profile, given the expected increase in scale and synergy opportunities following the merger.
Extra Space Storage will likely continue to tap debt markets to meet its near-term funding needs. Additionally, Extra Space Storage can utilize its at-the-market (‘ATM’) equity issuance program to help cover its funding needs, though shares of EXR have been somewhat depressed of late.
Downside Risks
There are some important downside risks to consider as it concerns this acquisition. For starters, it may raise antitrust concerns given that it will create the largest self-storage property firm in the US, though at an estimated ~13% of the market, the deal may not raise the suspicions of federal regulators. However, the US Federal Trade Commission ('FTC') has been cracking down on dealmaking between large entities of late, and increased regulatory scrutiny shouldn't be overlooked.
Additionally, another major risk concerns the large net debt load the combined entity will have to contend with while also contending with sizable total payout obligations (meaning free cash flow that could go towards deleveraging activities will be diverted to equity investors via dividends). While S&P has given a thumbs up to the deal having a positive impact on Extra Space Storage's credit rating, should interest rates continue to rise in the US, that would make managing the enlarged debt load a much more difficult burden.
Valuation
Shares of Life Storage have put up strong year-to-date performance and are up 39% as of this writing on a price-only basis (before taking dividend payouts into account), while shares of Extra Space Storage are up just 4% year-to-date on a price-only basis. As of this writing, shareholders of Life Storage are set to receive ~$134.60 worth of EXR shares for each share of LSI while shares of LSI are trading marginally below that level at ~$133.90, indicating investors are expecting the deal to close as planned.
Exposure to Life Storage is a better way to play this deal as Life Storage has a much stronger near-term cash flow growth outlook than Extra Space Storage, meaning if the deal doesn't materialize, I would rather have exposure to Life Storage than Extra Space Storage. If the deal does materialize, investors in Life Storage get to pocket the modest deal premium and benefit from the synergies the acquisition should generate.
Concluding Thoughts
Extra Space Storage acquiring Life Storage should help the former resume its growth trajectory due to improvements in its cost structure and longer-term benefits arising from industry consolidation as it concerns occupancy rates, pricing power, and limiting the chance of overcapacity buildouts. This acquisition appears to be a win-win-win for Extra Space Storage, Life Storage (shares of LSI have performed well year-to-date), and the US self-storage industry at-large.
As this deal is structured as an all-stock acquisition, it will boost Extra Space Storage’s total payout obligations by a considerable sum however, both entities are cash flow cows which will make it easier for the enlarged entity to handle its various financial obligations. I’m keeping an eye on Extra Space Storage, Life Storage, and the US self-storage space more broadly as this deal has the potential to meaningfully change the competitive landscape for the industry.
For further details see:
Extra Space Storage Buying Life Storage Will Change US Self-Storage Industry