W. P. Carey & Co. LLC (NYSE:WPC)
Q2 2012 Earnings Call
August 7, 2012 11:00 AM ET
Susan Hyde – Managing Director
Trevor Bond – President and CEO
Mark DeCesaris – Managing Director and CFO
Tom Zacharias – Managing Director and COO
Dan Donlan – Janney Capital Markets
Good morning and welcome to the W. P. Carey Earnings Call. All participants will be in listen-only mode. (Operator Instructions) After today’s presentation, there will be an opportunity to ask questions. (Operator Instructions) Please note this event is being recorded.
I would now like to turn the conference over to Susan Hyde. Please go ahead.
Thank you, Amy. Good morning, and welcome everyone to our second quarter 2012 earnings conference call. Joining us today are, W. P. Carey’s, CEO, Trevor Bond; Chief Financial Officer, Mark DeCesaris and Chief Operating Officer, Tom Zacharias. Today’s call is being simulcast on our website, wpcarey.com and will be archived for 90 days.
Before I turn the call over to Trevor, I need to inform you that statements made in this call that are not historic fact may be deemed forward-looking statements. Factors that could cause actual results to differ materially from W. P. Carey’s expectations are listed in our SEC filings.
Now, I’d like to turn the call over to Trevor.
Thanks, Susan and thanks everyone for joining us today. To briefly summarize our financial results, we experienced a decline in adjusted funds from operations relative to last year, primarily because last year we closed the mergers of CPAs:14 and 16 which had a big revenue impact for us, but this relative decline should not be mistaken for a drop in core performance which remains strong. And on this call, I’ll spend a bit more time discussing what lies behind the numbers because the underlying dynamics demonstrates why our proposed merger with CPA:15 and simultaneous conversion to being a REIT, will enhance the clarity and stability of our business model.
First, I should emphasize the dividend coverage and growth remains our most important goal and notwithstanding that decrease in AFFO, adjusted cash flow from operations did increase year-to-date from $55.9 million last year to $58.3 million so far this year. Because we increased the dividend the payout ratio also increased slightly from 76% to approximately 79%, but still this demonstrates our continued ability to cover the dividend despite some of the swing factors that I’ll get into in a moment.
Returning to AFFO, we reported $1.65 per share for the first half of the year down from $2.79 per share for the same period in 2011. As I just mentioned, the problem with this comparison is that last year’s liquidation of CPA:14 skewed our first half 2001 results. For example, of that $2.79 per share AFFO that we reported for the first half of last year $1.01 of it resulted from the recognition of $52.5 million in termination and subordination disposition revenue that we earned from that liquidation.
Without that transaction, the core business would have generated a $1.78 per share during the first six months of 2011 versus that $1.65 per share that I mentioned for the same period this year. Most of the remaining $0.13 per share decline in AFFO stem from the fact that structuring revenues are lower so far this year compared with the same period last year. That’s because we had lower deal volume of course.
As we stated on this call many times, deal volume can swing up and down due to many factors beyond our control and I’ll talk about that and our pipeline in a moment, but as a result of this bunching or lumpiness as we sometime say of deal flow from quarter to quarter and year to year. The structuring fees are more variable source of revenues for us as compared to real estate related income and ongoing asset management fees. But I certainly don’t want to imply that we don’t like structuring fees far from it.
The deal volume they represent even when comparatively lower from one period to the next, still enables us to grow our assets under management and there are leading indicator for us of the more stable fee streams that we expect to earn in future periods on a larger portfolio, that is the ongoing asset management fees and our special GP interest and a percentage of the cash flows of CPA:16 and CPA:17, which Mark DeCesaris, our CFO will discuss in a few minutes. Still structuring fees are variable and in the interest of enhancing revenue stability and predictability, we’ve made it a key strategic priority to reduce the percentage of total revenues that they comprise. We’ve been successful in accomplishing that so far by increasing our rent earning asset base.
One way to see this is to look at how much of the dividend is covered by AFFO that’s related only to real estate income. For example, AFFO from real estate alone year-to-date has been approximately $56.7 million, that’s up from $47.2 million last year, this same time by the way. And our Chief Operating Officer, Tom Zacharias will talk in more detail about this segment later on the call.
Now that $56.7 million in real estate AFFO compared to distributions of $46.2 million for a coverage ratio of 1.22 times compared with a coverage ratio for the first half of last year of about 1.1, which was based on both lower AFFO from real estate at $47.2 million and lower distributions, $42.7 million. So you can see that we’re comfortably covering our dividend with a more stable predictable portion of our revenue stream.
To turn briefly to the merger with CPA:15. On July 30, the SEC declared effective the registration statement to the transaction, which means that our next milestone will be the shareholder meetings for both W. P. Carey and CPA:15 that are scheduled for September 13. If it’s approved and other closing conditions are satisfied we currently expect that the closing will occur in the third quarter of 2012. But we obviously can’t guarantee that timing.
To recap earlier calls we had about the merger, it’s an accretive acquisition of a real estate portfolio that will enable us to raise the dividend to $2.60 annually. And in fact this is what we’ll have to do in order to comply with REIT distribution requirements. Following the merger the variability of our revenues is likely to be far less pronounced because a significantly higher percentage, around 80%, were derived from real estate income as opposed to asset management income, which includes those structuring revenues I discussed a moment ago.
Now, before I turn the microphone over to Mike – to Mark sorry, I’d like to talk briefly about the investment climate that we are experiencing. Through June 30 we closed on about $234 million of transactions on behalf of CPA:17 Global and about $35.5 million for Carey Watermark Investors. As mentioned, this was lower volume compared with the first half of 2011, which had been an unusually strong first half for us due to the C1000 and Terminal transactions.
We are fairly confident based on the current pipeline that the second half will be stronger than the first this year. But it’s difficult to say precisely where we’ll end up the year in terms of total volume. We don’t set fixed targets or quotas, because if we’re not seeing the appropriate risk return profile on any given deal, we prefer to stay on the sideline.
I do think volume is likely to be somewhat less than last year for a couple of reasons. First, as I mentioned on our call in May, the supply of capital (inaudible) net lease sector seems to be increasing at a faster rate than the demand for capital. In part that’s due to the low yield environment fostered by liquidity measures taken by central banks around the world and of course the slide to the so called safety or income oriented investments particularly in this country.
As a result, we’ve seen a corresponding increase in asset pricing especially in the more commoditized segment of the net lease sector in the U.S. The second factor is that in 2010 and 2011, we saw significant deal volume internationally, particularly in Europe, but this year we’re being more selective about potential transactions there due to the ongoing uncertainty. This is not to say that we won’t invest in Europe, we continue to see quite a few potential transactions. But we’re being much more opportunistic in our approach to pricing and terms.
Finally, while we continue to become acclimated to new markets, particularly in higher growth parts of the world, we’re being cautious in light of the different sorts of risks that investors face in such countries and we prefer to wait until the right deals come along, which means until we see the appropriate risk return profile and the right risk mitigation measures in place, before entering these markets. And over time, I do think the emerging markets will become a more important part of our asset management business.
So to recap, our core business remains strong and growing. Our dividend coverage is solid and we continue to believe the proposed merger will both significantly increase our liquidity and scale and also improve the stability and growth potential of our dividend.
And with that I will turn the call over to Mark DeCesaris.
Well, thanks, Trevor and good morning everyone. This morning we reported operating results for the quarter ended June 30, 2012.
And let’s start with the Investment Management segment. We structured approximately $270 million worth of investments on behalf of the CPA funds under management and earned approximately $11.3 million in structuring revenues in the six month period as compared to approximately $594 million in volume and $21.7 million in revenue for the prior year.
As Trevor mentioned this revenue stream has the most volatility in our business and the timing of when these investments close is very hard to predict. We also told you that they are accretive to our assets under management. We currently have approximately $9.5 billion in assets under management as of June 30, 2012.
And as a result, the overall economic revenue that we earned from managing these investments have increased by approximately $5.7 million or 14.2%. We received approximately $31.2 million in reported management revenues and approximately $14.7 million in distributions from our GP interest in CPA:16 and CPA:17 for the six months period. This compares with approximately $36.4 million in management fees and $3.8 million in distributions from our GP interest in the prior year.
You’ll recall that we restructured our compensation from managing these funds to be more tax efficient and as a result the distributions we received from our GP interest are supported by the lease revenue streams of the CPA funds in which we have that interest and we therefore include these distributions as part of our real estate segment. We’ll talk about the performance of the funds a little bit later in my comments but suffice it to say that we are comfortable with the stability of this revenue stream and the support it gives our dividend.
We also earned approximately $52.5 million in revenues from the liquidation of CPA:14 last year, which had an impact of approximately $1.01 per share on AFFO and accounts for the majority of the variance in our asset management segment.
Let’s move to our real estate segment, overall pro rata revenues from our net leased assets increased slightly by approximately $200,000 to $47 million for the six months ended June 30.
In addition, regular distributions received from our investments in the CPA funds which we consider to be investments in well diversified portfolios of net leased assets increased to $16.4 million versus $9.4 million in the prior year, an increase of approximately 74%. This comparison excludes the one-time special distribution of $11.1 million we received from CPA:14 when it liquidated last year. The majority of this increase is a result of our increased ownership in CPA:16.
I just mentioned that the distributions we received from our ownership in the CPA funds are significant. We currently own 7.8% of CPA:15, 17.9% of CPA:16 and a little over 1% of CPA:17. These funds are currently paying distribution rates of 7.35%, 6.67% and 6.5% respectively. More importantly, both CPA:15 and CPA:16, which are fully invested, have coverage ratios of approximately 150% and 129% respectively on normalized cash flow.
CPA:17 is still on fund raising mode and having raised over $2.3 billion to-date through its initial and follow-on offerings, we’re comfortable with the fund’s performance and expect the coverage ratios when the fund is fully invested.
Our reported G&A increased approximately $7.6 million year-over-year. Let me break this increase down for you and it’s primarily due to three factors. The first one is amortization of stock compensation increased by approximately $1.1 million. We had one-time expenses related to the proposed merger with CPA:15, totaled approximately $4.7 million.
And the last issue was expenses related to fund raising for which we’re reimbursed increased by approximately $1.7 million. The reimbursement for these expenses are included in wholesaling revenue, which saw a corresponding increase of $1.7 million as well.
As Trevor mentioned, our focus has been to grow a stable revenue stream that covers our dividend. We’re doing this today through our real estate segment by generating approximately $1.39 per share in AFFO from this segment versus a dividend of approximately $1.13 per share for the six-month period.
This number does not include the direct management revenues paid by the CPA funds in both cash and shares, which totaled approximately $31.2 million for the six-month period. If you were to include the asset management segment the company generated approximately $1.66 in AFFO for the six months. This represents a coverage ratio of approximately 146% over the dividend. Adjusted cash flow from operations for the six months was approximately $58.3 million or $1.43 per share versus $55.9 million for the prior year or $1.39 per share.
In December, we announced that we replaced our revolving credit facilities of $280 million, which was set to expire in June of 2012 with the new facility. The new $450 million revolver has a three-year term with a one-year extension at our option. There is also a $125 million accordion feature, which we can trigger on a best efforts basis by our banking group. Pricing is spread, is based on the spread to LIBOR of 175 to 250 basis points, we are currently paying a 175 over. And we currently have a – approximately $190 million available under this facility.
In addition, we secured a $175 million term loan that can be used when the proposed acquisition of CPA:15 closes. The merger is terminated or not closed by September 30, then this loan will expire. We continue to maintain a strong balance sheet with a total debt to total market cap ratio of approximately 24% and an unsecured debt to total market cap ratio of approximately 9.5%.
We carry on our balance sheet an investment in the CPA funds of approximately $454 million. And we have approximately $686 million in cash available across all the funds for investment.
With that I will turn the call over to our Chief Operating Officer, Tom Zacharias.
Thank you, Mark and good morning everyone. In the second quarter, W. P. Carey continued its business plan of upgrading the quality of its real estate by harvesting select investments and selling certain vacant assets. I will provide more detail in a moment.
Turning first to top level portfolio performance, total real estate revenues increased in the first six months of 2012 by 26% from the same period in 2011, due primarily to the increased ownership in the CPA REITs. As Mark mentioned, total pro rata net leased revenue was up slightly over the same period.
Turning now to the WPC portfolio metrics, the portfolio occupancy of the 11.6 million square foot portfolio was at 94.4% at the end of the second quarter. This is up 237 basis points from the beginning of the year. A large driver of this improvement was the sales of the vacant 437,000 square foot building in Charlotte, North Carolina in June. Year-to-date we have completed 10 lease renewals and two new leases have been executed totaling approximately 546,000 square feet and $3.5 million in annual revenue. With a vacant space currently available for lease, we have leases out or sale contracts out for roughly half of the space.
Year-to-date we have sold six investments totaling roughly $70 million in gross proceeds and approximately $44 million in net proceeds. Four of these sales were vacant or soon to be vacant investments. The largest sale with a portfolio of fixed net lease assisted living facilities in France, which we sold in April at an attractive cap rate of 6.2%, a very nice exit for our shareholders.
The refinancing pipeline for the WPC portfolio is very manageable. In 2012, we have only four loans remaining to be refinanced totaling $26 million. And in 2013, we have no mortgage loans to be refinanced. The proposed merger with CPA:15, which Trevor mentioned, will have additional benefits of expanding the owned portfolio, these benefits are outlined in the proxy materials that are being sent to our shareholders later this week.
Now turning to the managed funds. Occupancy in the three CPA REITs averaged 98.5% over the 106 million square foot portfolio at the end of the second quarter, which is very strong and up 73 basis points from the beginning of the year. The debt coming due the refinance in the CPA REITs is manageable. We have $20 million remaining in 2012 and $226 million in 2013.
Year-to-date on a refinancing front, we have completed $95 million and 13 loans at a weighted average rate of 5% or approximate eight year term. This is an attractive 240 basis points below the weighted average rate of the maturing loans.
As mentioned in the earnings release, our hotel fund Carey Watermark Investors acquired three more hotels since the last earning call, Hampton Inn outside of Boston, the Hilton Garden Inn in French Quarter, New Orleans and the Lake Arrowhead Resort & Spa in Lake Arrowhead in California. This fund now has interest in six hotels and assets under management of approximately $135 million.
Before concluding, my portfolio report I’d like to make a few comments about the current environment. We have not seen any significant distress in our tenants although in certain sectors, the year-over-year revenues have been down slightly.
As far as tenant defaults in our CPA funds, two small tenants have filed – which filed this year have affirmed their leases and two other tenants which filed have liquidated were either leasing or selling their real estate. In Europe, we owned approximately 35 million square feet. We are 98.3% occupied and no tenants are in default.
Now I’d like to turn the call back to Susan Hyde.
Thanks Tom. That concludes our remarks for this morning. So now we’d like to open the call up for a Q&A session.
(Operator Instructions) Our first question comes from Dan Donlan at Janney Capital Markets.
Dan Donlan – Janney Capital Markets
Thanks and good morning.
Good morning, Dan.
Dan Donlan – Janney Capital Markets
Just quick question on the lease renewals, kind of how are your conversations going with your tenants in Europe versus the U.S.? Are you seeing a little bit more push back on being able to drive rents in Europe versus the U.S.? Any commentary there would be helpful.
Dan yes, hi. This is Tom Zacharias. I have some numbers here which I’ll share with you as far as the lease renewals and these are for the year-to-date for the W.P. Carey portfolio. And they were all domestic renewals.
There is not that much really coming up in Europe in the next couple of years as far as lease expirations. But we were, the old rent was at $698 (ph), the new rent was $636 (ph), so that is down 9%. Now I looked at it for all of 2011 and we were up 10% in 2011, that old rent was $790 (ph), and the new rent $868 (ph). So we’re kind of, it will vary based upon whatever the activity is of the particular collection of leases coming up. But that’s been our experience and we’ve seen some good – more activity on the leasing front, I think the last six months that we did in 2011.
Dan Donlan – Janney Capital Markets
Okay. And what’s driving that do you think, the increase in activity, I mean some of your industrial peers have – go ahead.
Yeah I think people were waiting on the sidelines, finding out if they really needed the – to make the commitment for additional space. We have noticed that we are working with some of our tenants on expanding their facilities because their demand for the product is up. We’re working on about three expansions right now. So they’re I think the function of, in a slow recovery people are, companies are now ready to commit some capital.
Dan Donlan – Janney Capital Markets
Okay. And then you guys talked about $226 million coming due in 2013. Just kind of curious how does that spill up for amongst the funds and the REIT? And as a side point to that question, do you guys anticipate becoming more unsecured borrowers, if the merger does indeed go through, what kind of is your view point there on a long-term basis given that your company is going to be considerably larger.
Let’s take it in two parts. Tom, why don’t you address the first (inaudible)?
Yeah, there is very little in the current portfolio. As in a public company there was nothing coming due in 2013 as far as mortgage refinancings. There is four for the remainder of this year which we are working on.
So there is not much really happening and as far as the remainder of the year from CPA REITs, we have really – we did about $100 million and the reason that much more we’re really going to do, there are some assets in the CPA:16 line that we will refinance with longer term debt, but those are CPA:16 assets and there is no maturity really, it’s out like two and half, three years. As far as 2013, that’s all the CPA REITs and we are working on that. Some of that we may get, be able to pull forward and get done at the end of this year. And we – and Mark, you might want to address the (inaudible)?
On the second part of your question, Dan, which is do you see us becoming more – utilizing more in secured debt in the assets we acquired. I think in the short-term, you’re going to see us pretty much stick to our model. We like non-recourse debt it’s a very safe type of debt on this investment. We also realize there is some advantages on the public REIT side to using more of the unsecured debt. And I think over the longer term you will see us adjust our portfolio a little bit to that type of model, but we’ll always have pretty good component of a utilizing non-recourse debt I think.
Dan Donlan – Janney Capital Markets
Okay. And then just going forward I would imagine that if the merger is complete, would you suspect that your volatility in AFFO from fees and everything else would kind of subside just given that it’s going to be a smaller portion of your overall income?
Right Dan, that’s the explicit goal really, one of the key goals that is of the transaction. So that right now, currently 56% asset management fees versus 44%, those numbers might be slightly out of date but roughly 56% asset management, 44% real estate that’s going to shift to approximately 80% real estate and 20% asset management.
Of the asset management you have a significant component which is the stable ongoing asset management fees which are earned year-to-year as a percentage of the NAV of the portfolio as well as the special GP interest that Mark had mentioned, the cash flow interest in CPA:16 and 17. So that those themselves are relatively stable as well. So yeah, the answer is yes, we do expect more clarity and stability.
Dan Donlan – Janney Capital Markets
Okay, that’s it for me. Thank you.
(Operator Instructions) At this time, we show no further questions and I would like to turn the conference back over to Susan Hyde for any closing remarks.
Thank you. Just as a reminder, a replay of today’s call including a webcast and podcast would be available after 2 o’clock and the information regarding the replay is available in our earnings release. Just want to thank you again for joining us today and we look forward to speaking with you next quarter.
The conference is now concluded. Thank you for attending today’s event. You may now disconnect.