Equity Research

[Pages:7]Equity Research

May 10, 2004



155 North Wacker Drive Chicago, IL 60606

Alexandria Real Estate Equities, Inc. (ARE-NYSE)

Current Recommendation Prior Recommendation Date of Last Change

Current Price (05/05/04) Six- Month Target Price

Sell Sell 03/15/2004

$55.88 $50.00

OUTLOOK

We are maintaining our recommendation to sell shares of Alexandria Real Estate Equities. Despite meeting our first quarter FFO per share estimates, we feel the outlook is discouraging. Our concerns that contributed to the lower price target of $50.00 per share include low insider ownership, delays in the expected delivery dates of its developments, and higher than average levels of debt. As a result, we have lowered our price target from $55.00 to $50.00 per share, an anticipated decline of 10.5%.

SUMMARY DATA

52-Week High 52-Week Low One-Year Return (%) Beta Average Daily Volume (sh)

Shares Outstanding (mil) Market Capitalization ($mil) Short Interest Ratio (days) Institutional Ownership (%) Insider Ownership (%)

Annual Cash Dividend Dividend Yield (%)

5-Yr. Historical Growth Rates Sales (%) Earnings Per Share (%) Dividend (%)

P/FFO using 12 months FFO P/FFO using 2004 Estimate P/FFO using 2005 Estimate

Zacks Rank

$65.15 $42.30

35.47 0.06

167,805

19 $1,083

2.91 89 3

$2.40 4.29

19.2 N/A 7.3

13.0 12.4 11.7

4

Risk Level

Type of Stock Industry Zacks Rank in Industry

ZACKS ESTIMATES

Revenue

(in millions of $)

Q1

(Mar)

2002

34 A

2003

41 A

2004

43 A

2005

Q2 (Jun)

35 A 40 A 44 E

Q3 (Sep)

37 A 41 A 44 E

Low

Mid-Blend Reit-Eqty Trust

101 of 122

Q4 (Dec)

39 A 41 A 45 E

Year (Dec)

142 A 161 A 176 E 194 E

Funds From Operations per Share

2002 2003 2004 2005

Q1 (Mar) $0.95 A $1.04 A $1.10 A

Q2 (Jun) $0.97 A $1.05 A $1.11 E

Q3 (Sep) $0.98 A $1.06 A $1.14 E

Q4 (Dec) $0.97 A $1.08 A $1.16 E

Year (Dec) $3.81 A $4.23 A $4.51 E $4.76 E

Zacks Projected EPS Growth Rate - Next 5 Years %

7

? Copyright 2004, Zacks Investment Research. All Rights Reserved.

KEY POINTS

Management announced a 2004 FFO estimate of $4.48 per share. This is at the low range of its previously lowered estimates of $4.48 to $4.51. Alexandria's portfolio occupancy declined 70 basis points sequentially to 93.2% for the first quarter of 2004. Alexandria's redevelopment pipeline, its main source of growth is slowing. The very low dividend as compared to its peers suggests that a reduction in stock price is likely. The slowing level of growth and greater than average debt indicates that there is little room for capital appreciation. Corporate insiders have recorded sales at a rate of three sales to every purchase since the beginning of 2004.

OVERVIEW

Alexandria Real Estate Equities, Inc., is a real estate investment trust (REIT) headquartered in Pasadena, California. Alexandria owns, acquires, manages, operates, develops, and redevelops office and laboratory space in various parts of the U.S. The company owns properties situated in strategic locations and caters primarily to the pharmaceutical and biotechnology sectors. It also leases properties to research institutions, government agencies, and universities. The company has a portfolio of 89 properties (including those under development), encompassing roughly 5.7 million square feet.

The majority of the portfolio consists of suburban office space used for scientific research and development. Tenants such as ZymoGenetics, Pfizer, Quest Diagnostics, Corixa, and Merck lease the properties. Alexandria's 79 operating properties are located in California (34), Washington (5), Washington D.C. (20), Massachusetts (9), New Jersey (6), and the southeast region of the United States (5). The average occupancy of all its operating properties is 93.2%.

Large amounts of lease expirations are due to occur with Alexandria's portfolio of properties. For the next three years, (2004-2006), lease expirations based on the total portfolio are 12.3%, 6.4%, and 16.2%, respectively. Although the lease expirations may allow Alexandria to increase rental rates for some of its properties, there are also significant costs and risks associated with expirations. Alexandria faces the risk of not being able to lease the space as tenants opt to relocate, downsize, or own rather than lease. The costs associated with lease expirations include tenant improvements, lease commissions, and any variety of concessions needed to re-lease the space.

Management lowered its FFO guidance to $4.48-$4.51 per share for 2004. This is a decrease of $0.05 per share from its previous guidance. Although we initially felt management was acting too conservatively, we have lowered our 2004 estimate to $4.51 per share. This is lower than its previous five years of growth, but due to the uncertainty in the market along with the high level of expirations, we feel a lower growth rate can be expected.

Another signal of poor future performance relates to the "estimated in-service dates" of its properties under development. According to its first quarter report, the in-service dates (the date that its properties under development will be ready for occupancy) for 54% of its developments have been delayed by an average of two quarters. This is likely to slow the firm's future earnings growth.

At the time of our last report, overall debt for Alexandria was 44% of its total equity. However, the recent decline in shareholder value and the increased debt have raised this percentage to 63%, which is now greater than the average of its publicly traded peers (58%). This higher overall level of debt and the low average maturity of its loans (5.3 years) indicate that Alexandria's performance could suffer because of an increase in interest rates.

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Corporate insiders have sold nearly three times the number of shares purchased. Net sales by insiders along with the very low insider ownership (approximately 3%) are very bearish indicators for this stock. Another issue of concern is the seeming minimum level of disclosure by Alexandria's management. Other than the SEC's required disclosures, Alexandria does not appear to go into significant detail about its operations, therefore making shareholders susceptible to future negative announcements.

Alexandria's current price, as of May 5, 2004, is $55.88 per share. Our previous report, dated March 15, 2004, set a price target of $55.00 per share. However, in light of its recent performance and our lower expectations, we lowered our price target to $50.00 per share. This represents a further decline of approximately 10.5% in value.

INDUSTRY OUTLOOK

Our outlook for the real estate industry remains negative. The primary segments in this industry are REITs and Real Estate Management Companies. REITs are further divided into segments such as Office, Retail, Lodging, Residential, Healthcare, Industrial, and Mortgage. Overall, the real estate industry has performed well since 2000. However, fundamentals are starting to turn negative for certain segments of the industry as ongoing economic weakness takes its toll on occupancy rates. Valuations are at the high end of the range after three years of relatively strong performance, and we no longer feel there is sufficient appreciation potential among these companies. As an industry, REITS are currently trading at 110% of Net Asset Value, compared to the sector's long-term historical average of 101%, while on a cash flow basis, REITs are trading at a forward 12 month Adjusted Funds From Operations multiple of 14.0x, compared to the sectors' long-term average of 11.0x. Meanwhile, as a group, Funds From Operations are projected to grow at under 6.0% in 2004. The recent spate of equity offerings by REITs may indicate management of these companies also believe the top has been reached. Those looking for income will find attractive yields in this group, with the average REIT yielding just under 6.0%; however, prices will react negatively if interest rates begin to rise.

Office REITs continue to feel the effects of declining occupancy and lease rates as unemployment and cost cuts take hold, and as competition to fill space heats up. We expect this segment to continue to under perform in 2004. Residential REITs, likewise, are feeling the sting of rising unemployment and rental vacancy rates, and the strong market in single-family housing. Retail REITs are holding their own due to fairly strong retail sales despite several high profile bankruptcies. We expect this performance to continue and look for these companies to perform in line with general growth in the economy.

Lodging REITs will continue to see weakness due to slow business travel. Mortgage REITs may be facing a period of slowing growth, as interest rates have inched up from their previous lows. These REITs have performed extremely well the last few years, but as rates begin to rise, Mortgage REITs will see their spreads narrow and earnings will begin to decline. Industrial REITs should perform inline as most of the leases are for longer periods of time.

INDUSTRY POSITION

Alexandria Real Estate operates in the highly competitive and fragmented life sciences office and R&D markets. As illustrated in the table below its closest publicly traded peers includes Arden Realty, CarrAmerica Realty, Highwood Properties, Mack-Cali, Prentiss Properties, and SL Green Realty. In addition to the publicly traded REITs, it competes with private owners, pension funds, and owner occupied buildings. This results in high competition for the industry as a whole.

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The table provides some key data points such as market capitalization, percent of debt to equity, and growth estimates. Alexandria's debt level and estimated growth are above its publicly traded peers. Concerning the debt level, this makes Alexandria more sensitive to increases in interest rates as the cost of servicing its more than $700 million in debt increases. However, the higher expected growth rate of 7% suggests a mild premium to Alexandria's stock price. We feel that the relatively low market cap of just over one billion dollars could magnify changes in Alexandria's stock price. We feel a negative surprise is more likely than a positive at this point.

Comparison of Industry Peers

Ticker

Company

Market Cap (in millions)

Percent of Debt

ARE ARI CRE HIW CLI PP SLG

Alexandria Realty Arden Realty CarrAmerica Realty Highwoods Properties Mack-Cali Property Prentiss Property SL Green Realty Simple Average

1,083 1,859 1,528 1,257 2,267 1,395 1,617

63% 51% 70% 58% 52% 55% 55% 58%

5-Yr Growth Estimate

7 7 8 5 6 4 8 6

Zacks Rec

Sell Hold Hold Sell Sell Hold Hold

RECENT NEWS

May 3, 2004, Alexandria announced its operating and financial results for the first quarter of 2004. Despite signing leases for 295,000 square feet, total occupancy declined from 93.9% to 93.2% during the quarter. Total revenues and FFO per share met our expectations of $43 million and $1.10, respectively. Further, management changed its 2004 guidance to $4.48 per share from a previously stated range of $4.48 to $4.51 per share.

VALUATION

The long-term outlook for Alexandria's current dividend remains secure; however, we have lowered our expected growth rate by 50 basis points to 5.0%. This is due to the concerns listed in the Overview and Industry Position sections. In addition, we increased our required rate of return by 25 basis points to a range between 9.75% and 10.25%. Because of these revisions, our price range, based on the dividend discount model, is $49.52 to $54.74 per share.

As mentioned in our previous report dated March 18, 2004, management had reduced its 2004 FFO guidance to a range of $4.48 to $4.51 per share. At that time, we felt Alexandria would perform above this range and set an estimate of $4.52 per share. However, we have lowered our estimate by one penny to $4.51 per share. Although we have not reduced our 2005 estimate, which is $4.76 per share, we feel a lower P/FFO multiplier is warranted. The current multiple of 12.4x our forecasted 2004 FFO of $4.51 is too high. We have reduced the multiple to 11.1x to bring Alexandria's target price more in-line with the current outlook. This results in a target price of $50.06 per share.

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Based on our two revised valuation methods described above, we have set a target price of $50.00 per share. This represents a further decline in value of approximately 10.5%.

RISKS

Rising interest rates can have two negative impacts to REITs. First, investors move to higher yielding investments. Second, the cost of capital and the cost of servicing its variable rate debt go up. Increasing costs to re-lease space will have negative impacts on Alexandria's bottom line if these costs cannot be recaptured through increased rents. A downturn in the life sciences industries (its primary tenants) would decrease demand for space. The life sciences industries include biotechnology, pharmaceutical, medical research, and other related fields. There is a significant risk related shareholders of Alexandria. This is due to the seemingly low level of disclosure by management. There is a significant risk that any negative news will surprise investors and result in a quick sell-off of shares.

INSIDER TRADING AND OWNERSHIP

Corporate insiders own approximately 3% of the total shares outstanding of Alexandria Real Estate. During the first quarter of 2004 through today, insiders have sold 28,000 shares and purchased 9,734. This results in net sales of 18,266 shares, a bearish signal.

Institutional investors hold approximately 89% of the shares outstanding. Total institutional ownership has not changed significantly since our last report. The three institutional investors with the largest holdings of Alexandria include Fidelity Management & Research Co. (9.3%), Investco Global Management (5.3%), and Columbia Management Advisors (3.9%).

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PROJECTED INCOME STATEMENT & BALANCE SHEET

Alexandria Real Estate Equities, Inc.

Income Statement and Balance Sheet (Dollars in millions, except EPS data)

Sales Cost of Goods Sold SG&A Other operating expenses Interest and other

Zacks Adjusted Income before NRI Net Income Diluted EPS before NRI Reported EPS

12/99 86 19 7

19

20

22

22 1.46 1.46

12/00 107 22

9

24

26

26

26 1.52 1.52

12/01 128 26 12

31

29

30

30 1.64 1.64

Cash & Marketable Securities Current Assets Current Liabilities Long Term Debt Shareholder's Equity

3

3

2

13

12

11

30

31

56

351

431

573

263

319

333

12/02 145 30 13

33

28

40

40 1.78 1.76

4

6 59 615 486

12/03 161 33 47

39

26

49

60 2.06 2.64

5

7 376 389 507

12/04E 176 36 51

42

29

87

87 4.51 4.51

5

7 376 389 595

HISTORICAL ZACKS RECOMMENDATIONS

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DISCLOSURES

The analysts contributing to this report do not hold any shares of ARE. Zacks EPS and revenue forecasts are not consensus forecasts. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts' personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts' compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Buy- Zacks expects that the subject company will outperform the broader U.S. equity market over the next one to two quarters. We recommend that investors buy the securities at the current valuation. Hold- Zacks expects that the company will perform in line with the broader U.S. equity market over the next one to two quarters. We recommend that investors maintain their position and add on weakness as the valuation or fundamentals become more favorable. Sell- Zacks expects the company will under perform the broader U.S. Equity market over the next one to two quarters. We recommend that investors reduce their positions until the valuation or fundamentals become more compelling. The current distribution of Zacks Ratings is as follows on the 1955 companies covered: Buy- 11.8%, Hold- 80.8%, Sell ? 5.9%. Data is as of midnight on the business day immediately prior to this publication.

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