M&A Special - Prologis Inc. to Merge with Duke Realty in $26bn Deal
Deal Overview
Acquirer: Prologis Inc (NYSE: PLD)
Target: Duke Realty (NYSE: DRE)
Total Transaction Size: $26bn
Sector: Real Estate Investment Trusts (REITs)
Close Date: Q4 2022
Acquirer Advisors: Goldman Sachs, Citi Group
Target Advisors: Morgan Stanley & Co, J.P. Morgan Securities
On June 13th, 2022, Prologis Inc. (NYSE:PLD), one of the world’s largest industrial real estate investment trusts (REITs) announced it would merge with rival peer Duke Realty Corp. (NYSE:DRE) in an all stock $26 billion deal, including debt, making it one of the largest transactions in the REIT sector. Duke Realty shareholders will receive 0.475 of a Prologis share for each share held. Hence, as of May 9th,(the date of merger agreement and finalisation) Duke Realty shares were valued at around $62.87 per share, a 31.8% premium on their closing price of $47.71.
Prologis overview
Prologis Inc. is the world’s largest warehouse REIT headquartered in San Francisco. A merger between AMB Property Corp. and Prologis in June 2011 cemented their place at the top as the largest industrial real estate company worldwide. They provide logistics and real estate solutions for their clients while owning, developing, and maintaining logistics facilities. Prologis runs a 1 billion square foot network of industrial facilities around the world that help store, process, and ship online orders for some of the market’s largest companies such as Amazon Inc. ($AMZN) and FedEx Corp. ($FDX). They operate through 2 business segments: Real Estate Operations and Strategic Capital. The Real Estate Operations division represents the ownership and development of logistics properties while the Strategic Capital segment represents the management of unconsolidated co-investments and ventures.
Duke Reality overview
Duke Realty is a leading U.S. industrial REIT who specialise in development, leasing, property management and construction. As of December 2021, Duke Realty owned 545 industrial properties amounting to 162.7 million of net rentable square ft in 19 major logistics markets across the U.S. They operate through 2 segments: Rental Operations and Service Operations. Its Rental Operations are responsible for the ownership and development of industrial properties. Its Service operations segment is accountable for providing construction management and property management to customers and clients.
Industry Overview
A real estate investment trust or REIT is a company that operates, owns, or finances income-producing properties. REITs are modelled after mutual funds in the sense that individual investors can earn dividends from real estate investments without having to own or maintain any properties themselves. REITs, by law, are required to pay a minimum of 90% of their taxable income as dividends to shareholders each year, hence are an attractive investment for individuals from all income levels. Their comparatively low correlation with other risk assets also makes them an effective portfolio diversifier.
During the COVID-19 pandemic, consumer habits changed as more people went online to consume goods and services. Naturally this amplified the need to store extra inventory as more retail companies expanded into the e-commerce sector. This change majorly benefited industrial REITs as more companies were demanding warehouse space.
In addition, a world-wide fall in interest rates increased activity in the real estate market. With borrowing costs extremely low and mortgages historically cheap, new acquisitions and construction of warehouse space surged. As seen in the graph below, after Q2 of 2020, US house prices skyrocketed with house prices increasing as much as 18.5% year over year in Q3 2021. Due to the changes in consumer behaviour and interest rates, deals involving REITs reached an all-time high of $140 billion in 2021 alone, compared to $17 billion the year before in 2020.
Strategic rational
The merger between Prologis and Duke Realty is set to create an even larger industry giant with serious future growth potential. This deal would grant Prologis new capital synergies through an additional estimated 162.7 million square feet of operating properties across 19 major US logistics markets including Southern California, which is Duke Realty’s largest market.
According to the transaction report released by Prologis, this merger is set to provide the joint party with $310-$370 million in general and administrative savings, operating leverage, and lease and debt adjustments in year one. Going forward, additional accretion of $375-$400 million from incremental property cash flows an essentials income, lower cost of capital, and annual development value creation potential is expected. Prologis estimates that the addition of Duke Reality will add $0.20-$0.25 per share to its core funds from operations (a term used to describe the cash flow of a REIT) in the first year. This accretion is significant for a REIT that is expected to produce $4.50-$4.56 per share of core FFO this year alone.
Prologis has previously participated in M&A when they acquired DCT Industrial for $8.4 bn in 2018 and Liberty Property Trust for $12.6 bn in 2019. Both acquisitions have yielded returns higher than their industrial peers with DCT outperforming its competitors by 38.1% and Liberty Property Trust outperforming their peers by 22.4%. If past transactions are anything to go by for Prologis, the acquisition of Duke Realty is most definitely a strong play to bolster growth potential.
“We have admired the disciplined repositioning strategy the Duke Realty team has completed over the last decade,” said Prologis CEO Hamid R. Moghadam. “They have built an exceptional portfolio in the U.S. located in geographies we believe will outperform in the future. Our performance will be fuelled by Prologis’ track record as a value creator in the logistics space. We have a diverse model that allows us to deliver even more value to customers.”
"This transaction is a testament to Duke Realty's world-class portfolio of industrial properties, long-proven success and sustainable value creation we’ve delivered over the years," said Jim Connor, chairman and chief executive of Duke Realty. “We have always respected Prologis, and after a deliberate and comprehensive evaluation of the transaction and the improved offer, we are excited to bring together our two complementary businesses.”
Outlook and opinions
There has been a lot of speculation about the future short to mid-term growth potential in the REIT and housing markets. As the macroeconomic environment takes a downturn through hot inflation and hawkish central bank actions, growth prospects and valuations across the market are falling. This deal comes at an interesting time for the sector as equity markets have plunged over the last 2 quarters. Industrial REIT stocks have felt equal pain after Amazon’s ($AMZN) announcement that it had more warehouse space than it currently needs.
As mentioned previously, industrial real estate prices surged in recent years. However, this trend may not continue moving into the future. As consumer habits revert to in person shopping, the demand for industrial warehouse space may fall. Growing recession concerns on Wall Street and rising interest rates may hurt warehouse landlords as mortgages become more expensive which, in turn, tend to push down property prices.
However, investors can take confidence from the conviction Prologis has shown in the REIT sector by acquiring Duke Realty. With industrial space vacancy rates still at historic lows, the near-term outlook for industrial REITs such as Prologis looks solid. “The current supply and demand picture still looks fairly positive,” said Mr Knott of Green Street. Asia’s growing middle class and the growing e-commerce activity in that region all point to increased industrial activity. An upturn in demand for logistics assets may also strengthen industrial REIT growth potential as operators seek to accumulate inventory and warehouse space to hedge against supply chain disruptions.
With a possible recession around the corner and inflation data at 40-year highs, the REIT sector has shown remarkable strength. Prologis expanding their industrial warehouse fleet across the US and boosting their square foot network of industrial facilities to well over 1.1 billion, will only fortify their business operations and growth prospects.
I hope you enjoyed the article!
See you next month,
Andre
Disclaimer
This communication is for informational and educational purposes only and should not be taken nor used as investment advice, as a personal recommendation, or solicitation to buy or sell any financial instrument. This material has been prepared without considering any particular recipient’s investment objectives or financial situation and has not been prepared in accordance with the legal and regulatory requirements to promote independent research. Any references to past or future performance of a financial instrument, index or structured product are not, and should not be taken as, a reliable indicator of future performance. I assume no liability as to the accuracy or completeness of the content of this publication.