VEREIT (VER) had a sordid past, but it was finally moving past all of that. And then Realty Income (O 1.10%) came along and made it an all-stock offer it couldn't refuse. Now VEREIT investors need to decide if they want to take a quick payday or stick around and remain shareholders of Realty Income. Here's why selling would be a mistake.
A swift buck
To summarize the agreement between these two real estate investment trusts (REITs), Realty Income will pay 0.705 shares of its stock for each share of VEREIT. That amounts to a roughly 17% premium to where VEREIT was trading prior to the offer's announcement. That's nothing to scoff at, particularly when you look at the history of the company.
In October 2014, VEREIT, then known as American Realty Capital Properties, announced that it had made an accounting error. To be fair, the REIT had used a rapid series of aggressive acquisitions to build itself into one of the largest net-lease players, so the accounting development shouldn't have been too shocking. Still, the stock plummeted, the dividend was suspended, and management was ousted. The board brought in Glenn Rufrano, an industry veteran with notable turnaround experience, to help get the REIT back on track.
Rufrano and the team he assembled set out specific goals that Wall Street could monitor, including adjusting the portfolio, attaining investment-grade credit ratings, and reinstating the dividend, among others. At the start of 2020, VEREIT had basically managed to achieve all of its targets -- and, just as important, had put the legal fallout from the accounting issue behind it. And then the pandemic hit, pushing off the REIT's plans to shift back toward growth.
With the pandemic starting to ease, VEREIT was looking to 2021 to be its new pivot year. But the big question is how much growth investors should expect. With a portfolio of nearly 3,900 properties, it takes a fairly sizable investment plan to grow. Yes, the REIT is looking to spend between $1 billion and $1.3 billion on acquisitions in 2021, and it has ample cash to do it, but it is only calling for adjusted funds from operations (FFO) growth of between 3% and 6%. That's actually not bad, but it suggests that the 17% premium being offered by Realty Income brings forward several years of growth. And that after investors have spent years waiting on a slow-moving turnaround effort.
Basically, it is easy to see why an investor might want to take the money and run here. But that would likely be a huge mistake. There are multiple reasons:
1. You'll own the industry leader
VEREIT is being bought by what many consider to be one of the best-run net-lease REITs in the industry. Looking at Realty Income's 25-year streak of annual dividend increases is probably the best way to highlight just how well-run this industry bellwether is. That puts it into the elite Dividend Aristocrat space, an area that is home to very few REITs. You don't build a record like that by accident, and investors will basically end up owning a great REIT when all is said and done -- hopefully in late 2021.
2. More income
Based on the exchange rate, VEREIT shareholders will actually end up seeing a roughly 7% dividend increase thanks to the acquisition. In fairness, VEREIT cut its dividend in 2020 to preserve cash, so investors aren't exactly back to where they were before the cut. However, the dividend increase means that income-focused investors don't need to jump ship to look for better dividend opportunities. And Realty Income's history of steady dividend growth means that more hikes are highly likely in the years ahead.
3. A better portfolio
In addition, the combined company will be able to further rationalize its portfolio. VEREIT had been looking to trim down its exposure to office assets, which it believed offered less desirable risk/reward opportunities. Realty Income shared that view. Together, they will have enough office assets to spin them off as a separate REIT, leaving the combined entity focused on retail and industrial assets.
So the direction VEREIT was going with its portfolio will be sped up thanks to this deal. That's on top of the fact that Realty Income will become an industry behemoth with more than 10,000 properties, including a small but growing exposure to Europe.
4. Greater scale
Scale can mean a lot, including an ability to take on larger deals, which the combined entity will clearly be able to do. However, the biggest benefit is really access to low-cost capital -- and being a larger company should make that easier, whether it's selling shares or selling bonds.
However, it's important to note that VEREIT's credit rating is lower than Realty Income's. So VEREIT shareholders will end up owning a company that has even easier access to low-cost capital than VEREIT. In fact, Realty Income believes it can save millions of dollars just by refinancing VEREIT's debt as it matures over the next few years.
It often makes sense for investors to sell the stock of a company that's being acquired to capture a quick price boost. In this case, however, the long-term benefits of this merger are really attractive for VEREIT investors. Indeed, if you liked VEREIT, you will probably like the post-merger Realty Income even better. Add in the quick dividend boost VEREIT shareholders will see, and there's really no reason to jump ship. Indeed, the biggest mistake VEREIT investors could probably make today is to sell.