Published in the May/June 2012 issue of REIT magazine.
A year ago, industrial REITs AMB Property Corp. and ProLogis finalized the biggest REIT merger since 2007. In an all-stock deal, the former rivals combined to create one of the 10 largest U.S. REITs.
The merger also created the world’s largest owner of industrial real estate, a sector that plays a vital role in the fast-moving flow of goods in the era of globalization. The San Francisco-based company— now called Prologis (NYSE: PLD) with a lowercase “l”— owns or has interests in about 600 million square feet of distribution space and a footprint spanning 22 countries on four continents.
For AMB, the smaller of the two companies, the deal allowed it to quickly amass greater scale during the early stages of the recovery in its sector, deepening ties to big retailers, consumer products firms, transportation companies such as DHL and FedEx and third-party logistics providers, along with other types of tenants.
The former ProLogis was also motivated by the competitive advantages of greater scale, especially given the complementary nature of the foreign markets served by the two companies. But some analysts say the merger also represented a chance for it to regain the respect of investors in the wake of a dramatic retrenchment.
Once a darling of investors, the former ProLogis borrowed heavily during the last boom to acquire rivals and finance development projects around the world. During the Great Recession, the company made deep cuts to its workforce, reduced its dividend, halted planned developments and sold assets to raise cash and pay down debt.
While the former ProLogis and AMB had many overlapping U.S. markets, ProLogis had a bigger presence in Europe. AMB was ramping up its operations in China and Brazil prior to the merger. ProLogis, meanwhile, had sold its China operations and its interest in a fund owning facilities in Japan in order to fortify its balance sheet during the recession.
This year, the combined company, which has a land bank valued at about $2 billion, expects to spend approximately $1 billion (of which about a third is coming from joint venture partners) to develop projects in the United States, Brazil, China and Japan.
In Japan, Prologis has benefited from a spike in demand for modern facilities built to top seismic standards since the earthquake and tsunami last year, company officials say. The disaster took place shortly after AMB and ProLogis announced plans to merge. It battered the stock of both companies, even though they had little exposure to the hard-hit Sendai region and resumed operations quickly.
When global markets are fully recovered, the merged company expects to ramp up its spending on development to about $2.5 billion yearly.
A Hot Start
For both AMB and ProLogis, the merger “was really an opportunity to get on offense right off the bat,” explains former AMB CEO and co-founder Hamid R. Moghadam, now chairman and co-chief executive officer of Prologis.
“Instead of playing defense,” Moghadam says, the merger allowed both companies “to get forward-leaning at a time that the market was at an inflection point.”
Moghadam is leading the merged company in a co-leadership arrangement with Walter C. Rakowich, the former CEO of legacy ProLogis, that will last until Rakowich retires from the company at the end of 2012. Rakowich, who had been with the firm since 1994, served as president and chief operating officer of ProLogis from 2005 until late 2008, when he suspended plans to retire and was tapped by the board to lead a turnaround. He succeeded then-CEO Jeffrey H. Schwartz, who resigned.
AMB and ProLogis “felt that if they could combine forces they would have a significantly more efficient portfolio and sufficient size to go after some of the largest development projects in the world once it becomes viable to start development again,” says Ralph Block, a REIT historian and owner of Essential REIT Publications.
Carrying Heavy Weight
The merger has proven to be a mammoth undertaking, and company officials have had to navigate a series of global events that weighed heavily on Prologis’ stock while carrying out the integration.
Yet, analysts say the company has come a long way in a short time without too many hitches. “The merger involved bringing together two complex, multi-billion-dollar organizations with very different cultures. Trying to get your arms around that in short order was clearly a huge undertaking,” says John Stewart, an analyst at Green Street Advisors Inc.
“We think the integration is going reasonably well and are pleasantly surprised from that standpoint,” he adds.
As of the fourth quarter of 2011, Prologis had raised more than $1 billion through asset sales under a plan to reposition its portfolio to focus exclusively on global markets (like Los Angeles, New Jersey and Hamburg, Germany) and regional markets, such as Cincinnati and Columbus, Ohio. The company estimates that it will sell about 7 percent of its total assets, for a total of nearly $3 billion, under the plan.
More Synergy, Less Debt
Prologis has found even more synergy savings than it first anticipated. The company initially estimated that the annual cost savings resulting from merging would be $80 million, but raised its estimate to $115 million yearly in the fourth quarter of last year.
Most of the savings derive from lower general and administrative expense, and about 90 percent of the estimated $115 million annual figure had been realized by the end of last year, according to the company. Total merger-related costs are expected to be roughly $180 million, according to a Green Street report. According to Prologis, Green Street’s estimate encompasses $140 million realized in 2011. The balance will be realized by the end of this year.
Some analysts say the synergy savings will improve the company’s ability to service its debt and bring down its cost of capital as a result. “We think savings from cost of capital in the long term could be equal to or greater than G&A savings alone,” says Ki Bin Kim, an analyst at Macquarie Capital Inc.
Prologis has also taken steps to reduce its leverage since the merger, paying down debt with capital raised through property sales and contributions of assets to co-investment joint ventures. At the end of last year, its leverage, as a percentage of asset value, was 44 percent, down from just over 50 percent at the closing of the merger, according to the company. In February, Fitch Ratings lifted the company’s outlook to positive from stable and affirmed its triple-B-minus issuer default rating.
“They have modestly deleveraged, but do maintain good near-term operating liquidity,” says Dave Rodgers, an analyst with RBC Capital Markets. Still, he says the company may have to step up its deleveraging efforts if it is to embark on a more robust plan for growth through development.
Prologis plans to reduce its leverage to 30 percent by the end of next year, according to the company, which is seeking to achieve a single-A credit rating.
“The real focus of the integration has been on improving the balance sheet, even more than rationalizing the number of markets we are in,” Rakowich says. “We want to have one of the strongest balance sheets in the industry to allow us to take advantage of future dislocations in the market, and to sleep at night.”
A Tale of Two Companies
Regarded by some as a cerebral pension fund advisor, AMB was founded in 1983 as an investment manager serving institutions. It launched its first private equity fund, focused on industrial and retail properties, in 1989. The company went public in late 1997.
Two years later, the company sold its retail business to focus solely on the industrial sector. It made its first overseas investment in 2002 with the development of an 800,000-square-foot facility for consumer products giant Procter & Gamble. AMB added an internal development division in 2004.
Both AMB and the former ProLogis had large fund management businesses thanks to strong ties with institutional investors. By selling interests in facilities they developed to joint ventures with pension funds and insurance companies, they were able to expand their reach, recycle capital and generate management and other fee income.
“What allowed them to expand was the demand from third-party capital sources to not only have industrial exposure, but also to gain some global exposure,” says Rodgers of RBC Capital Markets.
The merger of AMB and the former ProLogis created a company with 22 funds. The company has been working to streamline its fund management business, which remains an important part of its growth strategy.
Previously known as Security Capital Investment Trust, legacy ProLogis was formed 1991 and went public three years later.
The company became one of the most prolific developers in
the industrial sector.
The company’s international expansion, begun in 1997, was guided largely by demand from its key customers. AMB, by contrast, took a more market-driven approach, focusing on hubs of global trade, which are typically served by major seaports and/or international airports.
Both companies owned large numbers of modern “big box” distribution centers, sprawling, low-slung buildings that are designed to facilitate the rapid transfer of goods. Now, such facilities, which are typically in excess of 400,000 square feet, have benefitted disproportionately from the recovery thanks in part to companies consolidating into fewer distribution centers in the name of greater efficiency, says Darla Longo, a vice chairman at CBRE Group Inc.
Although rents in the industrial sector are still significantly lower than they were at the peak of the last cycle, occupancies are climbing and supply continues to shrink thanks to a dearth of new construction, analysts say.
Prologis expects its occupancy rate to grow to about 94 percent by the end of this year, up from 92 percent at the end of 2011, provided the global economy continues to recover at its current pace.
In markets outside the United States, Prologis is capitalizing on rising demand for modern distribution space from companies shedding their old warehouses in favor of leasing and from surging inventories in emerging markets, company officials say.
“In emerging markets like Mexico, Brazil and China, consumption has gone up like crazy because large swaths of the population are moving into the middle class, buying more of everything from Coke to diapers,” Moghadam explains.
In Europe, the company has seen robust growth in occupancy, despite the recent sovereign debt crisis that made many investors concerned about its exposure to the region. Prologis is the largest player in its sector in Europe, where it owns assets valued at more than $10 billion, according to Moghadam. Most of its European portfolio, he says, is located in the United Kingdom, Germany, France, Poland and other countries on solid fiscal footing.
“Our business on the ground has been strong,” Moghadam says. The European portfolio “gained more occupancy in the fourth quarter than any other part of our business. That is a testament to the quality of our assets and people” there, he added.
As for the merger, Moghadam says the heavy lifting associated with the integration is done. Rakowich will retire, as planned, at the end of this year, leaving Moghadam at the helm of the company.
“Walt agreed to a transitional role to help with the integration and make sure I knew where all the bodies were buried,” Moghadam quips.
So far, their partnership has worked out well, despite the fact that similar power-sharing arrangements haven’t always ended nicely. Moghadam and Rakowich attribute that to a deep mutual respect and a promise they made to each other early on in the merger.
“We made a commitment that we weren’t playing favorites with people and process decisions. We would make decisions based on merit, not on what color jersey the person was wearing. I feel good that we have done that,” Moghadam says.
— Hamid Moghadam
They have presented a united front and acted decisively on staffing and other major issues to avoid the type of uncertainty that has undermined some past mergers. When AMB and ProLogis announced their merger plan in January 2011, Moghadam and Rakowich had already come to a consensus on picks for key management positions.
“We hold hands on all major decisions and we don’t make any major decisions without both being on board,” Rakowich says. The integration, he added, has been helped along by the fact that the companies had a lot in common, despite their different origins and longtime rivalry.
“Both companies owned really high-quality product and had some of the best people in the industry,” Rakowich says. “The differences between them were more in terms of geography than culture.”
Moghadam and Rakowich say they have put in place an organizational structure that will keep Prologis nimble despite its enormity. (As of late March, the company was the sixth-largest U.S. REIT in terms of equity market capitalization, about $15 billion.)
Under the company’s new structure, decisions about capital allocation, risk management and capital raising, both public and private, are made at the corporate level. Real estate decisions are made at the local level by divisions that function as independent businesses, with their own hierarchies, balance sheets and return targets.
“Scale has a lot of advantages, but one big disadvantage if you are not careful,” Moghadam says. “The potential disadvantage, particularly in an entrepreneurial business, is that you become bureaucratic and slow moving.”
“We are building a company with good top-down capital allocation and risk-management systems, but also one where real estate decisions can be made quickly in the field,” he says.
Anna Robaton is a regular contributor to REIT magazine.