Global Self Storage: Buying Properties At A Steep Discount

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About: Global Self Storage (SELF)
by: Paul Claussen
Summary

Global Self Storage's portfolio of 11 storage properties is 30% undervalued to the market.

The deep discount plus a 7% dividend yield funded from operations will keep a floor under the share price and limit the downside risk.

Until the stubborn discount begins to close, management can best deploy capital on share repurchases vs. buying additional properties.

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Global Self Storage (NASDAQ:SELF) is an owner and operator of 11 self storage facilities located in the US with a total of 766K net leasable square feet. This article explores the valuation of SELF's 11 physical properties might command in a liquidation scenario where the properties are sold, SELF's corporate debt is retired and all remaining assets are distributed to SELF's shareholders. A second question contemplated in this article is what is the best use of cash by SELF's management at this time. It is this author's view that the physical assets of SELF are trapped in the current structure and are materially undervalued. An argument follows that until the deep discount is partially closed, SELF's excess cash would be best deployed by management in repurchasing shares vs. buying additional properties. Finally, I will close with some related thoughts on building a self storage retirement income.

The first question is what are the 11 properties in the portfolio worth? There are a number of ways to arrive at a self-storage property valuation. For the purposes of this article, I will use two simple methods. First, a very simple multiple of leasable sq. ft. And, second, a simple income method based on multiple of net operating income (NOI). According to the 2019 Self Storage Investment Forecast by Marcus and Millichap, quality Class A properties have generally been transacting at an average cap-rate of about 6.5%. Yes, there are outliers. But, most are transacting in a range between 6% and 9%.

In the first method, according to the same Marcus and Millichap report, the average price/sq. ft. in 2018 was above $90/sq. ft. for transacted properties. Applying this to SELF:

Value = Leasable Sq. Ft. * $90/Sq. Ft. - LT Debt

Value = 766K * $90 - $19.2M = $49.8M or $6.44/share.

Now, let's look at the cap-rate multiple method.

Cap-rate = net operating income/purchase price of the property.

In their latest 10-Q, SELF reported Q1 NOI of $1,193,162 for the quarter ended March 31, 2019. Excluding consideration of any additional new capacity coming online in 2019, if you multiply the Q1 NOI by 4, we derive a projected annual NOI for 2019 of $4,772,648. We then divide annual NOI by cap-rate to derive a valuation. Next, subtract long-term liabilities (LT Debt) to reach a liquidation value. NOTE: For simplicity, I've netted out non-real estate assets and short-term liabilities which are basically a wash. In the Table 1 below, I show the liquidation value and discount to market value by cap-rates from 6% to 9%. As stated earlier, the 2018 average was 6.5%, but I have chosen to be conservative and focus on a higher 7.5% cap rate given that Global Self Storage's properties are in Tier 2 and Tier 3 cities. Even with this more conservative approach, the Table 1 shows that the stock market is steeply discounting SELF's physical assets. That discount ranges between 9% and 49% depending on market cap-rate assumption.

Table 1 Valuation By Cap-Rate for Projected 2019 Net Operating Income (NOI)

Table 1 source: Author compiled based on data from the 10-Q.

SELF has traded at a discount to liquidation value since I began following it about two years ago. Why does this discount persist in an "efficient market"? Given the stock performance chart in Figure 1, it is fair to say that management's efforts to sell a good story to institutions, funds, and family offices have been less than successful over the past 12 months. That is not for lack of a good story! Management deserves credit for having a good story to tell: Tier-2/Tier-3 strategy focus is working and resulting in improving profitability, rental rates, and NOI are increasing, revenue growing faster than expenses, capacity expansions completed/underway, etc. SELF is an example of how the short-term market can be lazy and inefficient. SELF is currently flying below the radar. It is a micro-cap REIT that has ZERO analysts following it. Only 20% of shares are held by institutions. Average daily volume is a paltry 22K shares and market cap has recently been below $30M. Until Friday, this stock was a sleeper.

Figure 1 - SELF share price

Where will SELF's share price go from here? On Friday 7-June, SELF's price moved up 6.5% on 6x average volume. So, perhaps others are catching on about the undervalued assets or perhaps buyers are trying to capture a 7% dividend before the next Ex-Div date on 14-June. In either case, if management did nothing other than professionally operate the existing properties, NOI should continue to grow organically from rental rate increases and from the planned 2019 expansion project. That along with a 7% dividend which is funded from FFO will put a floor under the share price and provide relatively limited downside risk in my opinion. My belief, and the reason I continue to accumulate shares, is that SELF cannot continue to fly under the radar forever. Sometime during the next 12 to 18 months, an offer will likely be made to either acquire all shares of SELF or to acquire the physical assets. In the latter case, SELF's management would probably pay off the LT Debt and distribute the remaining assets to the shareholders and move on to the next venture. SELF's management would have a fiduciary responsibility to consider any such an offer. I'm not an expert in securities law but would think such an event would be a material event and would, therefore, require disclosure. The fact is that similar storage facilities are being transacted in the US at higher valuations and sooner or later an astute operator or family office will take a shot at buying out SELF's shares to take it private or purchasing the physical assets. This discount is just too steep for this not to happen eventually.

In the meantime, should SELF's management acquire new facilities? Clearly, this is management's stated intention. They have shown an ability to acquire, integrate, and improve facilities. Management recently secured a $10M credit facility for the purpose of acquiring facilities in Tier 2 and Tier 3 cities. But, is this the best use of capital right now? The answer depends of course upon at what Cap-Rate the acquisition is made and also upon how much value SELF's management can add in terms of increasing NOI for the purchased facility. But, it is fair to ask where SELF's management can deploy capital at the best possible rate of return for shareholders? There is an argument to be made that until the current discount is at least partially closed, the best return for shareholders would result from buying back undervalued shares. I did a short analysis in Table 2 comparing stock buy-back to facility purchase. I've assumed a $2M investment in either buy back of stock or alternatively in purchasing an existing operating facility. For the Stock Buy Back, I've assumed 500K shares at the current price of $4 / share and assumed that the dividend savings are used to pay down LT Debt. In the purchase scenario, I've assumed that SELF's management acquires the facility at a 9% Cap-Rate, the upper boundary provided in Table 1, and that SELF's superior management team is able to quickly add value to the facility to raise NOI by 20% through price increases and synergies. Strictly for simplicity, I've assumed that both investments are funded without incurring new long term debt. This would theoretically be possible by using the marketable securities and cash on the balance sheet.

Table 2 Buy Back vs. New Facility Investment Analysis

Source: Author compiled based on publicly available data.

The net result of the analysis indicates that SELF's shareholders would currently benefit more from a higher valuation through a share repurchase than they would from purchasing a 12th facility. Both investments can be beneficial, but if we have to choose, buy-back is the better option. This is true at this moment in time solely due to the steep discount at which SELF's shares are currently trading.

Question: How much of the discount would need to close before it would make sense to deploy capital to buy that 12th facility? For that answer, see Table 3 below where I copied Table 2 and changed the share price from $4/share to $4.50/share, keeping the same $2M investment, reducing share buy-back to 444444 shares repurchased and all other assumptions remain the same. At $4.50/share, a 12.5% premium above current price, the increase in value/share is the same in both scenarios.

Table 3 Buy Back vs. Purchase Comparison at $4.50 / share

Source: Author compiled based on publicly available data.

Even if the share prices rise to $4.51/share, I would still argue that as long as SELF's implied Cap-Rate remains above 10%, SELF's shareholders will benefit from some combination of stock buy-back in addition to incremental facilities investment. SELF's share price would need to rise to $6.40/share at current NOI level to bring Cap-Rate below 10%. At a minimum, SELF could consider using share buy-back to buy the shares required for incentive compensation.

Bottom line is that a market inefficiency has resulted in a good opportunity for investors, particularly those investors interested in the self storage business. Let's say you were an individual owning a few acres in a good location and were thinking about building a 30K Sq. Ft. self storage facility perhaps with a goal of building a retirement income of say $1,500/week. Assuming ~$45/sq. ft. to build, you would need $1.34M to build it out, then staff, launch, ramp up, stabilize, and operate. OR, alternatively you could invest $1.2M in 300K shares of SELF at $4/share. The 7% dividend would generate $78,000 per year or $1,500/week income starting immediately. You would also own 3.9% of a diversified asset with 11 real facilities vs. one. You would have no ramp up period and no operations to manage. You keep your day job for now and your weekends can be spent at the lake. You also have the strong possibility of someone buying your shares out at some point for a considerable premium above the $4/share you paid. And given that you have also invested a slightly smaller sum in SELF, you could use the $140K balance to buy a boat, trailer, truck, and a couple of jet ski's for your family to use on your weekends at the lake.

Disclosure: I am/we are long SELF. 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.