Quick Real Estate Expansion Through Acquisition

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With a January 16, 2013 shareholder vote in the books, New York-based American Realty Capital Trust (NASDAQ: ARCT) has officially agreed to merge with Escondido, California-based Realty Income Corporation (NYSE: O). The two REITs will merge in a two-part cash-for-stock and stock-for-stock offering that will see current American Realty shareholders receive significant stakes in the larger Realty Income Corporation. Barring a last-minute legal hangup, the merger should wrap up quickly and could close as early as the end of January.

About Realty Income Corporation and American Realty Capital Trust
Realty Income Corporation is a commercial retail REIT that operates primarily in the United States. The company owns nearly 17 million square feet of office and retail space in 48 out of 50 U.S. states. Most of its tenants are regional or national chain stores like Walgreens and CVS. In 2011, the company earned $115.6 million on $467.2 million in revenues.

American Realty Capital Trust is a "self-administered" real estate trust that specializes in leasing out freestanding retail and office properties across the United States. With nearly 16 million square feet of office space spread across nearly 500 properties, the organization promises to add tremendous value to Realty Income's bottom line. In 2011, American Realty lost $94.2 million on $180.5 million in revenues.

How the Deal Is Structured
This merger agreement has a small cash component and a robust stock component. For each share that they own, current American Realty shareholders will receive cash payments of $.35 per share and exactly .2874 share of Realty Income. The combined value of this compensation is almost exactly $13 per share. As a condition of the deal, Realty Income has also agreed to raise its annual dividend by $.35 per share.

Prior to the deal's early-fall announcement, American Realty traded in a range between $11.50 and $12.20. Following the deal's announcement, the REIT's price has risen to near $13. Relative to an average pre-announcement closing price of $11.70, this represents a premium of about 11 percent. Relative to an average post-approval closing price of $12.80 per share, this represents a premium of about 1.5 percent.

It should be noted that Realty Income Corporation is set up as a REIT. As such, its price action is markedly different than that of a typical stock. With a yield of well over 4 percent, Realty Income is set up to produce income for its shareholders. With the addition of American Realty's income-producing assets to its portfolio, the organization is betting on creating enough value for its shareholders to offset the relatively paltry premium that it is paying for the smaller REIT.

Complications and Competition
After a seemingly meritorious lawsuit was filed to block the proposed deal in September of 2012, Realty Income revamped its bid for American Realty and raised its offer price by nearly $.80 per share. The company also resolved to beef up its dividend. In the process, it quieted critics who claimed that the deal undervalued American Realty and returned too little income to shareholders. After the successful shareholder vote, there appear to be no obstacles standing in the way of the deal's consummation.

It would be highly irregular for another REIT or management company to step in and float a rival offer at this stage. Then again, there are several organizations that have the resources to mount such an acquisition attempt with little trouble. These include Annaly Capital Management (NYSE: NLY) and Simon Property Group (NYSE: SPG).

American Realty would fit more naturally into Annaly's ecosystem. As one of the largest commercial REITs in the world, Annaly is always on the lookout for acquisition targets and has been known to pick off smaller, weaker rivals. However, the organization already has a great deal of exposure to the U.S. commercial real estate market. Many market watchers expect its next spate of acquisitions to focus on a different part of the real estate space.

Meanwhile, Simon Property Group is in better health than some of its commercial real estate rivals and could probably fund an acquisition of an organization like American with relative ease. Simon Property Group has revenues of $4.7 billion and half a billion in cash.  On the other hand, it may be gearing up for a partial acquisition of General Growth Properties (GGP). Even with ample cash reserves, it would be hard-pressed to afford both transactions within the same fiscal year.

Long-Term Prospects and Outlook
This deal looks to provide patient investors with a solid return on their investments. As the market for U.S. commercial real estate continues to improve, a larger and more robust Realty Income Corporation will be well positioned to make targeted investments and return capital to its shareholders. Unless the market suffers an unforeseen collapse over the next few years, Realty looks to yield at least 5 percent for the foreseeable future. In fact, the organization has already hinted at the prospect of further dividend increases.

In short, this merger represents an excellent medium-term buying opportunity for income-minded investors. While it may not produce quick, outsize returns, it looks to generate a steady yield for years to come. Investors who wish to build up a solid funding base for riskier activities would do well to look at Realty Income Corporation.


mthiessen has no position in any stocks mentioned. The Motley Fool owns shares of Annaly Capital Management. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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