REIT M&A—Getting it Right at the 24th Annual REIT Symposium

The title of this panel is 'M&A: Getting It Right' – identifying, negotiating, and integrating corporate acquisitions to maximize value through M&A. I couldn't be happier to have these four esteemed panelists to talk about what's going on in the world of M&A, because each of them brings a really different perspective to the table. Let me quickly introduce the panelists so you know who they are and what they bring. To my immediate right, Jon Bortz, who's the Chairman and CEO of Pebblebrook Hotels, which he founded as a blind pool in late 2009 after leaving LaSalle Hotels. He grew Pebblebrook to about 30 hotels with a gross asset value of about $4 billion. Last year, Jon launched a campaign to buy LaSalle, which he was in a bidding war with Blackstone, and he ultimately won. Pebblebrook today now owns over 60 hotels with a gross value of over $7 billion. To his right, Gordon Dugan, who's the former CEO of Gramercy Property Trust from 2012 to its sale to Blackstone last October. Prior to joining Gramercy, Gordon was the President and CEO of W. P. Carey, having joined Carey in 1997, becoming its President in 1999 and then CEO in 2004. He oversaw Carey's growth from about $2 billion of assets to $10 billion of assets, so he knows a lot on the acquisition side, and clearly having sold Gramercy knows what a sales process is like. To his right, Matt Lustig, who is the Managing Director and Head of Investment Banking for North America, also the Head of Real Estate and Lodging for Lazard. Matt has worked on some of the industry's biggest transactions. He's also very active in the REIT world, sitting on two boards, both Ventas and Boston Properties, two blue-chip companies. Matt has done both significant buy-side as well as sell-side work. And lastly, to Matt's right is Mark Ordan, who is the former CEO of QCP. We called him the serial CEO, which was the title in the panel book, because he's the former CEO of QCP, Sunrise, Washington Prime, and Mills. Just by show of hands, how many people have seen Pulp Fiction? All right, good. Everyone remember Harvey Keitel as The Wolf? I can't play the clip, but I call Mark 'The Wolf' because Mark has solved problems. Every time one of these companies – Mills, Sunrise, QCP – all had broken balance sheets, broken industry fundamentals, broken employee morale, and Mark comes in, stabilizes the company, and ultimately exits the company through attractive sales processes done by Wachtell. I'm sure they're going to take credit, but Mark deserves a lot of that credit. Let me quickly set the stage through a couple of slides to give the perspective of what's happening. This is on the left-hand side of the chart: REIT M&A over time. You can see the buildup in '06 and '07, ultimately culminating in the sale of EOP and Archstone. Obviously we went through the Great Financial Crisis, nothing happened, and then it started getting back to a reasonable sort of nine deals a year over the last number of years. Last year being a big volume year where we saw a lot of privatizations or quasi-privatizations, in the case of GGP. But clearly you had Forest City, you had EDR, you had Gramercy that went private. That's sort of give or take nine deals a year. If you think about what's happening in the overall transaction activity market, the chart on the left looks at just total real estate transactions. You can see last year, driven in part by some of the REIT M&A that occurred and the resale of assets, we reached a record of $494 billion of transaction activity. The chart on the right looks at what the REITs are doing from a buy and sell perspective. The REITs have taken advantage of the marketplace to be able to sell into the strength, but also selectively buy. If you actually look at the last three years, the REITs have been perfectly even with about $130 billion of acquisitions and $130 billion of dispositions. The REITs – we did a report last year called 'Something About You Looks Different' – because if you look at a lot of the REITs today, Jim Connor from Duke talked about this. Ten years ago, Jim was a suburban office, flex, mob, and industrial owner. Today, he's a pure industrial owner. So there's been a lot of change going on in that marketplace. As we think about the prospects for further M&A, you need a lot of targets. This looks at the number of REITs that exist going back the last 20 years. You can see significant M&A activity that occurred in that '05 to '07 timeframe, and then coming out of the Great Recession, significant new capital formation, a lot of IPOs, a lot of blind pools like what Jon did. Today, we're sort of sitting back at 174 companies. When I started in 1998, the average REIT market cap was $1.5 billion. We're well over $7 billion today. So we have the same number of companies, just significantly larger in scope. There's a record amount of dry powder sitting on the sidelines: $333 billion according to Preqin. The institutions still remain below their real estate targets, so the private side of the business remains very strong. The right-hand side of the chart looks at what's going on in the public world, which is not as strong. You've seen consistent outflows out of dedicated mutual funds as well as out of products in Japan. We've spent a little time on NAV. The sector today, after rallying significantly to start the year, has moved back to a modest premium. But if you pull back the onion a little bit, there's a lot of different sectors that trade at different valuations. If you look at the office or the retail sector or the lodging sector, they're generally at discounts. But when you move to apartments or industrial or the data centers, they're sort of at modest premiums. Then you look at the specialty sectors: in the case of healthcare, self-storage, manufactured homes, and triple nets, they're at pretty significant premiums. Clearly, depending on where these stocks trade, it dictates a little bit about how they move forward. We asked at our recent Global Property CEO Conference: 'Are there going to be more or less companies in your sector?' I'd just ask Barry. You can see the sectors on the left don't expect much M&A, and the sectors on the right, including malls, urban office, triple net, and industrial, to see some level of M&A. There's about eight pages of disclosures because lawyers at Citi need... I'm sure everyone's taking pictures of those; they literally go on forever. With that, that's sort of the intro. What I want to try to accomplish in the time that we have with our panelists is really four things. I'm going to join you here now. I'm glad you wore your Kiss socks for the panel. I don't know how appropriate that is in today's environment, but we'll go with it. I appreciate it. What we're going to try to do is start with what these people love and hate about M&A. We're going to discuss the hunt: finding the M&A opportunities. We're going to discuss the negotiation: dealing with a target or selling themselves, dealing with activists, dealing with passives. And lastly, we're going to discuss the integration: how to make these deals work and maximize value for shareholders. To start – and I've been doing this the last few years – I love James Lipton's 'Inside the Actor's Studio', so I steal his question. They always say, 'What is your most and least favorite word?' But I'm going to say, 'What is your most and least favorite word about M&A?'

Either you trust the counterparty you're dealing with to actually do what they say they will do, because you know there are many examples of M&A processes that are sometimes foisted upon people, or are done to satisfy someone but not done with vigor and good faith that they really want to get something done, or a price objective that at the end of the day is unrealistic because the seller doesn't really want to sell that market, but if they got overpaid for their situation, they would do it. And that's a tough way to sort of run a railroad from an M&A process point of view. Good exit package for a CEO is always helpful. I think that's good governance no matter what, frankly, and that's excellent governance. I agree with that. I just think why should management be forced into a position where they're hurting themselves by doing the right things for shareholders? It's a lack of alignment to not have a full fair exit package for a management team, because shareholders shouldn't have management as an impediment. You should be incented as management to do the right thing for shareholders. I feel strongly about that.

Paying John? To pay how much did you pay? Not relevant. One thing I want to add to what Matt said is on the trust side, and Mark said it as well, that dealing with in this particular case, it was fascinating to see Blackstone as a buyer, because they have an incredible process and move like nobody can move. But at the same time, they do everything they say they're going to do from the beginning to the end. They were consummate professionals. I kept waiting for that phone call of 'well we didn't know this building was this or whatever,' and there was none of it. They absolutely pick what they want to do and they're incredibly good to deal with if you can make a deal.

So you have to go against Blackstone. Well, you have two interesting things: one, you have to go against Blackstone, but then you have to do it in an open process. Most of these deals happen behind closed doors, they're negotiated transactions announced to the marketplace on a Monday morning. You had to negotiate in the open, dealing with your investor base. You had to pay a price that the seller was willing to finally accept and tell your own shareholders in public, 'don't worry, that's not a full price.' So how do you balance those two things and also bid against a competing bidder that had unlimited funds? That to me is an entire HBS case study. So walk us through how you accomplished it.

Matt, you mentioned dealing with hedge funds in your comments. But I'm wondering, maybe Mark can talk a little bit about this, but the shareholder base changes a lot when a deal gets announced. All of a sudden, you may already have an activist in your stock, you get a lot of these arb guys that come in, and then you still have the index funds which are now upwards of 30% of the shareholder base for over 40%. So there's a lot of different things that go on there. How do you accomplish something that you thought was good for shareholders if you're existing, and then you get this whole new wave of people that come into the stock once the deal is announced?

The one thing I would add is, we did a merger announcement four years ago, and because it was being announced and two public companies, we didn't have control of the narrative. That was a really difficult situation where we announced, we said what we could, but we were somewhat limited in what we could say, and it created an enormous confusion for shareholders. I remember one shareholder said, to Mark's point about getting that trust right away, you had a thousand phone calls. I remember one shareholder said, there were shareholders on our side, we were basically the acquirer, who said 'I don't think you're getting a good enough deal,' and then angry shareholders on the other side who thought we were getting too good a deal. I said, how can I get all of you guys in a room to talk this through? Because you face that all of a sudden. As much communication and transparency as possible is absolutely key, because you're going to get those stakeholders. I'm like, I just got off the phone with someone who thinks I'm paying too much, and you're telling me I'm paying too little. You guys ought to get together.

Matt, is there stuff that you're advising on the index front and the proxy firms and dealing with that, just because it has become such a large holding of REITs and does become a critical factor in these deals getting voted upon?

Yeah, look, I think from that perspective, they're the biggest shareholders as a percentage. We spend a lot of time with our clients, and the situation you're in is an extraordinarily painful one if you're advising a company on the sell side where the buy side is really creating the narrative. You don't have as much input necessarily as you want to have, because these deals get launched, you have one shot to message to the market why this may. You're basically answering the question 'why should you vote for this deal?' because that's your audience. You're going out with a proxy in a few weeks, and you have to sort of get that messaging right. The index guys will want to know a little bit more about process and how did it go and what was the governance related, and so they'll withhold judgment typically until the proxy comes out. You better have a pretty detailed proxy disclosure that describes a thoughtful, appropriate process that a board went through to reach its determination to recommend to shareholders a particular deal. But the piece of it that can be terribly frustrating, because I've been there when you're on the sell side and the buy side chooses a narrative that is incomplete and that leaves the market with as many questions as answers, and then you're stuck with a turmoil in your stock. You increase the risk of inviting uninvited, previously uninvited 'friends' to the marketplace in a bumpetrage or in a sort of hedge fund strategy to get involved and clarify it, and that's the last thing you really want. So I do think there's a renewed emphasis across all boards and deals of expecting the owners of the company to act like owners of the company, which they didn't all used to in the same way. Which is to say, the shareholders, whoever they may become, they own the company, and they should be addressed in a way that allows them to get into your head, subject to public disclosure, as to why this deal makes sense and they should vote yes. But the passive piece of it is more about was the process right, was it honestly arrived at, did it sort of conform to the principles that the lawyers and bankers will tell you are good quality decision making? But in a way, it's no different than running a company, you have to deal with all of the issues around you. So maybe there's more complexity now dealing with shareholders and because of shareholder turnover, but that's just the job. If there's a dead body in the back seat of the car, you gotta clean it up.

Mark, deal with the perspective of... you use that one a lot? I hadn't thought of it until the other day, I learned from Mike Billerman. You had to go shopping your QCP deal, you negotiated with a buyer, announced a deal, and then had to go shop. Robin talked early on about, because the private equity world today has got two extraordinary large players in Blackstone and Brookfield, and then Barry's got a seven billion dollar fund, but there's not a long list of parties like that. How does that... do we expect that to be more common in deals?

Well, it's important if you negotiate a deal with one party and you go through all your logic, you still want to make sure that you're getting the best price. So if you're well advised, the first thing you're going to do is say to the world, 'hey, if somebody else can come up with a better price, be thrilled.' Now usually management will benefit directly if the price goes up. But as a buyer, I would hate to have... I want to buy a house, I don't want to lose my deal. But a buyer is buying a public company, and a public company is owned by a shareholder, so a buyer has to respect the fact that you're going to do that. Now the buyer also has the ability to pay more. So I don't think that unlevels the playing field, but I think it's important that you can look your board members, your shareholders, and everybody in the eye, whoever it is, and say this was an objective, competitive process. Frankly, it doesn't matter whether the deal's signed or not, because if an offer comes in unsolicited, the board has an obligation to consider it, and if it's better than the deal that was signed, that's why there's a breakup fee at the end of the day. And actually, there was one paid in our deal, though that was unfortunately didn't need to be paid. Now during a go-shop process, there are people... I mentioned the word duplicity earlier. There are people who will in any process try to monkey around a little bit for their own advantage, which may be not in any way the best interest of the seller's shareholders. So again, you have to have the right lawyers who are watching the process closely and making sure that people aren't gaming the system, because they will if you don't.

Is there anything that you've learned from a failed M&A experience? We all know about the stuff that gets announced, but is there something that in your careers from a deal that didn't get announced that you've learned and applied in other transactions? Matt, I'm sure there's been a failed M&A deal. That's got a hundred percent batting action. Matt's the only one been involved with exactly.

No, look, I think as I said before, deals fail for so many different reasons. I think one of the things that comes up when you get close to a deal is you find the true colors of the influencers at the buyer and the seller, which sometimes you're not in a position to fully understand until people are sort of tested. That includes board members, it includes management, it includes financiers who are providing capital or not providing capital at a given cost for a deal. So I think for better or worse, deals fail for lots of reasons. But the piece of it that you always wish if something doesn't happen you did a better job at is really getting to better understand, and it's not easy to do because there's a reason if folks have mixed agendas that they don't share them with you until they have to, that you really understood all of those parties. But it's almost... I wouldn't say it's a miracle, but those of us who work in the M&A business every day, it's really hard to get deals done because so many things have to go right. So much of it is not the numbers, the numbers are comparatively easy to compute. It's really about business plans, executions, motivations, how people think. There are folks with very strong biases about the future that that's just what they think. There's no way to dissuade them, it's almost political or religious, they believe this is what the future is going to look like and the market may or may not. But a lot of folks have strong points of view that at the end of the day you didn't understand completely. So much of it is really getting on the table and fully understanding, and frankly some parties, when you get really close and absorb what it's really going to mean to do the deal, sort of back away. So a lot of that is really knowing your client and the board members and sort of how decisions get made and what motivates the underlying.

You also would never want to put people on a panel on M&A who fail at an M&A deal. But it's never the banker's fault. I think the bigger question is why do deals not even get started? I think you can look around the industry, whether it's REITs or any industry, and see plenty of underperforming companies and plenty of consistently underperforming companies. I think boards are in many cases asleep at the wheel. I think they may not be getting information that explains their relative performance, how their shareholders view them at the end of the day. I think there's this sort of negative perception of an activist. One of the things we found is that some companies, some investors, big investors, are afraid to actually argue for their own investments at the end of the day, they're afraid to rock the boat and complain to a board. There needs to be more communication between boards and institutional shareholders at the end of the day. I think if you cleared some of this out, you'd end up with more transactions. On the board point, my thought has changed on this. When a lot of the REIT executives were going on each other's boards, I sort of viewed it as a conflict of interest because we're all buddy buddy, we go to the NAREIT conference, you go to our conference, you go to conferences like this. Then I started to realize I got access to the boardroom. I spend now more time talking with REIT CEOs or CFOs that are on other boards about the companies they sit on versus their company themselves, and it provides that access to the boardroom that investors or analysts didn't have before. Now the good companies do that already. The good companies, Matt sits on two boards on Boston Properties and Ventas, I've presented to both of those boards. The CEOs are open to conversations, but I would agree with you, more companies need to follow that discipline.

So we've spent a lot of time talking about the hunt, we've talked about the negotiation. The last piece with the time that we have left is talking about the integration. Maybe John, now you inherited a company that you built, so you sort of knew where all the bodies were hopefully buried and you knew a lot about the assets. But how do you integrate? You don't manage the lodging assets, you manage the manager, so it's a little bit different. But how do you integrate both people assets, but then also manage the external communication in terms of that integration and how it's going?

Mark, so you've on the sell side, you're around for the sizzle but not the steak, the integration part. So how do you sort of manage that aspect of how the buyer ultimately... well, you want to, it's your job to make sure that the buyer gets, goes back to trust, gets what they paid for. So you want to make sure that you're selling the company in the best way possible, that your team is as encouraged about the future for them as you can. But then as the selling CEO, the next thing that happens is you're gone. So you've got to tie it up in a nice bow, and how's that integration going, and then you're out like 30 days.

Well, that's it. Gordon here, same thing. That happens pretty quickly, they don't need 51-year-old ex-CEOs hanging around. But in my case, Blackstone let me keep my office for a while and my email, so that's nice. But I have had some time off, which has been... last night at our dinner, I mentioned that I've been spending time in Paris with my wife and skiing a lot, and that got a spontaneous round of applause from the other great executives in the room. So it shows you where people would really like to be doing. Yes, family time is the most important time.

Yes. Matt, do you are you involved a lot in post-merger integration? I mean, if you're on the buy side you are, on the sell side as you describe, you're dealing much more with price and certainty of closing, and you're offering helpful suggestions to the other side which they may or may not take around people, around board members sometimes, and boards are getting integrated. And so you're doing that. But on the buy side, it really depends on your relationship with a client. If you're purely a transactional advisor, which is unusual for us, less so if you're staying close to a client because of ongoing relationships, you're talking about. I think on the buy side, it's so important to have planned your first 90 days in advance, know who's going to have what jobs, what they're going to do. You're required to have this period of time for a shareholder vote before it closes, and a part of a merger document will include what sort of access you have to information. Well, you can't do anything because the deal in theory might not happen, but you can do a lot of planning. I think the best deals that happen are extraordinarily well planned down to who's going to do what on what day, what are going to be the communication, the external focus stuff, but also internally how do you launch it. You've got to make a public announcement, generally sometimes you can do it on a Monday morning at the same time. How do you communicate to your employees? But you better have a plan really quickly, because people's attention has been diverging for a period of time from the time you announce it to the time you get to close, and you better move quickly and decisively. You may make some mistakes. You better understand systems, which are notoriously difficult to integrate. The IT piece of this is not necessarily the fundamental skill of a REIT CEO depending on which industry and what have you, but you better understand all the rest of that stuff. You don't have to know what it is, but you better have a plan, and each of your teams has to have a plan who's going to do what to whom when, and those 90 days are critical.

Michael, I should mention that the four of us had planned to talk about the importance of analysts in this process, but we're out of time. I know I'm getting hungry, so I know we're getting close to lunch. Is there any questions from the audience? We probably have time for one before we have to get over to the lunchroom. Is there someone who wants to stand up and have a question?

People hear the question? It's about the relevancy of NAV to an M&A transaction. Matt, you want to... considering you worked on some of those transactions. Look, NAV is one of the critical elements the board takes into account around deciding what the right price is to effectuate a transaction at. Owen this morning mentioned that street NAV for Boston Properties is between 122 and 150 something. The fact is, determining NAV is an art, not a science. An analyst as outstanding as Michael Billerman is and others don't have the information to frankly accurately describe NAV. Now, it's easiest to figure NAV in a simple 100% fee simple owned apartment business, let's say we could put a cap rate or dollars per unit on it. It gets really difficult when companies have material debt arrangements that aren't fully disclosed, joint ventures, leaseholds, contractual rights and obligations vis-a-vis property operations which are not disclosed because individually they're not material, but collectively they certainly are. So I think NAV is a huge determinant, I just think in certain property types and certain deal structures that may or may not be predominant in a given company, it's more or less transparent. So it's much harder as an outside shareholder without that disclosure and that access to determine what NAV is. I think you are left to what the statutes tell you, which is you better have a board with good judgment that had access to all of the information around what the status quo looked like, what the existing business plan, how the market was valuing shares in terms of plan A versus what the value might be in terms of certainty, taking into account a whole lot of factors. But certainly NAV is a critical factor, it's just not the only one. Analyst estimates are based on imperfect disclosure, so it's hard to fully rely on that. Still, you can't deposit NAV in the bank, you have a shareholder price. So if you can't deliver NAV to me, it's sort of a meaningless number.

Great. Well, thank you so much to each of you. This is very enlightening. I think we're moving where to the lunchroom across the hall. Next up, lunch across the hall with Sam Zell. Great, thank you.