Allied Properties Real Estate Investment Trust T.AP.UN

Scotia comment on transaction

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Seeking 100% UDC Sale; Redeployment Is Critical, In Our View

OUR TAKE: Neutral. We’re off a brief restriction. Allied updated its unencumbered urban data centre (UDC) portfolio sales process, concluding that selling a 100% interest is now optimal financially and operationally (implementing a comprehensive sales process). AP seeks to “supercharge” the balance sheet and lower reliance on equity markets + execute on its distinct urban workspace consolidation strategy over time. AP noted any sale proceeds will lower leverage, fund ongoing developments (~$275M), and possibly repurchase units (6.4% implied cap). Importantly, AP does not expect a sale to be dilutive to FFOPU.

We’re suprised with a potential 100% sale. Our prior base-case = 50%, in part due to possible special distribution requirements that we felt did not satisfy the criteria laid out for a transaction (i.e. selling the UDCs to pay special distributions). That said, we still believe there is tangible Current NAVPU upside on a sale (i.e., 3%+; Exhibit 1) and material debt reduction (Exhibit 2) sans AFFOPU dilution is a good thing. Ultimately, we think structural debt reduction and development completion would be viewed positively by the market, with near-term re-deployment into external growth a bit more mixed.

KEY POINTS

UDC portfolio sale. To reiterate our prior research (see our Q1/22 and Q3/22 results notes), we believe the UDC portfolio could be worth $1.5B+ vs. the ~$1.4B in our NAVPU and $1.3B AP IFRS value (Exhibit 1 = UDC portfolio sensitivity to cap rate and NOI). We had highlighted our view that a sale of a stake better fits Allied’s disclosed disposition criteria (which included paying down debt, bringing in complementary leasing expertise, and a “good trade”). We also believed there are special distribution considerations given the asset tax basis is likely far below current fair value (recall, AP acquired 151 Front in 2009 for $192M).

A 100% sale would bring debt squarely back to AP long-term target. We estimate a sale at $1.5B would lower net debt/EBITDA and debt/GBV by 2.6x and 9.7% to 7.0x and 24.6%, respectively (Exhibit 2), immediately transforming AP into one of the best CAD REIT balance sheets. Factoring in expected development completions (and assuming a 15% FV uptick), we estimate the pro-forma net debt/EBITDA and net debt/GBV = 5.9x and 26.5% (every 1.0x = $0.7B of purchasing power at a 5.5% cap).

Still some juice to squeeze, despite strong start to the year. AP is +17.0% vs. +7.4% for CAD REITs and +6.8% for U.S. Office REITs YTD, following a -37.8% total return in 2022. As shown in our REIT Stuff earlier today, AP was a bottom-5 performing REIT in 2022 (was our Top Pick). AP has seen the most AFFO multiple erosion during COVID in our universe (42%; Exhibit 3) and lost the most on P/NAV (Exhibit 4) vs. historical average. In contrast, we believe AP can deliver above-avg. ~10% NTM NAVPU growth (Exhibit 5), with the possible UDC sale additive to our forecast.