W. P. Carey Inc. quarterly report, Q2 FY2011

Business context and reporting period

W. P. Carey & Co. LLC filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2011. The company provides long-term sale-leaseback and build-to-suit financing, owns net-leased real estate, and manages affiliated non-traded REITs. At quarter-end, it owned or managed 990 properties; its directly owned portfolio had approximately 14 million square feet and 91% occupancy.

Financial performance and position

Amounts below are in millions of dollars except per-share data. Revenue includes amounts reimbursed by affiliates, which are offset by corresponding expenses.

• Six-month lease revenue rose to $33.3 million from $31.1 million. Operating expenses increased to $105.2 million from $86.0 million; interest expense rose to $9.8 million from $7.5 million. The filing does not provide a single company-wide operating-margin measure.
• At June 30, 2011, total assets were $1,459.7 million, cash and equivalents $26.5 million, total liabilities $720.9 million, and equity $732.0 million. At December 31, 2010, these were $1,172.3 million, $64.7 million, $499.3 million, and $665.5 million, respectively.
• Debt comprised $342.9 million of non-recourse debt and $233.2 million outstanding on the unsecured credit line. The company reported total debt of approximately $576.1 million, versus $397.0 million at year-end 2010. Approximately 60% was classified as variable-rate debt; some of that was swapped, capped, or subject to future rate resets.
• For the first half, investing activities used $125.2 million and financing activities provided $40.3 million; cash declined by $38.2 million. Distributions paid were $40.8 million. The declared distribution was $0.55 per share for Q2, or $2.20 annualized.
• The $250 million unsecured revolver was extended to June 2012 and had $233.2 million drawn. A new $30 million secured revolver, also maturing in June 2012, was undrawn. The company reported $40.0 million of unused capacity across the facilities, after considering availability, and was compliant with covenants. It also cited $254.3 million of unleveraged properties as potential financing capacity, not a committed source of cash.

Material changes and unusual items

• The CPA:14/CPA:16 Global merger and related liquidity event drove much of the earnings increase. W. P. Carey recognized $52.5 million of incentive, termination, and subordinated disposition revenue, including $31.2 million of termination revenue received in shares and $21.3 million of subordinated disposition revenue. It also recorded a $27.9 million gain upon obtaining control of previously equity-accounted properties.
• In connection with the transaction, the company bought $121.0 million of CPA:16 Global shares, purchased interests in three properties from CPA:14, and assumed mortgages. Investment in real estate and the REITs increased to $1,231.7 million from $947.0 million at year-end; total assets increased accordingly.
• CPA:16 Global’s UPREIT reorganization reduced W. P. Carey’s asset-management fee from 1.0% to 0.5% of asset value, eliminated certain prior incentive and termination fees, and provided for a 10% available-cash distribution and a 15% final distribution subject to return-of-capital and priority-return conditions. Management expected the revised structure to produce lower combined fees and distributions before tax, but higher after-tax cash than the prior arrangement.
• Six-month equity income included the effects of REIT merger-related charges and impairments. The REITs reported combined impairment charges of $39.8 million for the first half, compared with $13.0 million in the prior-year period; W. P. Carey’s share reduced its equity income. Company-level continuing-operations impairment charges were comparatively small.
• Stock-based compensation increased, including a $2.4 million charge from revised vesting expectations for prior PSU awards. The company anticipated approximately $29.7 million of compensation expense over the vesting period for 2011 awards.

Outlook, management commentary, and risks

• Management said cash from operations and distributions from equity investments should be sufficient for normal recurring liquidity needs, with cash, mortgage financing, credit facilities, or equity issuance available as additional funding sources. No formal earnings or revenue guidance was provided.
• Management described gradual economic and financing-market improvement, while noting market volatility, cautious lenders, European sovereign-debt pressures, and increased competition for investments. It structured $594.0 million of investments for managed REITs in the first half and said it expected near-term investment opportunities to continue, subject to market conditions.
• Management estimated annualized pro forma effects of the CPA transactions, including approximately $10.3 million of net after-tax cash flow from increased CPA:16 Global distributions and approximately $4.0 million of cash flow from acquired properties. These were estimates, not assured results.
• CPA:15 was exploring liquidity alternatives, including a possible merger, asset sale, or listing. Its independent committee had retained advisers; the company cautioned that no transaction was assured.
• Risks include tenant defaults and lease expirations (10% of owned-portfolio annualized minimum base rent was scheduled to expire within 12 months), property and tenant concentration, foreign-exchange exposure, and interest-rate sensitivity. Texas, California, and Tennessee represented 17%, 16%, and 12% of owned-portfolio rent, respectively. A 1% rate move was estimated to change annual interest expense on unhedged variable-rate debt by $2.4 million.
• Management noted proposed lease-accounting changes could affect sale-leaseback activity, but the proposal was not finalized and its impact could not yet be determined. No material litigation was reported; ordinary-course claims were not expected to have a material adverse effect. Disclosure controls were deemed effective.

Important facts for investors to verify

• How much of the reported earnings increase was transaction-related and nonrecurring, versus recurring management fees, rents, and equity income.
• Whether CPA:16 Global distributions and the acquired properties deliver the estimated annualized cash flow, and how the revised advisory economics perform after tax.
• The company’s refinancing plan for its credit facilities, both due in June 2012, and its capacity to meet near-term debt maturities and scheduled distributions.
• Actual outcomes of CPA:15’s liquidity review, the timing and terms of any transaction, and related fees or investment requirements.
• Tenant retention and rent renewal outcomes, impairments at managed REITs and ventures, and exposure to foreign-exchange and interest-rate changes.