When one company acquires another, investors need to make sure they understand what is happening. Sometimes, the purchase will be a slam dunk for everyone; other times, the outcome will seem less certain.
A closer look at Realty Income's (O -0.17%) acquisition of peer Spirit Realty (SRC) can help explain what is meant by this dichotomy.
Realty Income: The biggest is getting bigger
Realty Income is the largest net lease real estate investment trust (REIT) in the market. Net leases require tenants to pay most property-level operating costs. The REIT's market cap is a massive $36 billion, and it owns over 13,000 single-tenant properties. Add an investment-grade-rated balance sheet and 29 consecutive years' worth of annual dividend increases, and you can see why Realty Income is a Wall Street favorite.
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It has made a big acquisition before, noting the purchase of VEREIT in 2021, a $17 billion deal. That purchase went very smoothly, including the spin-off of the company's office properties into a separate entity. So, there's no reason to believe that Realty Income can't swallow a $5.4 billion market cap Spirit Realty in relative stride.
The transaction will increase the company's scale, jumping the portfolio to over 15,000 properties. It is expected to be accretive to adjusted funds from operations (FFO). And it shouldn't materially alter anything about Realty Income's portfolio, which will remain heavily focused on retail assets (around 80% of rents) with still-sizable exposure to industrial properties (15%).
That said, in addition to the move being accretive, which is a positive, it will also increase Realty Income's already industry-leading scale. That will give it even more ability to make big deals, including company acquisitions (like Spirit), large single properties (like the Encore Boston Harbor Casino), and portfolio transactions (basically buying a pool of assets from a single seller). Smaller peers just wouldn't have the heft or access to the capital markets needed to compete for such deals.
Digging into the details a little deeper
With that background, this is an all-stock transaction, with Spirit shareholders set to receive 0.762 shares of Realty Income for each of their Spirit shares. REITs have been out of favor since interest rates started rising in 2022, leading some to suggest Realty Income's stock is too low to justify the acquisition. Basically, it will have to issue more shares, and thus, some view the deal as kind of expensive.
That said, Spirit shares have been in a funk, too, so what Realty Income is buying is likely trading at a discount. The two issues probably wash out, but if you feel strongly that Realty Income is overpaying somehow, it might be advisable to rethink your thesis on the REIT. Getting bigger just to get bigger isn't necessarily a worthwhile effort.
As for Spirit, the stock price rose sharply on the news, as the chart below shows. There's always a risk that the deal doesn't close. In that case, selling now to lock in the gains would save you from the drop that would likely occur if the acquisition fell apart. Given Realty Income's history, however, it seems likely this deal will run its course as expected.
So, the big quandary is probably whether you want to own Realty Income. If you don't, you should probably capture the quick gain and get out before the deal is consummated. If you are happy to own Realty Income, just stick around and do nothing.
There's one more topic of interest with regard to Realty Income. It is getting larger and larger, which means growth will get harder and harder to achieve. Big deals are, essentially, required. And even then, growth is likely to be slower than what a smaller REIT could achieve with much less effort.
Owning the net lease industry's 800-pound gorilla may appeal to you, in which case, this deal should solidify your thesis. But if you want a growth-oriented net lease REIT, owning Realty Income probably won't be an attractive proposition.
Two choices, but a lot of issues to consider
When there's an acquisition, investors really only have two choices: sell or sit tight. Picking between the two options isn't always so simple, as Realty Income's proposed purchase of Spirit Realty highlights. You need to pick apart the deal and what the purchase might mean for the future.
Still, while you can't control acquisitions, you can control what you do about them. And the best course of action is to step back, take some time to think through what is going on, and then make a decision couched in your deeper understanding of the deal.
