When bull markets get into their later stages, many companies start to focus on mergers and acquisitions as ways to obtain growth, often using their own shares as currency. This can result in big strategic deals like the one in which Realty Income (O -0.11%) is buying VEREIT (VER) in an all-stock transaction.
Here's what this deal (announced on April 29) means for these real estate investment trusts' shareholders.
An unusual merger: 2 REITs enter and 2 REITs leave
Investors will receive 0.705 shares of Realty Income for every share of VEREIT they hold. Immediately after the merger transaction closes, the combined company will spin off all of its office property assets in a new company, which will be a taxable event for shareholders. So, if you are a VEREIT shareholder, after the transaction closes, you will own shares of Realty Income and shares of a second entity that owns the office property assets.
Realty Income, which bills itself as "the monthly dividend company" is a Dividend Aristocrat. In business since the 1960s, it owns 6,500 single-tenant properties and operates a triple-net lease model, which means its tenants are responsible for taxes, insurance, and maintenance. Realty Income has long-term leases that include automatic rent escalators with its tenants.
VEREIT has been more of a turnaround story, and this merger is the culmination of that process. It owns 3,800 single-tenant properties and operates using a sale-and-leaseback business model that's similar to Realty Income's. Single-tenant building owners sell their properties to VEREIT and then rent them back. If the REIT can borrow money to finance those purchases at a lower rate than the tenant could, the result is a win-win.
Realty Income can borrow at lower interest rates
The merger will result in a company with a geographically diversified portfolio of 10,300 properties. Realty Income's stronger investment rating will allow the new company to refinance VEREIT's debt at better rates, which is one of the key synergies for the transaction. The merger is expected to be 10% accretive to Realty Income's adjusted funds from operations in 2022.
After the deal closes, the combined company's largest tenants will be Walgreens, Dollar General, Dollar Tree (and its Family Dollar subsidiary), FedEx, and 7-Eleven. Its major industry exposure will be to convenience stores (9% of rent), grocery stores (8% of rent), dollar stores (8% of rent), and drug stores (8% of rent). VEREIT does have heavier exposure than Realty Income to the restaurant sector, which took a particularly heavy blow from the pandemic.
The new REIT that is to be spun off will be a pure-play office vehicle, owning 97 properties with an average rent collection of $183 million per year. About 76% of its portfolio will be leased to investment-grade clients, with its largest tenants concentrated in the healthcare, financial services, and government sectors.
Shareholders of VEREIT should be happy to see its turnaround story reach its conclusion via this merger with a highly respected peer. Realty Income shareholders will reap the benefits of increased diversification, and the prospect of higher funds from operations as the combined company refinances VEREITs debt. Realty Income's average interest rate on its borrowings is 3.4%, which is much lower than VEREIT's average of 4%.
In short, this looks like a win-win for shareholders of both companies.