Escondido-based Realty Income (NYSE:O) announced September 6 that it was acquiring American Realty Capital Trust (Nasdaq:ARCT) for $2.95 billion. The combined business will be the 18th largest REIT in the country, with 3,250 properties from coast to coast. Most importantly, the move almost doubles the number of investment grade tenants to 34%. If you're an American Realty Capital Trust shareholder, I'll explain why you should hang on to your new shares. If you're a Realty Income shareholder, I'll tell you why you should be excited about the future.
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American Realty Capital Trust Shareholders
The early buzz on financial message boards is that the deal is a bust and management should have gotten more than a 2% premium on its shares. As is the case in the most litigious country in the world, the ambulance chasers were out in full force following the news, suggesting the board breached its fiduciary duties by failing to maximize shareholder value, and making this deal seem like one of the biggest merger and acquisition disasters. It doesn't matter that Realty Income produced annual total returns over the past five years equal to Simon Property Group (NYSE:SPG), the biggest mall owner in the world or that Realty Income delivered 67 dividend increases since going public in 1994. You see, the greedy believe there is always a better deal out there and that management must be pulling a fast one on shareholders. If you've been a fan of ARCT management up until now, however, it makes little sense to bash what was obviously a well-informed decision to sell. If you can't beat them, join them. To play with the big boys requires getting bigger and this deal allows that to happen.
It's very important to analyze an acquisition announcement carefully. Realty Income is issuing 0.2874 shares for every ARCT share. Based on the September 5 closing price of $12.21, shareholders will receive 45.6 million shares of Realty Income stock and own 25.6% of the combined company. In addition to the stock, Realty Income will assume $526 million in debt and pay down another $574 million, using its available capacity under its $1 billion line of credit and approximately $750 million in new equity. Based on a December close, ARCT shareholders will be looking at annual dividends of $1.94 a share. Realty Income's September 5 closing price of $42.48 translates into a 4.6% yield. Realty Income has managed to deliver an 18.1% compound annual return since 1994, 700 basis points higher than the NAREIT index and 850 higher than the S&P 500. With the added diversification ARCT's portfolio brings to the table - FedEx (NYSE:FDX) is the largest tenant with 6% of annual rental income - Realty Income becomes even stronger. In six short months, ARCT shareholders have achieved an annualized return of over 40%. If you have a problem with this, you might want to give your head a shake.
Realty Income Shareholders
Henry Singleton, the founder of Teledyne (NYSE:TDY), was a master capital allocator, using expensive stock to make acquisitions and then repurchasing that stock when prices fell. In the opinion of many, he operated the most successful conglomerate anywhere, anytime. CEO Tom Lewis is using Realty Income stock that sits within $2 of an all-time high as the currency to make this current deal happen. The combination of the two businesses reduces its reliance on its top 15 tenants, while extending the duration of leases and the quality of its overall portfolio. By teaming up with ARCT, it becomes twice as large as National Retail Properties (NYSE:NNN), the next biggest public triple net lease company according to enterprise value. With just 5% of the net lease market owned by public companies, the opportunity to grow is virtually limitless. This deal shows many benefits from the wonderful world of mergers for Realty Income shareholders because it takes care of the future while providing an immediate financial benefit in the present.
The Bottom Line
This is a case of one plus one equaling three. If current ARCT shareholders are truly honest with themselves, they won't look a gift horse in the mouth. Hang on to the new shares and 10 years from now you'll be happy you did.
At the time of writing, Will Ashworth did not own shares in any of the companies mentioned in this article.