Sovran Self Storage: Consolidation Story Continues

| About: Life Storage, (LSI)

Summary

Sovran finally enters long-coveted California market.

Issues $234.5 million of equity to fund acquisitions.

Valuation remains slightly cheaper than its peers.

On January 19th, Sovran Self Storage (NYSE:SSS) announced $398 million of acquisitions along with its entry into the California market. Shortly thereafter, management announced the issuance of 2.3 million common shares for estimated proceeds of $234.5 million to assist in funding the acquisition.

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Like its peers, the company has historically done a good job utilizing scale and technology to improve pricing and operations at acquired businesses. Once again these initiatives will be particularly important to offset shareholder dilution from equity issuances this year.

Acquisition:

Sovran is acquiring 30 self-storage facilities in new and existing markets. The most notable is 7 properties in the Los Angeles market for ~$167 million and an eighth under construction costing $18.6 million. CEO David Rogers had this to say about the acquisition:

"While it's taken us a while to get there, we are thrilled to enter the Los Angeles market. We are doing it the way we intended - with a group of high quality facilities in sufficient scale, on an immediately accretive basis, with the opportunity to improve operating results in a meaningful way. This will present a future growth vehicle for Sovran."

Management had coveted assets in California for a while but wanted scale and had yet to find the right asset. Management telegraphed their desire in July of this year:

"I'll tell you that I wish we could have taken Horace Greeley's advice and 'gone west' a couple of years ago," Rogers said. "There really is a party going on out there. Unfortunately, we are just watching through the window on that one."

This provides a base for further tuck-in acquisitions. One author confirms the company had been eager to enter California:

Brian Somoza, the Los Angeles-based managing director of JLL's self-storage division, said Sovran has been chasing after just about every offering that has come to market in the state. "L.A. is very competitive. It is very difficult to enter with just one property and there hasn't been a ton of transactions out here," Somoza said, "The opportunity to enter the market with a cluster of properties is pretty rare in California."

The comment suggests the company may have paid up to enter this very competitive market, which is also Public Storage's (NYSE:PSA) largest.

Issuance of Stock

To fund the acquisition, management is issuing 2.3 million shares for proceeds of $234.5 million dollars. This follows nearly $30 million raised in Q3 and a larger issuance in March of ~$120 million. I suspect we'll see further analyst coverage as banks chase a new source of fees from the self-storage segment.

The consolidation story is well underway and investors appear very willing to help fund acquisitions. Management continues to target a 70% Equity, 30% debt mix for acquisition funding.

Consolidation Continues

The latest acquisition continues Sovran's consolidation strategy. In Q3, they announced the acquisition of 11 facilities for $66 million. In Q2, 9 facilities for $75 million and in Q1 two facilities for $15.2 million along with competing a previously announced $120 million acquisition.

The process mirrors that of its competitors. For example, Extra Space Storage (NYSE:EXR) has been equally as acquisitive and closed the $1.3 billion Smartstop acquisition in October. CubeSmart's (NYSE:CUBE) year was a little quieter - they acquired 5 properties in Q3 for $75.2 million for a year-to-date total of $228.4 million spent on acquisitions.

The larger players continue to use technology to improve acquired operations and take share from mom-n-pops, which still account for 80% of the industry. In a recent non-deal road show held by RBC (NYSE:RY), EXR management shared details on the consolidation opportunity:

Looking forward, EXR estimates there are still ~19,000 - 20,000 institutional quality assets that are not owned by the REITs (EXR 1,335 stores owned, managed, and JV). The company believes $500 million per year of acquisitions is an achievable goal with $300 million in the form of one-off transactions.

Another analysis done in 2015, provided further insight into the consolidation opportunity:

In addition to the public companies in this industry, there are more than 110 privately- held firms that own and operate 10 or more self-storage facilities each; about 2,450 firms that own and operate 2-9 self-storage facilities; and approximately 30,800 firms that own and operate just one facility.

Combined the four (PSA, CUBE, SSS, EXR) control about 10% of the industry and operate a similar consolidation playbook: use scale, operational expertise and investments in technology and marketing to improve acquired assets.

It is also worth noting the above authors also found that the average price of a Sovran acquisition has increased over time:

Sovran's price per acquired store has increased 71% since 2010 and 114% since 2006. If this trend continues, in order to grow at a constant rate, Sovran will be forced to issue larger sums of equity, diluting outstanding equity offerings. In addition, the premium paid for these facilities will drive up acquisition costs, hindering margins and tying up valuable capital which could be used in alternative business operations.

SSS Q3 Conference Call Takeaways

Since we haven't seen a SA article on Sovran for some time, readers may also find my takeaways from the Q3 conference call useful:

  • Same-store revenue growth accredited to 6.5% from 5.8% and 5.1% in Q2 and Q1 and guided to 6.25-6.75% in Q4. Pricing has been a nice surprise throughout 2015. This compares with CUBE's 7.4% increase in Q3 and Public Storage at 6.7%
  • Management expects Houston, its largest market, to be ok and its not yet showing weakness. Revenue was up 6.9% while occupancy declined as management increased price and reduced promotions. For example, rental rates increased 5.1% company-wide but increased 7.5% in Houston. Florida, New York and George were also strong.
  • Demand continues to increase as a result of steady growth in population in the markets they operate; New supply is modest so occupancy is high and they are able to put through price increases as well
  • Occupancy is at ~92% but remains 2-4% below peers
  • Deal-flow is increasing as brokers bring more assets to the market. Despite steady demand, consolidation is the industry remains the industry driver as opposed to organic growth

Valuation

Lastly, Sovran continues to trade at a slight discount to its peer group:

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.