Out of a chance encounter,
the business model that would
become Public Storage,
the self-storage industry
leader, was born
By Darlene Bremer
In 1972, two men working together on a real estate transaction were traveling to a meeting when they noticed a strange facility on the side of the road consisting of a series of connected garage-type buildings. Intrigued, B. Wayne Hughes and Kenneth Volk decided to stop at the site after the meeting to explore what turned out to be an early self-storage center.
On the way home, Hughes and Volk realized that they had seen the future, and the concept that eventually grew into Public Storage, Inc. (NYSE: PSA), the nation's largest self-storage REIT, was born. However, it was a long road from that initial site visit to the company in existence today that owns just under 1,500 properties totaling approximately 90 million square feet of net rentable space in 80 of the largest cities in the 37 most populous states in the U.S. In August, Public Storage became the ninth REIT added to the S&P 500.
In 1972, there was no known self-storage industry to speak of; just the odd facility here and there, located away from population centers and on back roads. Each man put up about $25,000, founded Private Spaces, Inc., and acquired a piece of land in a San Diego suburb on which to build their first facility.
"The name of the company was quickly changed to Public Storage, Inc. to clear up the public's misconception that the service being offered was part of a private enterprise or some sort of club," explains Hughes, a founder and current chairman.
Demand for the service at that first facility encouraged the new company to build more. Property acquisition as a form of expansion in the 1970s wasn't an available option since there were very few self-storage facilities in existence. Financing for that initial expansion derived from private limited partnerships, with the increased value accruing to the limited partners and Public Storage only realizing management and developer's fees.
With the goal of building facilities in every major U.S. city, Public Storage changed its financing method in 1975 to a public, all cash, limited partnership model. "This way no debt was involved in the creation of an asset. Investors put up the money and received a 92 percent interest in the asset, while the company became the general partner with an initial 8 percent stake in the asset's value," says Harvey Lenkin, formerly the company's president and chief operating officer. Lenkin retired on June 30 and still remains a member of the company's board.
The company used this financing method from 1975 to 1999 to raise $2.25 billion in equity capital to build and buy self-storage facilities throughout the country.
By the 1980s, however, other companies had entered the self-storage industry, and Public Storage began forming various entities (primarily partnerships) to acquire some of its properties. Beginning in the 1980s, Public Storage had 20 publicly held partnerships that were reorganized in the early 1990s into publicly traded REITs on the American Stock Exchange. Public Storage owned interest in those 20 REITs.
By the early 1990s, Public Storage had about 150 separate ownership entities that owned approximately 600 storage facilities across the country. However, the Tax Reform Act of 1986 and the significant leverage many partnership syndicates used led to the collapse of the public limited partnership model. Therefore, the company decided to focus its efforts on using a REIT called Storage Equities, Inc. to build and buy facilities and to merge all of the other ownership entities into one.
"Storage Equities would become the focal point of the company's efforts to expand without borrowing money," adds Ronald Havner, Jr., vice chairman, president and chief executive officer. In late 1995, the privately held Public Storage was officially merged into the publicly traded Storage Equities, and the combined public company used the name Public Storage, Inc.
The Next Step
The times have indeed changed for the company, but its fortunes have remained intact. In 1991, according to Lenkin, Storage Equities had an equity market capitalization of $89 million, $85 million in debt, its stock traded at $6 per share, and no research analysts covered the company. By 2005, Public Storage was trading at $63 a share, had an equity market cap of $8 billion, a total enterprise value of $10 billion, virtually no debt and is covered by approximately 10 analysts. From the end of June 2004 to the end of June 2005, the company's stock had increased 37.5 percent to $63.25 per share.
Public Storage also has some ancillary businesses that account for approximately 15 percent of its revenue stream, including tenant reinsurance, retailing and consumer truck rentals, pick-up services, and ownership interest in commercial properties. The reinsurance, retail, truck and pick-up businesses, however, exist solely to help consumers store or move their possessions, or to increase the level of convenience.
"Our goal, of course, is to create and increase shareholder value through the acquisition, creation and development of self-storage facilities and to provide income by financing, acquiring and operating assets in such as way as to increase the company's asset value and cash flow," Hughes says.
To reach those goals, the company relies on its basic operating philosophies of focusing on major markets with dense populations and clustering facilities to increase the efficiency of its advertising and marketing programs and the efficient use of personnel.
"We think of ourselves as a consumer service business, dealing directly with close to 1 million consumers a year," Lenkin says.
Market Position
Since the economic recession four years ago, the company's operating results have been on an upward swing.
"The company was indeed negatively impacted by the slow economy, but in 2003, we began a more aggressive marketing program to overcome the perceived weakness of the economy
and to influence consumers to use us for their storage needs," Lenkin says.
Using a same-store pool of approximately 1,300 locations that have been in operation for at least three years, occupancy increased from 85.3 percent in the first quarter of 2003 to 89.9 percent in the first quarter of 2005; earnings per share was 26 cents per diluted common share in the first quarter of 2003 and jumped to 38 cents per diluted common share in the first quarter of 2005; and FFO per common diluted share increased from 64 cents to 79 cents in that time period.
Over the past year, the company's same-store revenues for the quarter ending March 31, 2005 were up 4.9 percent to $198 million from the same time period a year before. In addition, for the quarter ending March 31, 2005, costs of operation were up 2.6 percent to $70 million, operating income at the property level rose 6.2 percent, or $128 million, rents received rose 4.7 percent to $11.41 per square foot per year, and operating margins were 64.8 percent, an increase of 1.3 percent over the same period in the previous year.
In addition, the company's total market cap rose from $8.8 billion on March 31, 2004 to $9.9 billion on March 31, 2005, its common equity cap rose from $6.2 billion to $7.3 billion, and its share price rose from $48.66 to $56.94.
PUBLIC STORAGE INC.
701 Western Avenue, Suite 200
Glendale, CA 91201-2349
818-244-8080
www.publicstorage.com
CHAIRMAN: B. Wayne Hughes
PRESIDENT, CEO & VICE CHAIRMAN: Ronald Havner, Jr.
CFO: John Reyes
TICKER SYMBOL: PSA
•52-WEEK HIGH: $67.10 (7/28/05)
•52-WEEK LOW: $47.44 (8/13/04)
CORE MARKETS: The company owns just under 1,500 properties totaling approximately 90 million square feet of net rentable space in the largest cities of the 37 most populous states. |
That aggressive approach has also paid off in the eyes of equity analysts. As of June, Banc of America Securities rates the company's stock as a "buy" because of its significant return potential of more than 10 percent over the next year.
"Even though 85 percent of the self-storage industry is dominated by small, independent companies, Public Storage is able to use its market share to capture synergies of revenues and expenses and boost profitability at the corporate level," says Ross Nussbaum, Banc of America Securities' principal and senior analyst.
Green Street Advisors rated Public Storage a "buy" because the stock has the highest discount in the self-storage group relative to its warranted share price as determined by the firm's net asset value (NAV)-based pricing model.
"PSA's market leadership position, well-located portfolio, solid balance sheet, and history of strong total returns warrant a premium valuation relative to its peers," explains Michael Knott, Green Street analyst.
John Sheehan, REIT analyst for A.G. Edwards & Sons, currently has a "hold" rating on Public Storage's stock, primarily reflecting of the company's valuation in relation to its historical price to FFO multiples and not as a negative reflection of its fundamental earnings or balance sheet outlook. "The company's stock is currently at the upper end of its two-year range of price to FFO multiples, and the risk reward at the current price levels is fairly balanced," he explains.
Investment Considerations
In terms of number of facilities, revenues and market cap, Public Storage is the self-storage industry leader. According to Lenkin, the company has consistently demonstrated innovation by being the first to create services such as a national call center, was the first self-storage company to advertise on television, and was among the first companies to install access control systems to safeguard its facilities.
"In addition, Public Storage is a comparatively low risk REIT investment because its acquisitions are financed solely with permanent capital and because it has no exposure to interest rate or re-financing risk," Lenkin adds.
Knott says he believes that the company's sheer size, history as a national operator, and attractively positioned portfolio separate it from its main REIT competition.
Public Storage is also developing a major program to reposition and refurbish its
portfolio. "The average age of our facilities is about 19 years, and we have hundreds of locations that were built
20 to 30 years ago."
RONALD HAVNER, JR. |
"A well-located portfolio has become even more critical in the self-storage industry as the business becomes more focused on locations in well-trafficked, retail-type areas as opposed to the industrial parks and out-of-the-way locations used by the first generation of facilities," Knott says. In addition, the company's strong track record of total returns to shareholders, an opportunity to own a piece of the largest player in an increasingly mature and recognized industry, a talented management team, and a pristine balance sheet makes Public Storage an attractive investment, Knott adds.
"Arguably," Nussbaum says, "PSA is the only recognizable brand name in real estate outside of the hotel industry."
In addition, Nussbaum says the company has some of the best earnings growth potential in the industry. Public Storage is increasingly consolidating the industry though acquisitions, and the occupancy rates in some of its newer development properties built over the last couple of years are increasing. "The biggest concern today is that the stock has outperformed other REIT stocks, and the price could stall if investors take profits. But that should prove to be only a short-term phenomenon," Nussbaum adds.
The flip side of being so large, however, is that it becomes more difficult for external growth to add meaningfully to earnings and value, unless new acquisitions are of a significant scale, according to Sheehan.
"Since the barriers to entry into this industry are lower than in other property types, investors need to be mindful of construction levels and pay attention to supply, as a glut in available facilities has a negative impact on occupancy and rental rate levels," Nussbaum says.
UPSIDE-DOWNSIDE
Samplings of what analysts are saying
about Public Storage, Inc.
Merrill Lynch
Rating: NEUTRAL (8/2/05)
"The development pipeline expanded at a brisk pace. Total development and redevelopment grew by 15 percent sequentially to $238 million. The majority of the increase came from greater redevelopment activity, with these projects rising to $111 million from $72 million last quarter. We favor these types of endeavors as much of the utilities infrastructure is already in place and the land is usually already taken down. Most important of all, redevelopments are undertaken for known properties with proven earnings power, thus eliminating much of the risk associated with traditional development work."
Goldman Sachs
Rating: UNDERPERFORM/CAUTIOUS (8/2/05)
"Even as the company exceeded our estimate in the second quarter, we see less likelihood of earnings upside relative to expectations going forward given high levels of occupancy and difficulty raising rental rates in the face of tough competition. The company continues to seek the right advertising balance, as increased media spending earlier this year coincided with lower move-in volume. More recently, experimental programs meant to attract a better customer were abandoned as occupancy trended downwards, and were subsequently abandoned. Uncertainty regarding success, or the ultimate price paid, for the company's bid for competitor Shurgard will likely be an overhang near-term."
Moody's Investors Service
Rating: POSITIVE (8/1/05)
"Moody's positive rating outlook for Public Storage reflects the rating agency's expectation that the REIT will maintain or continue to improve its earnings with higher occupancies and rental rates though the end of 2005, with this momentum carrying the REIT's performance for several years. In addition, Moody's expects that if Public Storage is successful in its bid to acquire Shurgard, it would be able to absorb the REIT with modest negative impact to its balance sheet, while improving its earnings potential,
efficiency and market leadership."
Wachovia Capital Markets
Rating: MARKET PERFORM (8/1/05)
"The (Shurgard) announcement, unfortunately and understandably, drew attention away from what was a strong quarter. Margins, revenue, occupancy and rental rates were each up while operating costs were relatively tame. We expect continued good operating performance for the foreseeable future but expect operating margin expansion to slow and believe occupancy has likely peaked. Assuming appreciation to the top of our range and a 2.7 percent dividend yield, we believe investors should expect a high-single-digit or low-double-digit total return." |
Future Plans
"In the future, our philosophy toward growth will not differ terribly from our historical approach," Hughes says. The company plans to consistently acquire and develop facilities and, because it doesn't envision many opportunities to find new major markets in the U.S., will focus on major metropolitan statistical areas (MSAs), that is, areas with a population of 1 million or more.
Public Storage is also developing a major program to reposition and refurbish its portfolio. "The average age of our facilities is about 19 years, and we have hundreds of locations that were built 20 to 30 years ago," Havner says.
These facilities need to be physically rehabilitated to make them more competitive, and the company plans to refurbish 50 to 60 of them a year. "In some cases, facilities will be completely razed and replaced with larger buildings to increase storage capacity, which should increase revenue," Lenkin explains.
"As major developed nations change their tax laws to begin to mirror the U.S. REIT
structure, the company may get involved in the self-storage industry in other countries."
B. WAYNE HUGHES |
The company plans to either use excess land that it already owns at the site, or it will acquire contiguous land to increase operations at the existing location.
According to Sheehan, the initiative to examine its older properties in strong locations that are no longer as competitive will help improve the company's future market position. "The self-storage industry has evolved tremendously, and upgrading older facilities will improve Public Storage's competitiveness over time," he adds.
Expanding into foreign markets is a potential growth strategy that Public Storage has been examining for several years, but so far the conclusion that such a plan would benefit the company or the shareholders has not been reached.
"However, as major developed nations change their tax laws to begin to mirror the U.S. REIT structure, the company may get involved in the self-storage industry in other countries," Hughes says. The initial entry, however, would probably be through the acquisition of existing facilities, which would present less risk.
"However, the self-storage industry in developed nations is in its infancy, so some time will have to pass before the idea can be seriously considered," Lenkin adds.
To improve its market position in the future, Nussbaum would like to see the company take advantage of these global opportunities at some point. "PSA is already an industry leader and working on improving its market share in key U.S. markets," Nussbaum says.
Public Storage and the self-storage industry were born at the same time, and both continue to grow and evolve together. By continuing to wisely allocate capital to acquire and develop attractively located facilities, the company should continue to improve and refine its operations and provide long-term security for its shareholders.
EDITOR'S NOTE: Neither Ross Nussbaum nor any member of his household has a financial interest in PSA. Banc of America Securities has performed non-securities services for PSA, its subsidiaries and/or its affiliates and has received compensation for those services in the past 12 months.
AG Edwards' research analysts receive no compensation that is directly or indirectly related to their specific recommendations or views.
Darlene Bremer is a regular contributor to Portfolio.
Evolution of a Company...