Investors never realized or attached little importance to the negativity surrounding Sovran Self Storage’s $1.3 billion acquisition of LifeStorage last week. LifeStorage is a privately owned self-storage company that is ranked among the top 15 largest in the sector. Sovran also announced an equity raise of $600 million to fund the transaction.
The drop recorded last week, attributed to the release of Fed minutes, was sharp. More than 90 percent of the equity REIT stocks fell. Sovran stock dropped by 7 %. This is the major drop ever to happen among the self-storage peers.
The subsequent Fitch announcement that they will place Sovran on a negative watch confirms our suspicion. Besides increasing leverage, Sovran will make an expensive acquisition. They will pay an initial cap rate of 4.8 percent, in line with the established self-storage rates, for a company founded five years ago.
However, the management argues that the portfolio of LifeStorage is better and will improve their quality. As a matter of fact, LifeStorage has the benefit of owning higher rent per occupied square foot and a greater surrounding population with a higher average household income.
Given that the company has been recently upgraded by S&P, they were quick to worsen its leverage metrics and increase debt. The transaction will be financed by a bridge loan of $1.35 billion initially, and later replaced by 50%/50% debt and equity. The debt financing percentage will be higher than the usual debt funding. However, the total debt to total enterprise will increase from 17% to 24%, still very manageable.
Sovran got carried away looking for a sizable operator to buy. LifeStorage investors must have celebrated the transaction given the fact that the company is only five years old. Size is an important aspect for a self storage company to compete in an industry where it has become essential to dilute the administrative and marketing costs. Of the 550 properties it has, Sovran will further add 84 more.
A drop in the stock does not mean stocks will be cheaper and, based on the valuation multiples, definitely not a buy.
Source: Sovran Self Storage Inc.(NYSE:SSS), LifeStorage, Fitch Ratings, S&P Global Ratings
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