Gordon DuGan - President and CEO
W. P. Carey & Co. LLC (WPC) Wall Street Analyst Forum November 17, 2008 11:50 AM ET
Good afternoon ladies and gentlemen. In our ongoing attempt to adhere to the published schedule, I would like to introduce the next company in today's program, W. P. Carey & Co. as an investment management company that provides long-term sale-leaseback and build-to suit financing for companies worldwide and manages a global investment portfolio worth more than $10 billion.
Publicly traded on the New York Stock Exchange as WPC, W. P. Carey and its CPA series of income-generating, non-traded real estate investment trusts help companies and private equity firms release the capital tied up in real estate assets for recapitalization, acquisitions and leverage buyouts. Now in its 35th year, the W. P. Carey Group’s real estate holdings are broadly diversified and comprised of contractual agreements with approximately 300 tenants, spanning 28 industries and 14 countries. From cycle-tested strategy portfolio diversification, tenant creditworthiness and acquiring mission critical assets has enabled W. P. Carey and its CPA programs to provide investors a steady cash flow through wearing economic climates.
So without further introduction, I would like to introduce Gordon DuGan, who is President and Chief Executive Officer of the company.
Thank you. I will jump right into it. Our intro was a mouthful in terms of what it is we do, but there are few things I wanted to talk about in terms of how we run our business and also a couple of things in terms of how we've always been a defensively positioned company and that typically means that you give up some of the upside in a very good market to helpfully protect your investors somewhat in a down market. And so why don't we just jump in to who we are at W. P. Carey.
Some of you may know and some of you may not, we are not unfortunately a household name, except in our business. In the sale-leaseback business, which is a business of buying corporate real estate and leasing it back to companies, we are considered one of the preeminent firms if not the preeminent firm based upon our longevity, our size and our global scale. And I'll touch on all of those.
But the firm was founded in 1973. We have launched 16 investment programs dating back to 1979 and through 2006, we've had 12 of those funds to full cycle averaging 11.5% through a variety of economic cycles and credit cycles, including some very difficult periods in early 1990s and then the early 2000 period after the tech bubble blew up. Obviously today we are dealing with very difficult times as well, but the point is that these are firms that have seen difficult economic periods before and have performed well, through those economic times and we don't have a perfect crystal ball about the future. But our track record in managing those cap funds through very difficult cycles, we would put up against anybody's track record.
We currently own or manage about $10 billion in assets and I will talk about how that breaks down, because we've somewhat unique business in the sense that we are an investment management company for the majority of our business, but we also own directly a variety of net lease corporate real estate assets on our balance sheet. And I will talk about these two segments and how they fit together.
In terms of our business, we are a global business. Of all the real estate-related businesses, we believe that the sale-leaseback at corporate real estate is the most easily global business. Because what we do for our investors, we go to corporations that own real estate on balance sheet, buy that real estate, lease it back to them, the company gets the capital they have got tied up in that real estate out of the business.
So if they make mammography machines, they don't need to own real estate, they need to own working capital. They need to pay the salaries of their engineering team, development team, sales team, but having their capital tied up in the real estate, they're very inefficient in sub capital.
So we go to corporations on a world-wide basis, buy real estate off their balance sheet, and lease it back to them. So all of these real estates that we own is leased at 100% when we buy it, leased on a long-term basis to these corporations. And again, in the real estate-related business, it's the most defensive way to invest in real estate.
And as commercial real estate goes through, it's going to be a tough cycle for it. I think that position is important, because we are positioned more defensively than other companies given the fact that the underlying investment what we do is long-term leases directly with companies where all the properties are 100% leased when we buy them.
The business of buying corporate real estate and leasing it back to companies is quite a large business. Corporations own in the United States roughly $1 trillion of commercial real estate own their balance sheet as we go into a difficult credit cycle. The trend has existed for some time of companies selling their real estate and leasing it back, and will only pick up at least in terms of the company's interest and disposing of all these owned commercial real estate.
Not all these companies will be able to able to raise the capital and today the trick is investors coming up with the capital to buy that corporate real estate off of the balance sheet.
In Europe, the amount of commercial real estate owned on balance sheet by corporations is three times of what it is in the US or roughly $3 trillion. So the market opportunity is enormous. Corporations in both the United States and in Europe own significantly more commercial real estate than all of the public investors combined.
So if you would have to take in the United States all the public REITs combined, they would own less than $1 trillion of commercial real estate. So this is the marketplace, if you will, for what we do is in fact very, very large.
In terms of annual volume, estimates range -- and this is for a couple of years back, but about $10 billion to $15 billion gets transacted in the United States in terms of sale-leaseback of commercial real estate. And in Europe, it is about 30 billion euros. That's gone down this year because of the credit crunch and I will talk a little bit about that.
In terms of our volume for this year, our volume is down as financing has dried up. It's not that there is a lack of interest on behalf of corporations, but there are two things occurring that we talk about in our earnings calls. One is pricing is adjusting. And when price adjusts in the commercial real estate business, it tends to adjust slowly and corporations are still adjusting to the new pricing, in reality, which is they are going to have pay more for a sale-leaseback than they did a year or two ago.
And the second piece is financing is difficult to get. And so our transaction volume is down. But while I say our transaction volume is down, we still invested over $400 million in 12 different investments in four different countries with companies in 10 different industries.
So we are still active and I'd point out the average lease term of 17 years is an insight on how we invest in commercial real estate, which is we want tenants on the hook for a very long period of time. And what that does again is emphasize the defensive nature of our underlying investments because the tenants are on the hook even though commercial real estate is about to go through a very tough cycle. As long as those tenants can pay the rent, they will have to keep paying us rent through a downturn in market rents and increase in vacancy, etc.
Just a couple of transaction examples. Kendall College is a culinary college owned by a company called Laureate. We purchased their property. It's near downtown Chicago and leased it back to them on a 20-year lease and the purchase price is roughly $29 million. So it's actually warehouse building that was converted office space. It's now been converted to office and classroom space and we have a 20-year lease with this company on this property.
This is a company in Europe, which is third largest distributor of IT goods and services in Europe, a company called Actebis. We bought their corporate headquarters and a couple of their logistics facilities and our purchase price for this was $58 million. Again this is a 20-year lease.
So we are buying properties that we think are key to the operations of these companies, putting them on very long-term leases. And while commercial real estate -- again vacancies and rental rates will fall. As long as Actebis can pay the rent, we will continue to receive steady cash flow through what is the difficult period and ongoing difficult period for the economy both in the United States and Europe.
In terms of how we find deals, we have an origination effort with offices in New York, London, and we have three people in Shanghai. I would not expect too much from our Asian business. We have not really figured what the right market business plan is for Asia. So we have some people there, but I would call it R&D at this point. I would not expect to see a lot of growth from our Asian business, but continue to see the business be predominantly the United States and Europe.
Here is a slide; it's a fairly typical slide of our investment process where we have origination, we have asset management and we have underwriting and structuring. In our underwriting and structuring side of those three quadrants, we have something that we think is relatively unique.
We have an independent investment committee, which means that none of these people are management of the business of W. P. Carey. And these people look over every investment that we make. Every sale-leaseback transaction that we look at goes through this committee of independent people. They include Frank Hoenemeyer, who is the Chief Investment Officer of The Prudential; Lawrence Klein -- Larry Klein, who won the Nobel Prize in Economics, who gives a macroeconomic viewpoint to our investment process; George Stoddard, who is head of the Direct Placement Department at The Equitable, etc.; and Nat Coolidge, who is head of Bond and Corporate Finance Department at John Hancock.
The point of this is everybody talks about risk management, risk mitigation, but then they always say well we didn't have any in place then, but now we have it in place now. And you wonder why they didn't have it in place when they needed it and now of course, everybody talks about risk management.
One of the keys to our business and our success in terms of investing investor money for 30 years has been that we have part of our risk management. It's having an independent committee of investment professionals, who have to sign up on every allocation of capital we make. And these guys have been around for a long time. They are not incented by stock options or anything else. They look solely at the merits of the deal and it's the risk return of that transaction worthwhile for our investors.
And this is a very unique system we had in place for again nearly 30 years now, and it has kept us out of trouble, because these guys have seen every cycle. Frank and George are both over 70 years of age. They have seen every cycle, every fad, every investment thing that can go wrong, and we have to run our investment ideas by these guys
It's a great way to mitigate risk just to have an independent of committee of world-class investment professionals, look over every investment idea we have. And it has kept us out of our trouble. We didn't have any telcom exposure to speak of, I think maybe one small investment in the dotcom area, and no dotcom sale-leaseback. We tend to stay away from faddish things because we have a process that tries to focus on the fundamentals.
One of the key aspects of our business in addition to long-term leases with these companies is the use of mission-critical facilities.
If you remember that Actebis warehouse and headquarters; if Actebis gets into financial difficulty and going into the economic environment we are in today, we have said publicly we expect more companies to have trouble meeting their obligations. All the major rating agencies have said they expect an increase in corporate defaults and we expect to see an increase in our tenants defaulting on their debt.
One thing that makes us different, however, is if they need our building to continue in operation, which they do often, they have to pay our rent to stay in business. So they can file for bankruptcy and if once they file for bankruptcy they stop paying the banks and their bondholders.
If they need our building, they have to keep paying rent on that building during bankruptcy. It's an administrative plan. It's the only time in the world we ever get paid like the lawyers do. We actually get paid during bankruptcy just like lawyers. And then if the company emerges from bankruptcy and they need that property to continue operations, they have to keep paying rent again once they emerge.
So there is an extra level of protection, if you can identify profitable facilities for profitable divisions of a company that in some case put us ahead of senior creditors because of the way lease law works. And the ownership of key assets is a very important thing in a downturn. So that's something that has always been part of our investment plan.
The second thing is diversification. We are never 100% right. We always have tenant default in every economy and so we broadly diversify by tenant and tenant industry. So we don't have too much exposure to any one business or any one industry because defaults are highly correlated by industry.
We talked about our cycle-tested strategy. This is a quick snapshot of what our business model is. We advise our fund series in all the revenues from being an investment manager for the W. P. Carey, from being an advisor on just less than $9 billion, up against the net lease real estate which tends to be more defensive as commercial real estate investments go.
And then we also own rental income. We derive rental income from our owned assets. So owned assets tend to be assets that were owned by this funds historically and is part of liquidations. We bought those assets on to our balance sheet and returned money to those investors.
But the growth driver of our business is the investment management business. The investment management business is a good business, because you don't risk a lot of your own capital and it's a high ROE business. But any investment manager is only as good as the job that investment manager does for its clients.
This is a snapshot of the growth in our assets under management. They have grown on a compound annual rate of 22% from 2001 to 2007. And our September 30, '08 figures, we announced that they have grown 10% last year to this year. I think this has something to do with the defensive nature of the kinds of assets we invest in.
Again in investment, the value of the investment manager is only as good as the job they are doing for their investors and a part of the job that we do for our investors is putting them in more defensive oriented investment. They tend to go up more slowly than dotcom starts or lot of other investments, but tend to be stickier because of their defensive nature in a more difficult environment like the one we are in.
Just a quick snapshot of the portfolio of the investment funds that we manage. It’s roughly 91 million square feet of the sale-leaseback corporate real estate throughout the world. Our average lease term on the existing portfolios is 13.2 years. It tends to go down over time because we start with -- you saw the 17-year average lease term for this year. And that takes down the fund's age, and we have an occupancy rate of just under 99%.
Again we don't develop, we don't take speculative risks in these funds and that shows in the steady cash flow that we are able to generate. They're very diversified by industry and by locations that you see here.
Just a quick snapshot of our track record. I mentioned that our average annual return on all 12 liquidated funds is 11.5. The average return on our existing funds you see for 2007 was -- call it on average 10%. We don’t have total returns for this year, but the dividend stream has been very strong for those funds.
And this is just -- [carries a pretty picture] which is our cumulative dividends paid to the investors of either W. P. Carey or our managed funds. And I think the important point here is other than it is a pretty picture is that the investors who invest with us invest for cash flow and for yield. And cash flow and yield have not gone out of style.
Investors today are worried about the sustainability of yield, but investors need yield. You still have a 10-year treasury below 4%. You have money market rates trending down to very, very low levels and so the investors will continue to seek and need yield in the future, is our belief. And we hope that that will keep demand for our investment products very strong.
In terms of the assets we own, we have a shorter lease term here, because these are assets that were again in the prior portfolios that were liquidated. But we own assets, [throw up] a very steady cash flow with an occupancy rate of just under 95%. So the assets we own on our balance sheet are just, what I would describe is, as a steady cash flow generation; again diversification among the assets we own directly.
In terms of trends impacting our business, there are some trends that are I think bullish for our business and I will touch on a couple of trends that are bearish for our business.
Over the last four years from 2005, 6, 7, 8, we were out of fund raising for our investment funds for much of that time. And that will go down as the golden era of fund raising for investments of our type or any other type. And the reason we were out of fund raising mode -- again everyone talks about risk management. Well, they are talking about risk management now, but there was no risk management when there needed to be risk management.
Part of our risk management is we were out of fund raising mode at the top of the cycle, because we saw an imbalance between investment opportunities and the supply of capital. And we couldn't change our underwriting standards and increase the investment opportunities significantly, so we had to reduce the amount of capital we've raised.
I don't know, very many money managers, who get paid for being money managers, were not stupid. We know we get paid for doing this. We spent most of the last four years out of the business of gathering new assets because we saw there weren't enough investment opportunities for the supply of capital. We said it in all of our earnings calls. It's come (inaudible) in a way that's going to have a negative effect on us and everybody else unfortunately. But what we didn't do is raise unbelievable amounts of capital, which we could of and put them to work in investments that didn't meet our criteria.
So I think the number one way to see whether or not somebody has been disciplined is through the last peak did they actually do what they said they did. They implemented some risk management. Everybody says they were great risk managers. Well, did they do it when they needed to do it, which is by not raising too much capital through the last cycle?
The good news for us is tightening credit conditions, increase the number of opportunities for sale-leaseback. When capital gets tight, companies are more likely to turn to selling them of their real estate and leasing it back. So we are going to see a tremendous number of investment opportunities today for all the reasons you would think. Money is very tight for companies. They still own all those assets we talked about. So we are going to see some great opportunities coming out of that.
And there has been this trend for companies to dispose of their owned real estate worldwide. So we think that today's market pricing and future market pricing is going to very attractive for investors and so we are out raising our funds.
Our 16th fund is actually fund number 17, because we skipped the number 13 for numerology reasons, but we are out raising fund number 17 today. We have raised over $300 million and we think there are going to be great investment opportunities coming out of the new fundraising in our business.
This is all very detailed. I would suggest that -- also to touch on couple of high points. I don't think anybody can read that, I can barely read it, but it’s all on our website for anybody to get.
The basic picture that you will see is that our investment management business is a strong contributor to our business. We do have some one-time revenue effects such as when we liquidate a fund as an investment manager, we have a carried interest in that fund. So the last one we liquidated above an 8% return, we received 20% of the profits. That fund did extremely well. So when we liquidated it, we got our share of the profit. We only recognized that income when we actually receive it in cash. We don't recognize it as we go even if we build up that over time.
As you look at our investment management contribution, you will see some one-time event. In terms of our real estate contribution again, what you will see is from an FFO standpoint, it's a very steady contributor of cash flow and again this is on our website. I'd encourage you to go on to www.wpcarey.com and see that's our portfolio vacancy bumps around, but it is currently running at about 5% and it's a very steady cash flow contributor.
And then we have trends from revenue, EBITDA, FFO, which is the typical earnings measure for real estate companies, and net income. What you will see is from 2001 to 2007, we have had a steady increase in revenue, EBITDA, FFO and net income.
And so far for the nine months of this year, we have had a very solid nine months. Again I think largely to the point that we tend to be defensive, we tend to be decent risk managers and we tend to be conservative.
And so as you look at our balance sheet today and our earnings flow, you will see that we are still experiencing solid results in a very, very difficult market. We've also been able to increase our dividends per share.
Again investors want yield, but they are worried that they are not going to get it. So they want reliable yield and we have been able to increase our cash flow and increase our dividend steadily over the past seven years. Our dividends have increased 23%, while our core operating cash flow has increased 33%, and we define that as adjusted cash flow from operating activities. And for the nine months of this year, our core operating cash flow is up over last year.
I think it's unfortunate. I am so bad with the macroeconomic climate that we are, sort of, holding our dry powder a little bit, rather than going out and making investments because we still believe that generally speaking things will get worse rather than better short term. So it's a good time to have a very strong balance sheet and be underleveraged.
Our total debt to market cap is just under 20% and of that 15% is non-recourse debt, which means its recourse only to a specific investment. So if God forbade, the worse thing happen with that investment we'd only ever loose our equity in that investment [for lender] to take the property and it will be a sad day for us. But we would not risk the company. The amount of debt that the company has guaranteed is only 5% of our total market cap.
So we are very conservatively capitalized in part for an economic period like this. Of course, we didn't see something quite this bad coming, and while we have been conservative, again tough times aren't great for anybody.
And then lastly W. P. Carey is structured as an LLC but there is no state filing or withholding requirements and no UBTI. The reason we are structured as an LLC is the majority of our revenues come from investment management services. And so like a Blackstone or a Fortress, they are also structured as LLCs, we have to be structured as an LLC to qualify.
And that's my presentation, I will turn it over to Q&A if anybody has any questions and then we can grab lunch. Or we can grab lunch and then ask questions, I don't care. Any questions?
Unidentified Audience Member
We have a statistic here. Average annual return, second bullet, 11.59%, that's the average annual return from 1979 to 2006. So that's nearly 30-year track record, every program we've ever sponsored. The other trick as an investment manager is to sell things and business that you don't very well and so your track record looks better. This is all we have done and that's our full track record in this.--
Unidentified Audience Member
The managed portion of our business has grown relatively. It used to be about a third of revenues and now it's over 50% -- roughly 60% of revenues.
Unidentified Audience Member
I think, five years ago, roughly.
Unidentified Audience Member
It will keep the investment management business. Our plan is to continue to grow. We don’t have a projection of where it will be, but the business we are trying to grow is the investment management business. It had a steady growth.
Again if you look at the assets under management -- that's the chart of our assets under management. We are able to continue to grow those, then we would expect to see that business to be higher and higher percentage of our business.
Well, thank you all for having me.
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