GNL - Necessity Retail REIT: Should You Get Out Of The Commons Before Merger With Global Net Lease?

2023-07-18 11:20:34 ET

Summary

• RTL is currently paying its shareholders a double-digit 11.8% dividend yield.
• The retail REIT is set to merge with sister REIT Global Net Lease in the third quarter of 2023.
• Responsibility for the preferreds coupon will shift to Global Net Lease following the change of control.
• The merger price is at a 36% discount to book value with external manager AR Global set to own a significant stake in the aggregate entity.

The Necessity Retail REIT ( RTL ) is merging with its sister REIT Global Net Lease ( GNL ). The transaction is yet to close and faces some stiff opposition from shareholders of both companies including a larger GNL shareholder called Orange Capital Ventures who argued in an open letter to the board that the merger is extremely value destructive, will result in a dividend cut for and credit rating downgrade for GNL, and is engineered to enrich external manager AR Global. It also includes a material payoff for Blackwells, an activist investor who launched a proxy fight with RTL and GNL to oust AR Global as external manager and place two of its nominees on the boards of both REITs.

At risk are the currently stagnated quarterly dividend payouts of both firms, dilution from the payouts to Blackwells that are expected to be as much as 2.1 million GNL shares, and the pyrrhic expense of a move to internalize both REITs. RTL last declared a quarterly cash dividend of $0.2125 per share , in line with its prior payout and for an 11.8% annualized forward yield.

Is RTL a buy or sell ahead of the consumption of the merger? It depends. RTL shareholders are set to get 0.670 shares of GNL for each common share of RTL, which currently implies a consideration of around $7.20 per share. Critically, upon the closing of the transaction RTL shareholders will own roughly 39% of the combined company with GNL shareholders set to own around 45%. Up to 17% is set to be owned by AR Global on the back of a $325 million stock and $50 million cash payoff for the internalization. What bears are right to highlight is the unusually large 17% equity stake set to be owned by AR Global that an expense essentially being borne by shareholders of the aggregate entity.

RTL's Operating Results Show Weakness

RTL's portfolio comprised 1,039 net leased properties spread across 27.6 million rentable square feet as of the end of its most recent fiscal 2023 first quarter. This was 92.6% leased, up sequentially from 89.8% in the fourth quarter and with a weighted average lease term of 7.1 years. It also had an annualized straight-line rent of $374.8 million and was 91% comprised of retail properties, 8% distribution properties, and 1% office properties. The REIT brought in first-quarter rental revenue of $113.6 million , up 19.7% over its year-ago comp but a miss by $4.17 million on consensus estimates.

Net loss attributable to common shareholders was $18.8 million , down versus a profit of $39.9 million in the year-ago quarter on the back of a number of operating expenses that came in higher than shareholders would have liked. For example, G&A expenses grew by 54% over its year-ago comp, a rate that was disproportionally higher than the rate of revenue growth. Total operating expenses at $103.7 million grew from $81.2 million in the year-ago period with interest expenses growing by $10.9 million from its year-ago figure.

However, non-cash expenses comprised a huge portion of this with cash net operating income coming in at $83.1 million. This was up 12.9% versus the year-ago period to drive FFO of $0.18 per share, down $0.05 from the year-ago quarter. RTL provides a non-GAAP measure called AFFO which their management states is a better reflection of actual operational performance. This came in at $0.23 per share , down from $0.24 per share in the year-ago period. AFFO was able to cover the dividend by 108%. However, this rate of coverage is dropping and AFFO includes some actual cash expenses including legal costs incurred as a result of litigation arising out of the REIT's 2017 merger with American Realty Capital-Retail Centers of America.

Are The Commons A Buy?

RTL realized a positive leasing spread of 12.7% on lease renewals completed during the first quarter to support growth against dispositions of $71.3 million during the first quarter. The REIT's disposition pipeline stands at over $100 million. Preferred shareholders of the Series A ( RTLPP ) and Series C ( RTLPO ) will see GNL assume responsibility for the quarterly coupon payments with a name change set to follow the change of control. The aggregate entity is expected to own and manage more than 1,350 properties with a combined real estate value of $9.6 billion at closing.

There are a ton of uncertainties with the merger. Firstly, whilst its set to close in the third quarter of 2023, the provision of such a large equity stake to AR Global is highly dilutive and will see both NAV per share and FFO per share of the combined entity come in weaker than it would otherwise have done. RTL is currently trading below total equity and tangible book value per share of $11.35 as of the end of the quarter. Hence, the merger price is at a 36% discount to the underlying value of RTL. This undervaluation is odd with RTL essentially crystallizing an unwelcome discount on commons trading for 64 cents on the dollar. Ultimately, the deal is not shareholder friendly but the currently fat dividend yield is likely allaying some concerns in the interim.

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