On Monday, 10/18 Prologis (PLD) will be holding a virtual investor/analyst day to review both the Strategic Capital (SC) platform and the development business. SC has had a pretty incredible run, roughly tripling its NOI contribution from ~$113 million in 2017 to ~$327 million this year through organic growth/contributions + M&A. This is fascinating on several levels, most notably in our view the fact that PLD is now completely offsetting its corporate overhead layer with NOI from SC before factoring in any promote income. All else the same this likely creates a "structural premium" in the public markets going forward to any private market value estimate for the wholly-owned and UJV assets. A couple of thoughts and our SC model/valuation assumptions below, which hopefully we can then compare to what the company presents on Monday:
- At a high level we think the SC platform excl. promote income is worth $9-10 billion. We use an illustrative 8% cost of capital in Figure 1 below which translates to ~$9.1 billion or 26x 2022E earnings, but for reference a 6% discount rate equates to $9.8 billion or 28.5x 2022E earnings. This translates to about ~$12/share or ~10% of the PLD's total market value.
- The SC model is highly sensitive to compounded AUM growth, so establishing a longer-term framework for how it could grow over time will be the key metric to watch for.
- The exercise is a little difficult when sitting outside of the company and owing to FX fluctuations, etc., but we estimate that PLD has been growing SC AUM "organically" by about +3% compounded annually from contributing assets into the portfolio. PLD buys or builds on balance sheet, then "recycles" a portion of that capital by effectively selling a ~75% interest into fund vehicles that it manages on behalf of third parties and retaining a ~25% ownership interest (earns a ~30% development profit/spread in the process). PLD continues to participate in the minority ownership economics of the assets, but perhaps more importantly earns recurring asset/property management fees as well as transactional fees for leasing space, etc. as well as "lumpy" promotes for achieving certain return hurdles. PLD then takes the recycled 75%, less any taxes and plus the development profit, to restart the process again, creating a "flywheel effect" where essentially the same nominal dollar capital is retained on balance sheet but assets in SC grows. We assume a +2% organic growth CAGR in our model to be conservative.
- Additional AUM growth comes from any third-party fundraising as well as contributions of assets acquired externally via M&A (DCT, LPT, etc. in recent years). This has resulted in big jumps in AUM as the sector consolidated, but we assume an additional +300bp of compounded growth for the purposes of being reasonable/conservative.
- Taken together, we have SC AUM growing at a +5% CAGR over a 5+ year duration without assuming any large M&A transactions. In our view this is the hurdle to look for on Monday.
- Recurring fees average about ~45bp of AUM over time, with transactional fees at about ~9-10bp of AUM.
- As you can see, there is a small degree of circularity in the model - the growth and value of SC depends on the amount of capital recycled and contributed from PLD's balance sheet on an ongoing basis, which in turn impacts the long-term growth rate of the development/asset ownership side of the house factoring in the size of development profits earned as well. We think this just adds credence to focusing on total earnings growth versus NAV as a framework for PLD especially, but we are interested to see how the company thinks about segmenting the different buckets. Our framework is: assets wholly and partially-owned at a point in time + assets under development at a point in time + SC with a reasonable long-term compounded AUM growth rate + promote income (lumpy and heavily discounted).
- It has come up in the past, but we actually don't think the SC business should be separated as an independent asset manager, at least not in function. It is possible that SC could be spun off one day and retain the Prologis brand and sign management agreements similar to the Mexican and Japanese vehicles. But for all practical purposes, the two sides of the house depend on and feed each other.
Figure 1: PLD Strategic Capital Assumptions / Valuation
Please e-mail with any questions.
Rob Simone, CFA
Managing Director
Twitter: @HedgeyeREITs
