Blackstone Group Inc. (NYSE:BX) – market cap as of 16/09/2019: $63.96bn
Dream Global Real Estate Investment Trust (TSE:DRG.UN) – market cap as of 16/09/2019: $3.22bn
Intro
On September 15, Dream Global Real Estate Investment Trust announced acquisition agreements with affiliates of real estate funds manager, Blackstone, in an all-cash $4.7bn deal. Blackstone will pay $16.79 cash per Dream Global unit to acquire all assets and subsidiaries of the Canadian firm, representing a significant premium of 18.5% to the closing price on TSX on September 13. The acquisition elevates Blackstone’s existing portfolio of logistics and office properties, as well as adding attractive value to Dream Global’s real estate portfolio with a 9.1% premium. The new fundraising is the biggest yet for a real estate fund, promoting the war chest Blackstone has aggregated to invest in property for more than $36bn. The deal is expected to finalize by December, following a vote by Dream Global’s shareholders.
About Blackstone Group Inc.
Blackstone was founded in 1985 by two former colleagues at Lehman Brothers as a mergers and acquisitions boutique. The Blackstone Group Inc. is a New York-based multinational private equity, alternative asset management, and financial services firm. Blackstone specializes in credit, private equity, and hedge fund investment strategies. The investment firm manages $545bn in assets as of June 30, 2019, including but not limited to investment vehicles focused on private equity, public debt and equity, and real estate on a global basis. Pioneering the listing of shares within management on the public stock exchange amongst private equity firms, Blackstone went public through a $4bn IPO in 2007. Blackstone Group sold a 12.3% stake in the company for $4.13bn.
In the last decade, Blackstone has held a strong position as the largest investor in leveraged buyouts, while its real estate business has actively acquired commercial real estate. As of April 2019, the firm disclosed that it was converting from a publicly traded partnership to a corporation. Blackstone’s largest transaction was in real estate in 2007, when the firm acquired Hilton Hotels Corporation for $26bn. The Hilton deal is often referred to as the deal that hit the “high water mark” and the start of the end of the multi-year boom in leveraged buyouts.
In the first quarter of FY2019 Blackstone generated $2.02bn in revenues, representing 6% YoY growth. Growth was driven primarily by fee-related earnings, such as Management and Advisory fees. In the first quarter, strong appreciation generated $540m of additional Net Accrued Revenues, offsetting $204m of Net Realized Distributions. The total AUM for real estate has increased 17% to a record of $140.3bn with inflows of $5bn in the quarter, primarily due to the launch of a fundraising campaign for the sixth opportunistic European fund and fourth real estate debt fund.
About Dream Global Real Estate Investment Trust
Dream Global is the owner and operator of a differential, high-quality portfolio of office and industrial properties situated in key markets in Western Europe, specifically in Netherlands and Germany. Office property makes up 94% of Dream’s portfolio, while industrial property only takes up to 6%. The local and in-house platforms of Dream Global REIT are composed of over 140 local leasings, asset management, property management, and development professionals. One of the biggest leverage of Dream Global’s business is its diversified tenant base with over 1750 tenants, including Deutsche Post as its largest and long-standing tenant.
In 2011, Dream Global went public and raised $470m, of which $120m of it was self-invested. Today, Dream Global boasts a market capitalization of C$3.2bn, focusing on Big 7 in Germany and G5 in the Netherlands as its target markets. Big 7 represents Germany’s biggest cities that are Hamburg, Berlin, Frankfurt, Munich, Köln, Stuttgart and Düsseldorf whereas G5 is the Netherland’s top five cities: Amsterdam, Rotterdam, The Hague, Utrecht, and Eindhoven. Over the first half of 2019, Dream Global held acquisitions of $135.2m and dispositions of $144.8m. The fair value of Dream Global’s portfolio increased by $204.3m over the previous quarter based on external appraisals as of June 30, 2019. The fair value gains are essentially attributable to yield compression and market rent growth in the Big 7 and G5 markets.
As of February 20th, Dream Global REIT has a gross asset value of $5.7bn. For the year ended December 31, 2018, Comparative Properties NOI increased by 4.3% from the twelve months ended 2017. This growth was largely attributable to increased occupancy and in-place rents. Dream Global’s portfolio consists of 228 properties and comprises of 19.9m square feet of GLA, as of December 31st, 2018. Of this total, 122 of the properties are located in Germany and 104 in the Netherlands.
Industry Overview
The western European commercial real estate industry operates against a worrying macroeconomic backdrop. Current trade tensions are a source of uncertainty for European economic growth which depends in large part on exports. Germany, which is Dream Global’s main market as well as the Eurozone’s most export-led economy, stands on particularly shaky grounds after suffering a staggering 5.3% annual contraction in industrial production as per July’s economic data.
This climate of uncertainty prompted an unprecedented flow of capital into real estate markets. Exceptionally low interest rates, with the yield on the 10-year Bund currently standing at -0.58%, have boosted the demand for property, leading to record-high valuations. Indeed, rental income provides an attractive alternative for investors desperately seeking higher yields than those on government debt. Taking advantage of this demand, large real-estate investors like Blackstone and Brookfield have embarked on aggressive rounds of fundraising, culminating with the record $25bn that Blackstone raised a few weeks ago. With more cash on their hands, real estate investors launched a series of multi-billion-dollar acquisitions, best exemplified by Blackstone’s $18.7bn purchase of GLP’s logistics assets over the summer.
The current real estate landscape in western Europe is fiercely competitive as the property cycle enters its late stages. As such, investors’ hopes for capital and income growth from real estate assets has sunk. According to data from Prequin, two-thirds of fund managers have cut their 2019 return targets. One of the only markets in Europe which still has the potential for income growth is the office market. The past 10 years have seen few office building development projects, which has made for a relatively low supply when measured up against today’s low rates of unemployment. This imbalance has caused Dream Global’s portfolio of office buildings to appreciate and ultimately allowed the fund to generate a 15% annualized return over the past 8 years.
Other forces have also been at work. The European office market is undergoing a paradigm shift due to the entry of disruptors such as WeWork. The influx of flexible workspace providers has elevated the tastes of tenants, who now demand more services and extra features from their landlords. One of the reasons Dream Global’s portfolio of office buildings is attractive to Blackstone is precisely because it can respond to these demands. Dream Global is invested in high-quality assets located mainly in Germany and the Netherlands, several of which incorporate Boutique Office or Smart Office concepts, which provide tenants with additional services. The location of the assets is also crucial: Amsterdam is Europe’s second-largest co-working hub, with nearly 400 thousand square meters of co-working spaces.
The change in the business model behind office real estate comes with its pros and cons. Flexible terms and additional services mean higher rents and integrating the appropriate technologies allows for lower operating costs. On the flipside, offices filled with a large number of small businesses are arguably more vulnerable to an economic downturn. Nonetheless, a growing number of serviced offices are now filled with larger companies — HSBC, for example, is reported to have recently agreed to lease over 1,000 desks from WeWork. Overall, serviced offices represent a key trend which is likely to lead to more consolidation in the office market in the future as a means to achieve the economies of scale and the diversification needed to withstand the economic cycle.
Deal Structure
The deal is structured as an all-cash takeover, meaning Dream Global unitholders will not benefit from any potential upside of the transaction but will also not bear any risk. The deal will see Blackstone pay CAD 16.79 per share of Dream Global, which represents an 18.5% premium to Friday’s closing stock price. Given the solid premium, analysts expect that the deal will win the approval of the minimum of two-thirds of unitholders required in order to go through. Indeed, an investor who invested in Dream Global at the beginning of this year would have made an attractive 47% return on his investment. However, this overshadows the fact that the transaction only represents a 9.1% premium to Dream Global’s end of June EPRA NAV, a metric which represents the fair value of the company’s net assets on a long-term, ongoing basis. As part of the acquisition, the company is acquiring all of Dream Global’s subsidiaries and assets but no decision has been made yet regarding the treatment of Dream Global’s debt. The company currently has €675m of outstanding senior notes, which it may potentially repurchase. The deal is still subject to regulatory approvals and other customary conditions and is expected to be completed by the end of December 2019.
Deal Rationale
In their latest fundraising round, Blackstone gathered $36bn for its real estate fund, which as a result of a decade long property boom amassed over $154bn. This makes it the firms’ second-largest investments branch after private equity. The acquisition of Dream Global is undoubtedly a direct result of a growing demand for warehouse space driven by the e-commerce and retail sectors. The developments in these sectors caused the properties to surge in value and thus become an interesting prospect for private equity funds. Companies such as Amazon and Zalando are rapidly expanding their operations in Europe and are placing importance on the availability and swift delivery time of their products. Amazon, for example, has devoted itself to providing its customers with same-day delivery of their order, which requires an extensive network of warehouses and offices across the continent.
The purchase of the Canadian REIT by Blackstone follows the pattern of its peers’ growing appetite for expanding their logistics properties portfolios. In early 2019, Prolongis struck a deal to acquire warehouse owner Industrial Property Trust for $4bn and Colony Capital announced it will buy an entire warehouse portfolio worth $1.2bn. In June, Blackstone itself splurged $18.7bn on a portfolio of US-based warehouses. However, in terms of acquiring Dream Global, Blackstone is mainly looking at a portfolio comprised of just 6% of warehouse space properties and 94% of offices. The deal is thus primarily motivated by the demand for office space driven by the trend of companies growing in size and expanding their operations internationally. The Dream Global assets will add on a substantial number of office properties to Blackstone’s portfolio and a small but strategically placed number of warehouse properties that can be built upon in the future, given demand prevails.
The large inflow of capital into the ever so competitive real estate industry is evidence of investors having confidence for the prospects of the market. However, some see worrying signs of a real estate bubble precisely due to the influx of capital into the market. As yield-hungry investors flood the market with money and interest rates get near all-time lows, a sudden capital flight might have disastrous effects on the potentially overpriced assets.
Another reason for the deal is the effect Brexit will have on big businesses moving out of London and into continental Europe. The transition will inevitably drive demand and thus the value of office spaces in other financial hubs such as Frankfurt and Amsterdam. According to the Dutch financial markets authority Chairwoman, 40% of European financial trading is expected to be housed in the Netherlands post-Brexit. Dream Global owns a vast amount of office space in almost all new financial hub candidate cities which would be utilized by big corporations fleeing Britain.
The deal is also very beneficial for Dream Global, as the transaction upon completion will have increased the REITs equity market capitalization by nearly eightfold and will deliver annualized returns of 15 per cent to its unitholders. Hence it will exceed both the European and Canadian REIT benchmark by approximately 60 per cent and allow Dream Global to compete with the best-managed real estate private equity funds and pension funds globally.
Market reaction
On September 16th, the day after the announcement of the transaction, Dream Global Real Estate Investment Trust (DRG-UN.TO) listed on the Toronto stock exchange was up 16.94% by the end of the trading day, closing at 16.57 CAD (Canadian Dollar) per share, an equivalent of $12.5. On the same day, Blackstone Groups Inc. (BX) New York Stock Exchange-listed shares were down 0.57% to $53.53.
Additionally, on September 17, Moody’s has declared it is placing the ratings of Dream Global REIT under review for a potential downgrade following Blackstone’s acquisition announcement. Moody’s considers governance risks in Dream’s credit profile, which include the potential weakening of controls if the company transitions from a publicly listed entity to a private equity capital controlled entity. Despite the news of a downgrade review, the stock of Dream Global did not react much thus showing investors’ overall positive outlook on the acquisition deal.
Deal Advisors
Dream Global’s financial advisor is TD Securities, while Osler, Hoskin & Harcourt LLP and Greenberg Traurig Germany LLP are its legal counsel on the deal. RBC Capital Markets, BNP Paribas, and Deutsche Bank Securities Inc are serving Blackstone as its financial advisor, while Davies Ward Phillips & Vineberg LLP and Simpson Thacher & Bartlett LLP are acting as its legal counsel.
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