SRC - Realty Income Balloons With Spirit Realty Takeover

2024-01-19 22:45:08 ET

Summary

• Spirit Realty Capital shareholders have approved the merger deal.
• The deal is expected to be positive for Realty Income and will result in sizable AFFO per share accretion.
• The merger will diversify Realty Income's portfolio and lower rent concentration for top industries and clients.
• Our projection for Q4.

Well it is official. Realty Income Corporation ( O ), recently announced that it would acquire Spirit Realty Capital, Inc. ( SRC ). Just today we learned that Spirit shareholders approved the deal. No vote is coming from Realty Income shareholders, so if you are a holder of Realty Income and do not like the transaction, you have no recourse, unless you want to sell and move on. We have had a buy rating on O since $48 when we moved from short to long back in early fall. Let us discuss the deal in more depth.

We believe that this deal has a strong rationale, and is positive for Realty Income, though Spirit Realty shareholders may also think otherwise. However this is not evidenced by the vote tallies. At the special meeting of Spirit Realty stockholders held today, over 99% of the votes cast were voted in favor of the merger. About 86% of the outstanding shares of Spirit common stock were counted in the vote.

When we first went long on the company we were quite bullish and expected to see the company continuing to seek out investment opportunities that have strong future growth characteristics. We also saw the seeking out deals with CPI-based rent escalators that are uncapped. It is something that is a facet of 30% of the leases in the international portfolio. In our opinion it is a key source for same-store rental growth as well as overall revenue.

We took another look at Spirit Realty this afternoon and we believe that this transaction will certainly result in sizable AFFO per share accretion on a leverage-neutral basis. We also see it providing cost synergies. If we revisit the prior release of the news , Realty Income estimated the transaction to be over 2.5% accretive. Since both companies are levered, the post-transaction leverage will be about 5.5X. This is an all-stock deal. Realty Income is not using any of its cash on hand, which is key. With the leverage, it really can't afford to blow through more cash in our estimation after a tough 6 quarter run.

So, as this is closing, Spirit shareholders will receive 0.762 newly-issued Realty Income common shares for each Spirit common share they own. At the end of the day, current Realty Income holders will own over 85% of the newly combined company, to give you an idea of the combined impact of the dilution. One other factor is worth noting for preferred shareholders. All of Spirit’s outstanding shares of Series A Cumulative Redeemable Preferred Stock are going to exchanged in like kind for shares of Realty Income Series A Cumulative Redeemable Preferred Stock.

Overall the assets are pretty complementary to Realty Income's. We think it helps preserve and expand cash flows for Realty long-term. It also diversifies the portfolio of holdings. This deal will lower rent concentration for nine of Realty Income's current top 10 industries and 18 of its current top 20 clients. Further, the deal is about a 20% boost to Realty Income's annualized contractual rent, which will balloon to $4.5 billion. Convenience stores are still the largest industry, at 11% of the port. Following the merger, there will be more diversification, and while convenience stores will remain the largest industry, the concentration is reduced to about 10% of annualized contractual rent. Realty Income is now about to increase in market cap sizably and will trade as 4th largest REIT in the S&P500 by enterprise value.

As we look ahead to Realty Income's upcoming Q4, you can be sure the conference call will have questions about having Spirit and the implications for guidance. As Q4 closed already we have a good eye on what we are expecting for Q4 when it is reported. We like the deal overall here. But our Q4 expectations are for quarterly revenue of $990 million-$1.0 billion, net income of $190-$210 million, and to generate funds from operations of $1.03-$1.05. The same-store rental revenue is also key, and we are looking for $725-$735 million on this front, with remaining revenue from other activities including new lease origination, lending, etc. Overall, we expect a stable quarter, and future growth ahead with Spirit Realty's assets coming into the fold here in Q1.

Your opinion matters

So what do you think of this transaction? Did you ever doubt it would close? Are you an SRC shareholder that voted? Are you an O shareholder who would have voted against it? Do you think it will be as accretive as we discuss? Do Let the community know below.

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