HomeMost PopularW. P. Carey: Shares Tank On Transformative Transaction

W. P. Carey: Shares Tank On Transformative Transaction

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W. P. Carey (NYSE:WPC), a real estate investment trust (REIT) with a diverse portfolio of real estate assets, experienced a significant drop in its share price on September 21st. The companyโ€™s stock closed nearly 8% lower after announcing a transformative plan to divest its entire office portfolio. Some of these assets will be spun off into a separate publicly traded company, while the remaining properties will be sold. The rapid timeline for these transactions took investors by surprise and elicited a negative market reaction. Although the move may increase expenses, it also offers certain benefits.

A Closer Look at the Transactions

According to the press release issued by W. P. Carey, the company has implemented a strategic plan to exit the office real estate sector. This plan involves two separate actions. First, a portion of the office portfolio will be spun off into a new publicly traded company. The expected closing date for this deal is November 1st of this year. Second, the remainder of the office assets will be sold off, with completion targeted for January of next year.

If this comes as a surprise, itโ€™s because W. P. Carey has been steadily reducing its exposure to office real estate over the years. In 2015, office assets accounted for 30% of the companyโ€™s annualized base rent (ABR), but this figure has since dropped to 16.1%. After these transactions, the companyโ€™s office ABR will be reduced to 0%. Letโ€™s first examine the assets being sold and then delve into the more complex spinoff.

The sale includes 87 properties, of which 70 are currently leased by the Spanish government. The remaining 17 properties are occupied by a total of 20 tenants. These assets comprise six million square feet of space and generate $77 million of ABR. Notably, the properties leased to the Spanish government boast a 100% occupancy rate with an average remaining lease term of 11.5 years. The other 17 properties have an 86.7% occupancy rate, with a more modest lease term of 8.2 years.

The expected proceeds from the sale are approximately $800 million, including the transfer of around $140 million in mortgage debt to the buyers. The spinoff company, named Net Lease Office Properties (NLOP), will consist of 59 properties occupied by 62 tenants. It has higher square footage at 8.7 million square feet and generates $141 million of ABR. These assets have a 97.1% occupancy rate and an average lease term of 5.7 years. The majority (89%) of NLOPโ€™s ABR comes from North America, with the remaining 11% from Europe.

While the exact valuation of these assets remains uncertain until the spinoff occurs, management plans to transfer $169 million in mortgage debt to NLOP. Additionally, NLOP will obtain a $455 million credit facility, with $350 million allocated for transfer to W. P. Carey. These figures will affect the enterprise value of NLOP and its equity.

Itโ€™s worth noting that W. P. Careyโ€™s decision to divest its office portfolio is motivated by the challenges facing the office real estate industry. National occupancy rates plummeted to around 50% earlier this year, posing a threat to office property owners and potentially causing a decline in property values. Despite having high occupancy rates for its current office assets, W. P. Carey aims to reduce risk for shareholders and use the proceeds to decrease its overall leverage.

While the market response may cause concern, letโ€™s examine the potential implications of these transactions for W. P. Carey.

Implications and Outlook

Following these transactions, W. P. Careyโ€™s annual ABR will amount to approximately $1.25 billion. The weighted average lease term for its remaining properties will increase from 11.2 years to 11.9 years, and the occupancy rate will rise from 99% to 99.3%. This shift is expected to have a positive impact, with 66% of the ABR coming from North America and 33% from Europe. Furthermore, 62% of the ABR will be derived from industrial properties and warehouses, compared to the current 53%. Retail properties will account for 20% of the ABR, up from the current 17%.

The cash proceeds from the transactions will be used towards debt reduction, potentially lowering W. P. Careyโ€™s net debt from $8.56 billion to $7.10 billion. With a reduction in interest expenses of approximately $52 million, the enterprise is estimated to generate operating cash flow of around $1.05 billion and EBITDA of roughly $1.28 billion. Although the companyโ€™s EV to EBITDA multiple is expected to rise from 14.8 to between 15.8 and 16.1, the price to operating cash flow multiple is projected to decline from 13 to between 11 and 11.7.

Given the available data, itโ€™s understandable that investors may have concerns about these transactions. While the EV to EBITDA ratio suggests the enterprise could become more expensive, the lower price to operating cash flow implies an opposite trend. The decision to divest the office assets and the accompanying cash flow considerations likely influenced managementโ€™s pursuit of these transactions. Overall, I view this move as marginally positive for the company, but not enough to warrant an upgrade from a โ€˜holdโ€™ to a โ€˜buyโ€™ rating.

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