Earnings Call Transcript - ARE Q4 2020

Operator, Operator

Good afternoon, and welcome to the Alexandria Real Estate Equities Fourth Quarter and Year-end 2020 Conference Call. Please note, this event is being recorded. I would now like to turn the conference over to Paula Schwartz. Please go ahead.

Paula Schwartz, Executive

Thank you, and good afternoon, everyone. This conference call contains Forward-Looking Statements within the meaning of the federal securities laws. The Company’s actual results might differ materially from those projected in the forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained in the Company’s periodic reports filed with the Securities and Exchange Commission.

Joel Marcus, CEO

Thank you, Paula, and welcome, everybody, today. With me, as usual, Jenna Foger, Steve Richardson, Peter Moglia, and Dean Shigenaga. I want to welcome everyone and extend our thoughts and prayers to each one of you to continue to be well, safe, and COVID-free. Just over one year ago, January 21, 2020, the United States had its first reported case of COVID-19 in Seattle. And just today, a little more than a year later, we have lost more than 443,000 Americans, a number that is actually quite astounding to imagine. And that does not even count the millions, probably tens of millions of Americans who have suffered truly irreparable personal, mental, and financial harm due to the worldwide pandemic. President Roosevelt on Pearl Harbor Day referred to that day as a day that would live in infamy. I think we will all feel that 2020 is a year that will live in infamy in all of our memories. Talking about the pandemic, there is much work to do to control the virus’ spread. We need to enhance manufacturing supply chains as well as a big effort on distribution, administration of the vaccines, as well as continued testing. We, as a country, I think, for decades, have been ill-prepared and behind the curve to respond to a true worldwide and kind of a 100-year pandemic. Our readiness just has not been there, unfortunately. Much work to do to rebuild businesses and lives so devastatingly impacted. It will take a good part of this decade to do that for many people who’ve been really devastated. We still have not discovered the root cause of the virus, natural or man-made, or brought those responsible to account. We at Alexandria, at the Vanguard, the heart of the life science industry, are honored, proud, and yet humbled to serve this mission-critical industry, which has been at the forefront, 24/7, truly as the savior of humankind in this pandemic. It doesn’t get more important or impactful than that. There are two primary causes behind the COVID vaccines' rescue of humanity from this pandemic, I firmly believe. The first one is our free market system here in the United States, the economic system that facilitated the innovation, competition, and cooperation between our biotech and pharma industries and the government, which literally doesn’t happen in other countries around the world. There would likely be no multiple COVID vaccines today if there had not been venture capitalist readiness to invest before product or profit was visible, and no corporate leadership would be willing to double down other than those in our country with their own money in the spring of 2020 to fund a crash effort to produce a safe and effective vaccine by year-end, truly unheard of.

Jenna Foger, CRO

Thank you so much, Joel, and good afternoon, everyone. Echoing Joel here, as the entire world looks to the power of science, the life science industry, and specifically our tenants, to lead us out of this devastating COVID pandemic. 2020 has underscored why Alexandria has dedicated our business, our passion, and purpose to help drive this mission-critical industry forward. Without a doubt, the biopharma essential R&D engine has persisted with amazing productivity and resilience throughout the past year, which has further magnified our tenants' role as the key solution to overcoming today’s greatest health challenges, bringing unprecedented positive sentiment to the sector, as Joel mentioned. The achievements in COVID vaccine development from our tenants, Pfizer, Moderna, Johnson & Johnson, Novavax, AstraZeneca, and many others in the fourth quarter, specifically of 2020 and into the beginning of 2021, have marked the culmination of a full year’s worth of tireless, truly collaborative efforts across the industry with significant aid of federal funding.

Stephen Richardson, CFO

Thank you, Jenna. A tremendous deep dive. Good afternoon, everyone. A clear, insured vision fused with undaunted determination during 2020 from the Alexandria team has enabled the company to thrive during this unprecedented and challenging time. At a high level, consider the truly exceptional growth during the past 12 months. The operating platform has grown from 26.9 million square feet to 31.8 million square feet, an increase of 18%. The redevelopment pipeline has grown from 12.1 million square feet to 17.8 million square feet, an increase of 47%. It is important to note that this development pipeline has been smartly derisked with 45% of this value in significantly pre-leased projects well underway, 40% in covered land plays, and just 15% of this value in land. The total Alexandria Real Estate platform has grown during 2020 from 39 million square feet to 49.7 million square feet, an increase of 27%, a truly remarkable achievement. The Company’s leadership and central role in the nation’s life science ecosystem is clearly evident and only increasing in each of our core clusters. The year 2020 demanded the very best from our teams, from operational excellence to the vision and execution of critical strategic growth initiatives. Alexandria is pleased to present its outperformance highlights for Q4 and 2020. Operational excellence: The company collected 99.8% of its accounts receivable during COVID from April 1 through December 31, 2020, and we are at 99.6% for the month of January. Alexandria’s labs were deemed essential infrastructure and have been operational from day one in the pandemic. Leasing outperformance: During Q4, we leased approximately 1.4 million square feet and a total of 4.35 million square feet during 2020, which is meaningfully above our 10-year average of 4 million square feet and consistent with our 5-year average of 4.4 million square feet. The current and near-term development pipeline is 78% leased or negotiating, a significant metric when one considers the active pipeline is now at 4.8 million square feet, up from 4.1 million square feet just three months ago at the end of Q3. An exceptionally strong core: During this challenging time, we achieved the highest annual rental rate increases during the past 10 years with cash increases of 18.3% and GAAP increases of 37.6%. The fourth quarter was also strong with cash increases of 10.7% and GAAP increases of 29.8%. We are honored to work with the most innovative life science companies in the world, and believe these metrics further validate the value we are providing to the life science ecosystem.

Peter Moglia, COO

Thanks, Steve. I’m going to follow up on some remarks we made about our valuation on Investor Day. I’m going to update you all on our development pipeline and briefly comment on a new acquisition. As the inventor and pioneer of the essential life science real estate asset class, we have created our campuses and clusters in the best locations with the market’s best assets. By combining our irreplaceable locations and our world-class campuses and ecosystems with meticulously designed, highly functional buildings and a world-class tenant base, Alexandria has aggregated the best life science real estate base in the world, and it isn’t close. During Investor Day, we highlighted our views that the private market has been sending strong signals that there should be significant upside in our stock price. This included a comparison of Ventas’ acquisition of the Genesis property in South San Francisco for $1,260 per square foot, which has since been updated to $1,301 per square foot. Blackstone’s recap of BMR at a value of $1,100 per square foot against a very simple back of the napkin, $767 per square foot implied value of our operating portfolio, which was based upon the difference between the closing price of our common stock on September 30, 2020, and the book value of other significant assets such as construction in progress, venture investments, and cash divided by our total operating square feet. We acknowledge that the implied value of our operating portfolio can vary up or down depending upon the valuation of our other assets and liabilities as well as adjustments for joint ventures, but we believe the underlying thesis remains true, which is that Alexandria is significantly undervalued. The Genesis property is vastly inferior to our South San Francisco asset base. It is located on the opposite side of the 101 Freeway, making it part of the cluster by address only. The original South Tower is an office building conversion, which sat vacant for years and required some reworking to make it function. The North Tower has relatively small floor plates, causing it to have a load factor that exceeds what is typically acceptable in the market. Both buildings have relatively low floor-to-floor heights that will dictate a lower finished ceiling than the market prefers. As a result, the two buildings did not attract a high-quality tenant base. Blackstone has done well reforming and adding to BMR's original somewhat older and tired asset base. But given Alexandria's superior locations, assets, and tenants, our asset base should command a premium valuation on the real estate alone. Taking all this into account, our assets should be valued significantly higher than what is implied by today’s stock price. Since Investor Day, more evidence from the private markets has come to light, such as the sale of the 2.3 million square foot former Forest City lab portfolio from Brookfield to Blackstone BMR for $3.45 billion, which implied an approximately $1,500 per square foot total valuation according to Green Street. Approximately 90% of the portfolio is concentrated in University Park, which was the original Cambridge development area before the emergence of Kendall Square. According to CoStar, the allocation to those assets yielded a value of $1,800 per square foot and an implied cap rate of 4.2%. This value, and therefore the overall value of the transaction, would have likely been materially higher if not for the fact that those assets are in relatively short to medium-term ground leases. When comparing this portfolio to Alexandria's primary Cambridge asset base located in the preferred Kendall Square location, it is apparent that the location of our assets is superior as we are aggregated at the front door of MIT, proximate to the Kendall Square T stop in the center of gravity of the East Cambridge ecosystem versus being on the western edge of MIT, far from the heart of the campus in the less desirable area of Cambridge port.

Dean Shigenaga, CFO

Thanks, Peter. Dean Shigenaga here. Good afternoon, everyone. Our team is super passionate about our strategic initiatives to drive unique, disruptive, and highly impactful solutions to tackle society’s most complex and pressing challenges. They are also very pleased with continued recognition as a leader in ESG. We have focused on 115 projects aimed at solving the opioid epidemic, combating the COVID-19 pandemic, the GRESB sector leadership, and leadership in health, wellness, and safety. Our team's passion goes well beyond operational excellence and strong financial and operating results from our real estate business. Our fourth quarter and year-end 2020 financial and operating results were outstanding. For 2020, we reported strong growth in total revenues of 23.1%, NOI growth of 24.8%, and adjusted EBITDA growth of 17.4%. EPS and FFO as adjusted were $6.01 and $7.70 per share diluted, respectively. Our high-quality properties and tenant roster, combined with our outstanding execution by our best-in-class team, continue to generate strong performance, including many results representing some of the top in the REIT industry. Investment-grade rated or large-cap publicly traded companies generated 55% of our annual rental revenue, with consistently high and timely payment of rent well into the 99% range each month. We experienced strong 5.1% cash same-property NOI growth. Our strong leasing velocity showcased record rental rate growth of 37.6% and 18.3% on a cash basis, combined with an adjusted EBITDA margin of 69%, highlighting operational excellence and occupancy of 94.6% or 97.7% adjusted for vacancy at recently acquired properties. Our quarterly rental rate growth related to lease renewals and releasing of space does occasionally vary since it is only one-quarter of our annual leasing volume. For example, in the third quarter of 2020, we reported 30.9% cash rental rate growth, while in the fourth quarter of 2020, we reported 10.7% cash rental rate growth. The key takeaway is that rental rate growth for 2020 was robust at 37.6% and 18.3% on a cash basis. Importantly, our outlook for 2021 reflects continued strength in financial and operating performance, including rental rate growth on lease renewals and releasing of space at 30.5% and 17.5% at the midpoint of our guidance ranges.

Joel Marcus, CEO

Operator, if we could go to questions, please.

James Feldman, Analyst

I guess I want to start off with the Fenway acquisition. I’m hoping you can talk a little bit more about what you like about that submarket. What do you like about those three buildings or properties for the future? And then how should we be thinking about just your Boston strategy going forward, given it just seems—now that you have moved to the mega cluster model, it seems like there are a lot more submarkets to choose from. Where does Fenway fit into kind of the larger Alexandria footprint we might see?

Joel Marcus, CEO

Yes. Thanks, Jamie. This is Joel. I will ask Peter to comment in a minute. We don’t want to say too much about Fenway at this point. Peter has given a little bit of detail. He can talk a little more about it. I think it is pretty clear that the location of Fenway, which has good proximity to the other submarkets—obviously, to Boston itself and Downtown and Cambridge—but it is also pretty proximate to the collection of important Harvard hospitals, etc. It has been a submarket that has been vital for several decades, and we think the timing is right for a shift to a more life science orientation there. That is one of the motivations that attracted us.

Peter Moglia, COO

Look, the 401 Park asset is a really nice office R&D building. It has some dry lab in it. It has a great tenant roster. It has great duration and leases. There will be opportunities for us to convert some of that to lab over time. The development of 201 Brookline is doing really well ever since we were awarded the transaction. There has been great activity. We will be reporting on that in future quarters. There are some opportunities at the 401 Park building as well to mark some rents to market. Overall, just a typical Alexandria value creation play here with a combination of using our brand to increase rents and bringing new product to market, ultimately creating a nice urban campus.

James Feldman, Analyst

And then $1.5 billion, obviously, a very large transaction. Is this something we should expect to see from Alexandria going forward?

Joel Marcus, CEO

Yes, I don’t think you—I’m sure Blackstone has the same feeling. You never know until something like the University Park assets comes forward when or if that will ever happen. So I don’t think you can make any general assumptions about things like that. I think they’re very opportunistic and depend upon the timing and space. So I wouldn’t read anything into it or out of it. Every one of these is quite unique on their own.

Sheila McGrath, Analyst

I guess, Joel, I was wondering your thoughts on the new administration if you believe there will be more or less favorable to biotech research and investment and also bringing the manufacturing of pharma back to the U.S. Just your big picture thoughts there?

Joel Marcus, CEO

Yes. We don’t fully know what the health side of the administration is going to look like. We have some indication, but I would say it is too early to tell. I think, though, that when it comes to the enormous funding available at the NIH and in much of the funding that goes on at really the basic research level, that has remained, I think, very favorably bipartisan for decades now, and I don’t think there will be any change in the rate of increase regarding that. The biggest worry would be a knee-jerk reaction by some to raise corporate taxes to somewhat address deficits or just because it seems fair. The challenge with that is policymakers and lawmakers should really know better and understand that plants can revert back to Ireland or more favorable tax havens if the incentives aren’t appealing enough to do those things in America. I hope people take a long-term view of that. At the moment, I think by and large, it looks favorable.

Emmanuel Korchman, Analyst

Joel, just wanted to circle back on the early remarks you made about scale, especially the scale you have in your cluster markets. Can you just elaborate on the direct advantages of having the market trend and the scale versus an environment where the tenants are growing quickly? Are these kind of going to match up naturally where tenants are just going to slot into space that is available rather than working through a relationship they have had with you to build space years from now?

Joel Marcus, CEO

You have revealed the office playbook because when you have a generic commodity product, that is true. But I think as Peter indicated, when you have a mission-critical project, much like the Waples in Sorrento Mesa with Cue Health, you don’t just turn it over to the cheapest guy on the street or the one who may have something available. It is much more careful than that. Office space is a different story. With critical R&D and critical next-gen manufacturing, that just doesn’t happen that way.

Richard Anderson, Analyst

I was looking back in time about your Moderna exposure, went from about 382,000 square feet in the first quarter to 615,000 square feet in the fourth quarter. Can we consider COVID a new line of business? As Jenna mentioned, leaning towards the therapy side once we kind of get beyond this year?

Joel Marcus, CEO

Well, I think maybe two things, Rich. One is, pandemic viruses like COVID-19 are the biggest we have seen in our lifetime, different than HIV/AIDS, which turned into a chronic condition. COVID-19 will be with us for a long time, with continuous efforts not only on the vaccine side and the booster side but also testing. Testing will be critical going forward, along with therapies that might be easier to access. The opportunity is big, and that is what we have looked at when considering companies like Moderna. They represent platforms for many different illnesses. No closing remarks other than to wish everybody be safe, be healthy, and COVID-free, and we look forward to talking to you on the first quarter call. Thank you again, everybody.

Operator, Operator

Thank you. The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.