TEXT-S&P: Equity Residential ratings unaffected by Archstone news
Nov 27 - Standard & Poor's Ratings Services said today that its rating and outlook for Chicago-based Equity Residential (EQR; BBB+/Stable) are unchanged following EQR's announcement that it has entered into an agreement to acquire 60% of Archstone Enterprises L.P. from Lehman Brothers Holdings Inc. for roughly $9.4 billion (excluding transaction costs). The acquisition will include the assumption of $5.5 billion of debt (including a noncash component related to the mark-to-market for certain debt that adds roughly $310 million debt and $355 million of unconsolidated joint-venture debt). The transaction size and debt assumption will decline further after Archstone sells roughly $750 million of assets that EQR is under contract to acquire. The acquisition is expected to yield a low initial return in high 4% area, based on EQR's projected 2013 net operating income (NOI). The transaction is expected to close in the first quarter of 2013. As proposed, the transaction will result in initially higher leverage and weakened coverage measures, and the company is reliant on asset sales proceeds to achieve its deleveraging goals. However, in the current, favorable environment for multifamily assets, we believe the company will be able to execute on its planned equity sale and asset dispositions such that leverage and credit metrics will return to pre-transaction levels by the end of 2013. We view the transaction as strategically positive for the business because it accelerates the company's portfolio-repositioning plan and believe there is limited integration risk. However, we could lower the rating if planned asset sales are delayed resulting in debt levels being elevated and credit metrics being weaker for longer than we expect. EQR will acquire 78 communities totaling 23,110 units (about $367,000 per unit) located in the company's existing core markets. We believe the transaction makes sense from a business and portfolio perspective given that the assets the company is acquiring are in existing markets. Pro forma for the acquisition, EQR's exposure in Washington, D.C., will rise to 20.1% of NOI from 16.1%, exposure to the New York area will rise to 14.8% from 13.8%, exposure to the San Francisco Bay area will rise to 10.3% from 7.8%, and exposure to Boston will increase to 9.2% from 8.0%. Some of the assets in the existing markets, notably in Washington, D.C., which has experienced some softness recently, could be disposition candidates and reduce the concentration in certain markets. Given EQR's large operating platform and strong technology systems, the transaction could provide operating efficiencies, particularly as it spreads overhead over a larger asset base. This transaction also effectively allows EQR to accelerate the completion of its portfolio repositioning through the combination of acquiring its share of Archstone's assets and divest of at least $3-$4 billion of assets in noncore markets primarily through 1031 exchanges over the next 12 months. EQR plans to use proceeds from these sales to repay debt assumed through the proposed Archstone acquisition, as well as existing EQR debt. EQR will repay more than $400 million of GSE debt at close. Another $1.2 billion and $880 million of GSE debt is pre-payable in 2013 and 2014, respectively. We expect EQR to repay a meaningful portion of the GSE debt with asset sale proceeds, which is essential to reducing debt and returning key credit metrics to pre-transaction levels. EQR is expected to initially fund the acquisition with 60% debt, including assumed debt and revolver borrowings, and 40% with equity and asset sales. EQR will issue roughly $3 billion of equity-$1.9 billion directly to Lehman upon closing and $1 billion of new equity and expects to dispose of about $1 billion of assets by the time the transaction closes. The new equity and asset sales are expected to fund transaction costs and repay debt. Assuming EQR funds the investment as proposed, including the issuance of equity and completion of $1 billion of asset sales to reduce debt, we estimate EQR's credit metrics will initially weaken from pre-transaction levels (45% debt to undepreciated real estate, 6.8x debt-to-EBITDA, and 2.6x fixed-charge coverage). We estimate pro forma debt-to-EBITDA will be roughly 8x (pro forma for Archstone cash flow) and debt-to-undepreciated real estate will be about 50%, as a result, EQR will need to successfully execute dispositions to reduce debt and strengthen its credit metrics. Our rating and outlook assume EQR can successfully execute on its disposition strategy, as well as raise $1 billion of new equity to reduce total debt and secured debt. Under our base-case scenario assumptions, which include the noted equity raise and asset dispositions, as well as 2012 and 2013 same-store NOI growth of 5.5% and 4%, respectively, we estimate EQR will repay about $2 billion-$3 billion of debt by the end of 2013 and end the year with $11 billion-$12 billion of debt and preferred, and EBITDA will be in the $1.6 billion area. Based on these assumptions, we estimate key credit metrics will end 2013 at levels closer to current levels, including debt-to-EBITDA around 7x-7.5x and fixed-charge coverage in the 2.6x-2.7x range. Due to the increase in secured debt and sale of unencumbered assets, we estimate that unencumbered NOI will decline to the low 50% area in 2013 from over 60%, but we expect unencumbered NOI to rebound to about 60% in 2014 due to additional secured debt reductions, organic growth, and the stabilization of some development properties. As part of this transaction, EQR has put a $2.5 billion bridge loan in place. However, under our base-case scenario, we do not assume the company uses this facility. EQR may also increase its revolving credit facility from $1.75 billion to $2.5 billion and extend the maturity to 2018, and may also potentially put a $750 million term loan in place. We assume EQR will use its revolver line temporarily to fund the acquisition, but we expect the company will repay borrowings with asset sales. We also assume the company would only use if the timing of planned asset sales is delayed. Should asset sales prove difficult to execute and EQR is unable to repay GSE and other secured debt as assumed, or if the company draws on its various bank facilities to repay GSE and other secured debt, resulting in elevated debt levels for longer than we currently expect, we would likely lower the rating one notch.