Baseball fans know the struggle when a power hitter excels against fastballs but finds it challenging to handle breaking balls. This difficulty in making adjustments is commonly referred to as “trouble with the curve.” Interestingly, this phrase shares its name with a movie featuring Clint Eastwood and Justin Timberlake. However, in the world of finance, we are currently facing a different curveball in the form of Realty Income Corporation’s (NYSE:O) unexpected announcement of its acquisition of Spirit Realty Capital, Inc. (NYSE:SRC). This move has caught us off guard as we were preparing for Realty Income’s earnings report. Let’s take a closer look at this surprising development and its implications.
The Rationale Behind the Transaction
Realty Income’s decision to acquire Spirit Realty has a solid rationale. With recent signs of weakness in Realty Income’s performance, including Q2 net income of $195.4 million, or $0.29 per share, and adjusted funds from operations (“AFFO”) of $1.00 per share, the company was clearly in need of a boost. Additionally, the company’s net debt to adjusted EBITDA ratio stood at 5.3x at the end of Q2, and it had $3.5 billion in liquidity for Q3, consisting of cash and cash equivalents of $253.7 million. Given these factors, the acquisition presents an opportunity for Realty Income to enhance its growth potential and cost synergies.
Diving deeper into the transaction, we can confirm that the deal is expected to result in a significant increase in AFFO per share on a leverage-neutral basis. According to Realty Income’s estimates, the transaction will be over 2.5% accretive. However, it’s important to note that this is an all-stock deal, which means it will be dilutive in the short term. Spirit shareholders will receive 0.762 newly-issued Realty Income common shares for each Spirit common share they own. As a result, existing Realty Income shareholders will own approximately 87% of the combined entity. The merger is subject to the approval of Spirit shareholders and is anticipated to close in the first quarter of 2024.
Maximizing Cash Flow and Diversifying Holdings
An intriguing aspect of the acquisition is the emphasis on cash flow. Realty Income’s President and CEO, Sumit Roy, highlighted the complementary nature of Spirit’s assets and their ability to generate durable cash flows across various economic cycles. Given the current economic climate, this focus on cash flow is a vital consideration. Moreover, the acquisition will lead to a significant reduction in rent concentration for Realty Income, expanding its holdings and reducing dependence on specific industries and clients.
After the merger, Realty Income’s annualized contractual rent will increase by nearly 20%, reaching $4.5 billion. The portfolio diversification resulting from this merger is a positive development, even if it means a decreased concentration of convenience store rent. By broadening its tenant base, Realty Income is positioning itself for long-term stability and resilience.
The Impact on Realty Income’s Position in the Market
Upon completion of the merger, Realty Income’s total enterprise value is expected to reach approximately $63 billion, making it the fourth-largest real estate investment trust (REIT) in the S&P 500. This considerable growth in enterprise value will undoubtedly have an impact on the company’s standing within the industry.
Timing, Market Response, and the Road Ahead
The timing of this acquisition may raise some eyebrows, given the current economic situation. However, in reviewing Spirit Realty’s portfolio, it becomes clear that the combination of these two companies makes sense in terms of diversification and potential future growth. While the market has initially responded with skepticism, considering that Spirit Realty’s shares were valued at $42 in August, this deal at $37 per share may prove to be a worthwhile opportunity for Realty Income.
The next important milestone for Realty Income shares will be the Q3 earnings report, expected to be released after the market closes on November 6th. Our expectations for the quarter include quarterly revenue of $985 million, net income of $200 million, and funds from operations of $1.02. The same-store rental revenue will play a crucial role as well, with an anticipated range of $715-$725 million.
Join the Discussion
We would love to hear your thoughts on this transaction. Do you find it unusual that Realty Income shareholders will not have a vote on the merger? Do you agree that this acquisition was a steal considering Spirit Realty’s recent stock price? How do you feel about the timing of this deal? Join the conversation and share your opinions with the community below.
