LXP Industrial Trust (LXP) – Merger Arbitrage/Increased Offer – Upside 6%+

Current Price: $15.16

Offer Price: $16.00 (potentially increased)

Upside: 6%+

Expiration Date: TBD

 

A quick note on an activist pressure/strategic review situation that has the potential to develop into a bidding war. The downside seems to be well protected.

Warehouse/distribution center REIT LXP Industrial Trust is being attacked by REIT activist Land & Buildings, which has recently proposed a non-binding offer at $16/share, a 6% spread to current prices. However, the activist has made it clear that the offer might be increased after the due diligence:

Our interest in acquiring LXP is based on publicly available information. If as a result of our due diligence we find evidence of additional value inherent in the Company based on operating results, synergies or otherwise, we would be willing to upwardly adjust the offer price to reflect such additional value.

A week later (8th of Feb), LXP announced a strategic review to explore options, including a sale. LXP currently trades at around 5% cap rate and 19x FFO – a substantial discount to all warehouse/DC (distribution center) peers, including MNR, which was a target of a bidding war last year with the final bid ending up at a 4% cap rate and 25x FFO.

According to Land & Buildings (here and here):

LXP is materially undervalued. The Company trades at a substantial discount to net asset value even as there is a wall of capital looking to invest in industrial assets. LXP trades at a 5% implied cap rate, while the inferior Monmouth Real Estate Investment Corporation portfolio recently sold at a 4% cap rate and an Industrial Peers average at a mid-3% cap rate.

[…]

A logical move is to sell assets and return capital to shareholders when trading at a discount to NAV like Lexington is today, which we believe could be readily executed in the active industrial transaction market.

Quick FFO comparison table with peers:

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Note – MNR FFO was adjusted for the strategic review and sale-related expenses.

Valuation closer to MNR (4% cap, 25x FFO) would result in LXP price target at around $18-$20/share. By the way, Land & Buildings claims that financing will not be an issue and it has already received confident vocal approval from a number of debt and equity financing sources.

The current 5-6% spread seems a bit wide here keeping in mind undervaluation relative to peers and potential for a reviced bid – the stock jumped to $15.92/share after the strategic review announcement. Some part of the spread is explained by the general market sell-off over the last 10 days. However, a larger part of the skepticism here could be related to the background of the activist. Land & Buildings is led by a prominent RE activist Johnathan Litt, who is known to be more of a small shareholder (the whole fund is reported to have $600m AUM)/playmaker than an actual asset acquirer. His playbook is to push his nominees to the board and try to monetize assets/organize company sales. This has worked out really well in some cases (BRE Properties, Associated  Estates, MGM Resorts, Mack-Cali in 2016) and not that well in some of others (Taubman Centers, Mack-Cali in 2018). Johnathan Litt was also present in the recent MNR (LXP peer) bidding war last year, trying to get his nominees on the board to oversee the sale process, however, he has exited the position in May, before two higher bids were announced. So it’s likely that the market doesn’t trust Land & Buildings’ acquisition attempt, but rather sees it as an opportunistic stalking horse bid to put the company in play. Meanwhile, LXP management has a lackluster track record and over the last 6 years has been engaged in a prolonged portfolio transformation into the industrial (warehouse/DC) sector, which obviously affected the company’s financials during this period. The good thing is that the warehouse/DC sector is currently red hot (demand outpacing supply, vacancies at all-time lows, rents are increasing, etc) due to the booming e-commerce, meanwhile LXP’s portfolio transition is almost done. As stated by the activist:

Secular and cyclical drivers of demand signal that strong rent growth is on pace to continue, and record leasing and absorption levels have pushed vacancies to all-time lows. In short, Lexington should be ideally positioned to take advantage of this perfect market to help it finally close the consistent discount between the Company’s net asset value and its share price.

So there’s a good chance that the opportunistic set-up could work out favorably here. A big positive is that it seems that LXP is willing to work that way and has already announced the strategic review. In the end, I wouldn’t be surprised to see a higher bid from a strategic buyer here (the same way the bidding war ended with MNR).

The downside to pre-announcement prices stands at 5-6%.

 

LXP

Since 2015 LXP has been transitioning from a net lease mixed bag portfolio with most assets in the higher-earning/risky office sector to the current portfolio of 93% in the industrial sector. The company expects to complete the transition to 100% by the end of this year. To mark a substantial completion of the transition the company changed its name in Dec’21 (previously was known as Lexington Realty Trust). LXP has also lowered its leverage from 6.7x net debt/EBITDA in 2015 to around 5x.

Currently, the industrial part of the LXP portfolio consists of 126 properties with 56m total sq. ft., most of which are warehouse and bulk distribution facilities. The majority of the leases are single-tenant. From Q3 presentation:

As with most peers, the portfolio is currently almost fully leased (99%).

The geographical location of LXP assets:

A substantial amount of properties are located in second-class markets like Memphis, Dallas/Ft. Worth, Atlanta, Cincinnati, etc. Thus, LXP is not really comparable to the highest quality peers, e.g. TRNO (42x FFO) or PLD/DRE, however, the peer group provided in the FFO multiple comparison table above is somewhat more comparable, especially MNR and STAG, which both LXP and MNR also mention as the two closest peers.

By the way, most of LXP peers have already reported Q4’21 results, with a continued trend of strong performance/outlook and improving rent rates. LXP should report Q4 results shortly and I expect it to be in line with the peer’s trend as well.

STAG Feb’22 call:

Demand exceeded supply in almost all U.S. markets throughout 2021. This drove the strongest market rent growth we have seen in our portfolio in our operating history. Based on our current projections, we expect to see continued strong market rent growth throughout 2022.