Sovran Self Storage, Inc.

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Sovran Self Storage, Inc.

6467 Main Street
Buffalo, New York 14221
U.S.A.
Telephone: (716) 633-1850
Fax: (716) 633-8397
Web site: http://www.sovranss.com

Public Company
Incorporated: 1995
Employees: 824
Sales: $113.6 million (2003)
Stock Exchanges: New York
Ticker Symbol: SSS
NAIC: 525930 Real Estate Investment Trusts

Based in Buffalo, New York, Sovran Self Storage, Inc. is a real estate investment trust (REIT) trading on the New York Stock Exchange and involved in the self-storage industry under the Uncle Bob's Self Storage banner. As of March 2004, the company owned or managed 265 properties in 21 states, mostly in the eastern part of the United States but also in Arizona and Texas. With 15.5 million net rentable square feet, Sovran is the fourth largest self-storage company in the country. It is also one of the most innovative in the industry. Sovran offers free truck rentals to customers, flexible storage spaces that allow a customer to rent the minimum amount of needed space, and a humidity control system.

Early 1980s Origins

The predecessor to Sovran, Sovran Group, was founded in 1982 and incorporated in New York state in 1983. It was primarily involved in the syndication of limited partnerships, which bought and managed a variety of real estate interests. In 1985, Sovran first became involved in the self storage industry, which was in its infancy at the time. Self-storage facilities, mostly mom-and-pop operations, had sprouted up to meet the needs of a changing America. Because people were now more likely to change jobs, and sometimes careers, on a more regular basis, many people found themselves in need of storage facilities for many of their belongings, either on a temporary basis or as a way to supplement limited storage available in their apartments or condominiums. Aside from demand, self storage facilities presented an attractive investment opportunity because they could be constructed at less than half the price of an apartment building, cost much less to maintain than apartments, yet still achieve the same rent quota.

For the next decade, Sovran Group built up its self storage business while remaining involved in other areas of real estate. In 1987, one of Sovran's four partners, Ronald Mariellos, sued the other three—Charles Lannon, Kenneth Myszka, and Robert Attea—contending that they ousted him as a director and officer of the company in order to prevent him from collecting a bonus associated with the purchase of Florida Storage Properties. His partners offered $125,000 to buy out his share of the business, but he refused and took his grievances to court. At the time, Sovran Group was comprised of six subsidiaries: Sovran Capital Inc., Sovran Blend Inc., Sovran Management Inc., Sovran Ltd., Sovran Securities, and McKenzie Construction Corp. Mariello eventually settled with his partners, leaving Lannon, Myszka, and Attea to carry on Sovran's transformation into a pure play self-storage company. Another key player would be David L. Rogers, who joined Sovran as controller and due diligence officer in 1984 and in 1988 became chief financial officer.

REIT Formed in 1996

Late in 1994, Sovran Group initiated a number of moves that would separate out the company's self-storage facilities, which would be packaged into a REIT called Sovran Self Storage, Inc., incorporated on April 19, 1995 under Maryland law. In recent years, REITs had become an attractive investment vehicle for many sectors of the real estate industry, such as apartments and commercial properties, so that forming a REIT to roll up assets in the highly fragmented self storage industry held an obvious appeal.

REITs had been created by Congress in 1960 as a way for small investors to become involved in real estate in much the same way a mutual fund permitted them to pool resources in order to buy stock. REITs could be taken public and their shares traded like any other stocks; likewise, REITs were also regulated and monitored by the Securities and Exchange Commission. Unlike stocks, however, REITs were required by law to pay out at least 95 percent of their taxable income to shareholders each year, thus severely limiting the ability of REITs to raise funds internally. During the first 30 years of existence, REITs were hindered in their growth because they were only allowed to own properties. Third parties had to be engaged to operate or manage them. Moreover, the tax code made direct real estate investments an attractive tax shelter for many individuals, thereby absorbing funds that might have been invested in REITs. The situation changed with the Tax Reform Act of 1986, which greatly reduced interest and depreciation deductions and prevented taxpayers from generating paper losses in order to lower their taxes. The Act also permitted REITs to provide customary services for property, in effect allowing the trusts to operate and manage the properties they owned. Despite these changes, REITs were still not embraced as an investment options. In the late 1980s, banks, insurance companies, pension funds, and foreign investors (in particular, the Japanese) provided the lion's share of real estate investment funds. That period also witnessed overbuilding and a glutted marketplace. Commercial property values fell dramatically in the early 1990s, and lending institutions, following the savings and loan debacle, were forced by regulators to be more circumspect about their investments. Capital essentially dried up and REITs finally became an attractive way for many private real estate companies to raise funds. They also gave many limited partnerships a way to provide liquidity for investors, leading to many REITs that rolled up assets and became giant real estate companies.

At the time Sovran made its public offering in June 1995, the REIT owned 74 Uncle Bob's self-storage facilities, with 3.8 million square feet of rentable space in locations that reached from Connecticut to Pensacola, Florida. Of those facilities, 62 had been owned by Sovran's limited partnerships and another 12 were purchased in connection with the offering. Sovran netted about $136 million from the offering, of which $70 million was earmarked to pay down debt. The balance made up a war chest to pursue further acquisitions. Sovran was only one of five REITs involved in the self-storage area, and given that combined they controlled only 10 percent of the market, there was ample opportunity for growth. A few weeks later, the offering's underwriting group, led by PaineWebber Inc., exercised an over-allotment option, which raised an additional $16 million for the REIT.

In the last half of 1995, Sovran acquired eight more self storage properties; the next year, it bought another 29. For its first full year in operation, Sovran generated $33.6 million in revenues and net income of $15.7 million, establishing a pattern of steady growth that would continue through the rest of the 1990s. The company issued another 1.5 million shares of common stock in 1997 to help fuel expansion. During the course of the year, Sovran acquired 28 storage facilities to strengthen its position in such cities as Cleveland, Fort Lauderdale, and Dallas/Fort Worth. It also opened units in new markets: Houston, northern Michigan, central Virginia, and Baton Rouge. To better manage its portfolio of self storage assets, management in 1997 established four geographical regions, each headed by a regional vice-president. Sovran also took steps to refine its Uncle Bob's brand and improve marketing efforts. A new logo and signage were developed and a new color scheme adopted. In addition, the company took steps to improve its shareholder distribution, launching a Web site and taking other steps to make investors aware of Sovran's potential. Because the company was mostly owned by institutional investors, there was no need at this point to hold a local annual meeting. Instead, a meeting with a handful of institutional investors in New York City sufficed. After posting $49.4 million in revenues in 1997 and net income of $23.1 million, Sovran in 1998 acquired 50 self storage facilities to boost its total number of stores beyond the 200 mark. As a result, rental income improved by 40 percent over the previous year to $69.4 million, although net income was relatively flat compared to 1997, totaling $23.4 million.

Company Perspectives:

Sovran operates its stores under the trade name Uncle Bob's Self Storage, and serves over 125,000 customers in 21 states.

"Flex-a-Space" Introduced in 1999

The self-storage business was now mature, occupancy rates were tailing off, competition was keen, and overhead costs had already been trimmed. To attract new business and grow profits, self storage operators became eager to find a competitive edge through innovation. The industry leader, Public Storage Inc., made an unsuccessful attempt to offer a delivery service of sorts, with storage containers dropped off at customers' houses and retrieved later. Some competitors formed alliances with moving companies as a way for both parties to take advantage of each other's customer lists. In 1999, Sovran introduced an idea that it hoped would differentiate it from the field: "Flex-a-Space" movable walls. It used a track-and-wheel system that allowed a wall to be brought in to accommodate the actual amount of space a customer needed. According to one example, a customer renting a ten-by-ten-foot space for $85 a month but who only needed a space measuring eight-by-ten could have the flexible walls adjusted accordingly and reduce his monthly rent to $75. Not only would the customer save money, the Uncle Bob's facility would benefit as well, improving its revenue by 9 percent on the cost per square foot. What also made "Flex-a-Space" so appealing was that competitors were not able to quickly emulate the idea. Aside from installing the track-and-wheel system, on which Sovran filed a patent, competitors also faced a problem with their management software, which was not set up to help site managers deal with the variables of track space rentals. Sovran rolled out "Flex-a-Space" to 62 locations in six major markets—Atlanta, Cleveland, Phoenix, Tampa, Dallas/Forth Worth, and Norfolk/Virginia Beach—in 1999 and launched a $10 million program to convert all of its locations by the end of 2001. Another enhancement introduced during the year was a Corporate Alliance Program, which offered companies discount rates as well as a uniform leasing and invoicing system when using Uncle Bob's facilities across 50 different markets. In 1999, Sovran acquired 18 more facilities and moved into three new markets, as well as upgrading 31 other stores. Revenues for the year improved to $84.3 million and net income grew modestly to $25.6 million, suppressed somewhat by the investment in the "Flex-a-Space" program and the cost of acquisitions.

In 2000, Sovran moved into a new $6 million headquarters in Buffalo, eschewing offers from southern communities to relocate. This was also the first year that the company held an annual shareholder meeting in Buffalo, attracting 65 people, a surprising turnout that prompted management to make the local session a yearly event. Sovran continued to bring innovations to the Uncle Bob's chain, introducing to 11 facilities in 2000 its exclusive Dri-guard dehumidifying storage system, the same type of humidity control system used by the U.S. military, which proved helpful in protecting metal, papers, fabric, furniture, and electronics. Sovran acquired only five stores in 2000, primarily due to a scarcity of attractive targets and high interest rates. However, the company was able to boost sales internally with the opening of a new central call center at its Buffalo headquarters, which picked up overflow calls to the company's more than 200 stores. As a result, business was picked up that in the past would have gone to a competitor. For the year 2000, Sovran grew revenues to $90.2 million and net income to $25.7 million.

Growth Continues in the 2000s

In 2001, Sovran began taking steps to have all Uncle Bob's stores connected to the central call center, and ultimately all sales inquiries would be handled from company headquarters. The company also ramped up its Internet sales. Another improvement to the Uncle Bob's chain was the launch of a fleet of rental trucks, some of which were available for free use by storage customers. The trucks were geared toward the amateur mover and offered all the blankets, ramps, and dollies needed for a move. An added benefit was that the trucks also served as rolling billboards promoting Uncle Bob's Self Storage. Conditions were not conducive to strong growth in 2001. The company acquired just eight stores and sales were flat, totaling $91 million, while net income fell to $24.2 million. Nevertheless, the company was able to extend a practice of increasing the dividend it paid to shareholders each year.

In 2002, Sovran continued to bring its Flex-a-Space, Dri-guard humidity control, and truck rental business to all of its locations. It also returned to an aggressive pursuit of external growth, over the course of the year spending $82 million to acquire 23 stores, of which 19 were in existing markets in Texas and New York and another four in a new market, the Hamptons, Long Island. In addition, the company added 130,000 square feet of new space to existing properties, which helped Sovran bring new growth to their balance sheet. For the year, the company posted sales of $102.1 million and net income of $26.3 million.

Sovran shied away from acquisitions in 2003, buying just two properties because management considered prices too high, as a number of investors now recognized the reliability of self-storage cash flows and were looking to become involved in the sector. This situation led to overbuilding of facilities and ultimately to lower pricing. Despite these factors and the effects of a poor economy, Sovran was able to grow internally. At the same time, management prepared to return to a more aggressive approach to acquisitions by refinancing its long-term debt and increasing its borrowing capacity by $100 million. For the year, revenues improved to $113.6 million and net income to $28.4 million. Once again the company increased its dividend, which had grown from $2.05 in 1996 to $2.41 per share in 2003.

Early in 2004, Sovran took advantage of high prices for self storage facilities by selling four units located in non-core markets—Akron and Elyria, Ohio; Allentown, Pennsylvania; and Nashville, Tennessee—for $10.2 million. At the same time, the company was lining up a number of properties to acquire in its high-growth markets, earmarking $40 million for acquisitions in 2004. The industry in general was enjoying good conditions, reducing the need for discounts, and setting up Sovran for a banner year. With the industry still composed of many mom-and-pop operations and the need for self storage continuing to rise, there was every reason to expect that Sovran would enjoy steady growth for the foreseeable future.