Benzinga | Dec 14, 2020 09:23AM EST

Public Storage Shareholder, Elliott Mgmt., Sends Letter To Board, Highlights Nomination Of Trustee Candidates To Board

Elliott Associates, L.P. and Elliott International, L.P. (together, "Elliott"), which together have made a substantial investment in the common stock and economic equivalents of Public Storage (the "Company" or "PSA"), today announced in a letter that it privately nominated six trustee candidates to the PSA Board last week.





The PSA Growth Opportunity

Elliott has been engaged in a private dialogue with Public Storage for more than a month, according to the letter, which Elliott said was made public in response to incomplete disclosures regarding its involvement and in order to facilitate a broader discussion regarding the best path forward for PSA. The letter makes the case that Public Storage has significantly underperformed its self-storage REIT peers over the last decade, despite having numerous structural advantages.

Elliott attributes this underperformance to a failure by PSA to invest aggressively and to lagging same-store sales growth, both of which have been exacerbated by substandard corporate governance and investor communication. The letter suggests that the best path forward for PSA is increased investment in its stores, its employees and its customer experience, combined with governance and investor-communication enhancements to ensure the proper oversight and transparency regarding the significant value-creation opportunity that exists.

In the letter, Elliott outlined a set of proposals for Public Storage, including the following concrete steps:

* Refresh the Board with independent trustees who will add valuable experience in relevant industries while bringing a diverse set of skills and perspectives to the Board. The letter noted the Company announcement yesterday of certain limited steps to refresh its Board -- steps that validate some of the concerns Elliott has raised privately regarding the current Board's long tenure and lack of independence. However, the letter asserts that these steps fall short of the change needed at PSA, which needs to come in consultation with shareholders to have credibility with investors. Otherwise, even steps in the right direction will look like entrenchment and reinforce the perception that the Board is resistant to self-evaluation and course correction.

* Form a New Board Committee to evaluate PSA's performance and plan, focusing specifically on organic growth strategy, capital allocation and balance sheet optimization. The letter notes that Elliott has worked with many companies on steps to create these kinds of committees to evaluate, design and implement value-creative changes.

* Restore Investor Credibility, starting with an investor day, to reveal the committee's work and lay out a plan for the future of the Company. According to the letter, an Investor Day would provide a natural opportunity to publish a robust investor presentation and articulate a strategy for sustainable value creation.

The letter concluded by expressing a preference for continued constructive dialogue with the Company toward a comprehensive plan to deliver the value-creation opportunity that is possible at Public Storage today.

The letter and trustee bios can be found in their entirety at PSAGrowth.com.

The full text of the letter follows:

December 14, 2020

The Board of Trustees

Public Storage

701 Western Avenue

Glendale, CA 91201

Attn: Chairman Ronald L. Havner, Jr.

Attn: Lead Independent Trustee Gary E. Pruitt

Dear Members of the Board:

We are writing to you on behalf of Elliott Associates, L.P. and Elliott International, L.P. (together, "Elliott" or "we"), which together have made a substantial investment in the common stock and economic equivalents of Public Storage (the "Company" or "PSA"). Our investment in the Company makes us one of your largest investors and reflects our belief that Public Storage has a unique opportunity today to create significant long-term value for all of its stakeholders.

We want to start by thanking you for taking the time to discuss our views on PSA's business during these last few weeks. We appreciate your attention, and we hope to continue this constructive conversation with the Company. We also want to reiterate our admiration for Public Storage and the achievements of B. Wayne Hughes and his successors, whose entrepreneurship paved the way for what is today a $40 billion industry. Within that industry, PSA's first-mover advantage has given it a moat of irreplaceable assets that continues to provide the Company with a meaningful competitive advantage, giving rise to the opportunity we see for PSA today.

We are writing to you publicly today because recent news reports, as well as the Company's own decision to disclose our dialogue in a press release, have left current and prospective PSA stakeholders with incomplete information regarding our involvement. We therefore thought it best to share some of our research, our perspectives and our proposals regarding PSA and begin a broader conversation about the best path forward for the Company.

Public Storage has -- and has had for quite some time -- the best assets and platform in the industry. Yet, despite that critical advantage, its total shareholder return has dramatically underperformed its peers over the last decade. Through our time- and resource-intensive diligence process, we have concluded that Public Storage's underperformance derives from two main issues: (i) a failure to invest more aggressively in its strong asset base and (ii) lagging sales growth. Substandard corporate governance and a lackluster investor relations program have compounded these problems, deepening the underperformance. By underinvesting in new stores, existing stores, store-level employees, innovation and customers, the Company has failed to capitalize on the considerable first-mover advantage, leaving its shareholders to pay the price of that opportunity cost.

Fortunately, all of the Company's issues are fixable. In fact, we were pleased to see the Company announce yesterday that it is taking certain limited steps to refresh its Board -- steps that validate some of the concerns we have raised privately regarding the current Board's long tenure and lack of independence. However, these steps fall short of the change needed at PSA. We believe that only by undergoing a full, honest and comprehensive review of the Company's strategy and then by taking decisive action to jump-start performance can Public Storage reclaim its rightful place as the leader of the self-storage industry.

We have proposed a multi-step plan to set Public Storage on a path to growth and superior performance -- (i) form a truly independent Board, (ii) empower the Board to review the Company's strategy and enhance its long-term growth plan, and (iii) rebuild the Company's credibility with investors. As investors, we have worked with companies on similar plans with successful results, and we believe we are uniquely positioned to work with PSA to regain credibility with investors and create substantial shareholder value. In addition, we have put forward a slate of exceptional nominees, who have the experience, skills and perspectives to help PSA better serve all of its stakeholders. Given the quality of PSA's assets -- and of our nominees -- we trust that a robust and well-designed process will yield a successful outcome.

Elliott's Investment in Public Storage

Founded in 1977, Elliott is one of the oldest funds of its kind under continuous management and today manages approximately $41 billion of capital for both institutional and individual investors. We are a multi-strategy firm, and investing in public and private real estate around the globe is one of our largest and most successful efforts.

Elliott's investment approach is distinguished by our extensive due diligence, and our efforts on Public Storage have followed this same approach. Selected examples of our substantial diligence efforts on PSA include:

* Engagement with a leading management consulting firm to complete an extensive survey of 2,215 self-storage customers over four weeks examining the customer decision-making path and experience, as well as an analysis on the quality of locations, historical growth, margin profile and online presence at Public Storage and its public peers;

* Conversations with dozens of external experts from all parts of the industry value chain (e.g., CEOs, Presidents, Regional Managers, District Managers);

* A survey of 125 Public Storage and 125 competing Extra Space locations across the country;

* An extensive shareholder survey, speaking with investors in both Public Storage and its self-storage peers;

* An analysis of testimonials from leading online review platforms; and

* Our own hands-on diligence, including renting storage units at both Public Storage and its peer companies in leading markets.

This work has informed our views on multiple areas PSA can improve, and we believe that the current management team -- along with a refreshed, independent Board of Trustees -- can form a plan to address PSA's underperformance.

Public Storage's Long-Term Underperformance

Public Storage has significantly underperformed its self-storage REIT peers over the last decade despite having every structural advantage possible: the highest brand awareness, the best (and most) locations, first-mover advantage, regional density and the most pricing data. The chart below demonstrates the current cumulative total shareholder return (TSR) of Public Storage versus its peers as of December 11, 2020:

See "Total Shareholder Return Analysis."

This staggering returns gap was not the result of a single drop, but rather consistent underperformance, year after year, including being the worst (8) or second worst performer (2) of the group in 10 out of the last 12 years:

See "Annual Total Shareholder Return Ranking of Self-Storage Companies."

Shareholders expect this underperformance to continue -- a group of shareholders we surveyed through an independent firm ranked Public Storage last among close peers on every qualitative metric, including general store experience, projected same-store growth, corporate governance, investor communication, management quality and execution, digital experience and, critically, pricing optimization.

How Public Storage Got Here

The underperformance illustrated above cannot be attributed to any structural disadvantage relative to PSA's peers -- e.g., a lack of scale to compete or a lack of institutional knowledge to identify areas of growth. Instead, our diligence points to two main drivers for Public Storage's underperformance: (i) a failure to invest more aggressively in its strong asset base and (ii) lagging sales growth.

Failure to Invest More Aggressively

PSA's failure to exploit its structural and strategic advantages and invest more aggressively has been the primary driver of its underperformance over the last decade. For several decades following its inception, Public Storage did invest heavily in expanding its store base, such that by 2010, it owned more than five times as many self-storage facilities in the United States as its largest competitor. Despite this commanding footprint, however, Public Storage only owned 5% of the industry's square footage; 90% was still owned by regional and local competition, leaving a large opportunity for further expansion.

During this time, Public Storage's market position also drove operational success, as regional scale translated into better pricing and occupancy visibility and fixed-cost leverage in marketing and G&A. As a result, PSA had the highest return on capital among publicly traded peers, and that return was significantly higher than its cost of capital. With a pristine balance sheet, access to capital, high incremental returns on capital, an operational edge on competition and a highly fragmented industry of unsophisticated competition to acquire or out-develop, Public Storage was primed to dominate the next decade. Unfortunately, the Company failed to do so.

Ceded Relative Market Share

Instead, Public Storage ceded many of these advantages to increasingly sophisticated peers. After the storage industry demonstrated its resilience to economic turmoil and demand started to outpace stagnant supply in the early 2010s, investors were drawn to the attractive returns on capital and stable financial performance storage businesses were generating, bringing in large amounts of new capital and higher levels of financial and operational sophistication. Despite all of this activity, the public REITs' incremental returns on capital remained high, with Public Storage at the top of the heap.

See "Public Storage Relative Market Share Over Time."

Public Storage took some steps to invest over this period, increasing its owned store base by 456 stores from 2010 to Q3'20 (a 22% increase) and generating high returns. However, Extra Space increased its owned stores by 640 stores over the same period -- a 217% increase -- and CubeSmart and Sovran (now Life Storage) increased their owned store counts by 45% and 81%, respectively. At the same time, peers aggressively entered the third-party management business, an asset-lite approach to building effective scale through increased access to data, location density and acquisition pipelines. Taking these additional stores into account, the peers increased their store counts by an average of 150%, and Public Storage watched as its effective market share relative to its closest competitor decreased from 2.5x to 1.4x.

Insufficient Capital Deployment

In our experience, three primary reasons a company would forgo aggressive deployment of capital into its business are (i) lack of access to capital, (ii) low returns on incremental capital investment, or (iii) few opportunities to deploy capital. Over the past decade, none of these reasons have applied to Public Storage.

With Public Storage's superior data, scale, fixed-cost leverage, brand name, regional density and access to high-return development opportunities, it should have been the preferred buyer of any seller. However, an overly conservative underwriting model and an overly conservative approach to leverage hamstrung its growth. PSA's obsessive focus on an investment-grade credit rating has left it underlevered compared to its peers, yet it still pays more for its capital by issuing perpetual preferred equity instead of accessing the debt markets.

In order to take market share the way they did, Public Storage's peers raised and deployed significant amounts of capital while PSA held back, with low leverage yielding lower equity returns. Between 2011 and Q3 2020, for example, Extra Space increased its net debt by more than 300% and its share count by almost 40%, while Public Storage increased net debt by 73% and its share count by only 2%. As a result, Extra Space's invested capital increased by more than 250% while Public Storage's increased by only 48%. Given that Public Storage had an investment-grade credit rating, billions of dollars of capital available and the best return on capital of its peers, the Company's conservative approach to capital deployment stands in stark contrast to the strategic actions of its peers -- and their total shareholder returns show the result:

See "Invested Capital Growth vs. TSR Over the Last Decade."

The Company still has an industry-leading platform and a base of properties that can yield high-return development, so increasing investment to a level commensurate with its relative scale should drive accelerated growth.

Third-Party Management

Owned stores do not tell the whole story: Customer brand awareness and market data are driven by managed stores as well as owned stores. Between 2010 and today, PSA's self-storage peers were able to quickly grow their "effective" store base by focusing on third-party management. Public Storage, by contrast, only recently entered the third-party management space in 2018. PSA's self-storage peers have been building acquisition pipelines and exploiting valuable data from the third-party management space for more than a decade before PSA entered this business.

The direct financial impact of third-party managed stores is lower than that of owned stores, but the minimal upfront capital and incremental "effective scale" through regional market share made third-party management an attractive endeavor for PSA's peers in 2010. The better data provided by these third-party management opportunities also allows for better decision-making: Larger store bases drive better brand awareness, and the acquisition pipeline allows for more capital to be deployed to create value. We are happy to see that the Company has decided to enter the business, but we question why this Board took so long to see it done and why the pace of managed store growth is so tepid compared to its competitors.

Lagging Same-Store Sales Growth

The secondary driver of Public Storage's underperformance has historically (and more importantly going forward) been lagging same-store sales growth. The self-storage industry has a low cost of capital, so small, consistent differences in organic growth can drive significant valuation discrepancies.

See "Mature Same-Store Growth (2010-2019)."

Poor Store Experience

Our research, surveys and personal experience have shown that the customer experience at any given Public Storage location significantly lags peers. We believe this is a direct result of its conservative approach to costs, including under-incentivizing retail workers and skimping on store experience. In our view, targeted spending increases throughout the store base will drive stronger revenue growth and position Public Storage to thrive and compete.

Public Storage was rated last on "General Store Experience" in an investor survey, and our proprietary customer survey showed that customers rate Public Storage lower on "Cleanest" and "Friendly Staff" compared to Extra Space. Our side-by-side store visit survey showed Extra Space stores outperforming directly competing Public Storage locations on every qualitative measure of store experience we surveyed. Critically, Public Storage has underinvested in its employees who are set up to fail with a lack of proper incentives, training or career advancement opportunities. Investors and industry participants believe that workers on the ground can drive improved store performance through increased sales conversion, upselling, price discrimination and reducing churn. By investing in its employees, Public Storage can improve its customers' experience and improve its growth trajectory to match and ultimately exceed its peers.

Pricing/Occupancy Optimization Algorithm Focuses Too Much On Occupancy

Self-storage is a balancing act of price and occupancy -- managing the interplay of street rates, promotions, price increases and churn. There is no doubt that Public Storage and its REIT competitors all understand this interaction and have strong pricing algorithms in place. However, we have received consistent feedback that Public Storage's algorithm is highly sensitive to changes in occupancy, meaning its focus on industry-leading occupancy may well be holding it back from maximizing revenue. Current and prospective investors we have spoken with rated Public Storage last among the large self-storage REITs on pricing analytics and optimization, and industry participants consistently noted this dynamic. We are confident that a review by management and a fresh set of independent trustees could address this issue, either by adjusting the algorithm or by proving to investors and industry participants that the existing algorithm is optimal.

An Opportunity for PSA Growth

We have been encouraged by certain steps that management has taken: It has increased capital deployment (although still not proportional to its scale); launched the "Property of Tomorrow" campaign; raised some unsecured debt; and hired a head of Investor Relations. More recently, just yesterday and following our private outreach, the Company announced the replacement of three Trustees in a nod to our clearly valid concerns about Trustee tenure and independence. But these incremental changes are not enough. More ambitious change is needed for investors to have confidence that today's Company has embraced a new direction for shareholders, employees and customers alike.

Corporate Governance and Investor Relations

We do not believe that the current Board of Trustees can lead Public Storage toward long-term success, even with the changes announced yesterday. Prior to those changes taking effect, PSA's Board has a 12-year average tenure and lacks a sufficient number of independent trustees, making it one of the least independent Boards in the S&P 500. Three members have been on the Board for more than 20 years, and five members are on boards of related companies (including the most recently added trustee). Governance and ESG providers have given poor ratings to Public Storage's governance structure, and numerous shareholders have expressed their concerns about the Board's lack of independence in their proxy voting disclosures. Right now, the Company's Board does not include a single trustee with self-storage industry experience outside of the PSA bubble, and the Chairman is the former CEO who presided over profound underperformance along with the rest of the Board.

Public Storage needs fresh perspectives and leadership. Adapting to a changing environment -- which is an apt description for the self-storage industry over the last decade -- requires new ideas, independent thinking and an innovative mindset. This Board presided over the Company while it trailed peers and ceded market share; the shareholders we surveyed are right to be skeptical that it should be trusted to evaluate the next stage. That is why, while the new Trustees represent a step in the right direction, real change needs to come in consultation with shareholders to have credibility with investors. Otherwise, even steps in the right direction will look like entrenchment and reinforce the perception that the Board is resistant to self-evaluation and course correction.

This lack of credibility with investors is underscored by the fact that Public Storage does not currently publish an investor presentation on its website or provide shareholders with meaningful guidance. PSA's prepared remarks on quarterly earnings calls have averaged 22 seconds over the last five years. The Company is both the largest REIT to not give guidance and one of the largest companies without any kind of investor presentation. Investors we surveyed rated PSA last among close peers in "Investor Communication," with one investor even describing it as "antagonistic." Public Storage's shareholders interactions clearly need improvement, and as investors with deep experience in helping companies communicate their stories, we are uniquely positioned to help.

Our Proposal

We are asking for substantial Board refreshment. As previously mentioned, by any objective measure, Public Storage's current Board does not meet the standards of good corporate governance, and its attempts at self-help simply lack credibility. We have privately nominated six exceptional and well-qualified Trustees. They will add valuable experience in relevant industries, and their diverse skills and perspectives will put the Board in a better position to serve all of its stakeholders. (Please see the Appendix to this letter for their full backgrounds.)

We are also asking the Company to form a new Board committee to evaluate its performance and plan. We believe it is imperative that the Board form a committee of independent trustees, both old and new, with a specific mandate to provide recommendations on i) the Company's organic growth strategy, including customer experience, new potential revenue streams and pricing / occupancy optimization, ii) capital allocation, including development, redevelopment and acquisitions, dividend and capital return policy, and minority interests in public equities and iii) balance sheet optimization.

While we are confident in the case for change, we recognize that change is usually best led from inside a company. We have worked with many companies in the past to help them establish these kinds of committees to evaluate, design and implement value-creative changes. We are not prescribing or demanding specific changes -- as long as the review process is independent and robust, we are confident the committee will arrive at the best answers, whether or not they align with our own findings.

We are asking for the Company to restore its relationship with Shareholders, starting with an Investor Day in the first half of 2021. The Investor Day will be an opportunity for the Company to reveal the Board's conclusions of the committee's work and chart a new path forward where shareholders are valued stakeholders. Further, given the Company's historical disappointing investor communications, an Investor Day would provide an opportunity to publish a robust investor presentation and make a clear and compelling case to investors that they should own Public Storage's stock.

Working Together

Elliott and other investors want Public Storage to invest in its future by taking steps to create considerable value through growth. We look forward to engaging with other shareholders regarding our ideas, and we are committed to a transparent process to keep all key stakeholders fully informed -- which is one reason that we are publicly sharing this letter and our nominees.

We thank the Board for considering our thoughts and look forward to continuing our discussions to unlock Public Storage's full potential. We hope to work constructively with you on the changes needed at PSA -- the changes all PSA stakeholders deserve.

Best Regards,

Johannes Weber

Portfolio Manager

Jeremy Grant

Associate Portfolio Manager