How Realty Income's Acquisition of Spirit Realty Impacts Dividend

Realty Income (O) announced it will acquire retail REIT peer Spirit Realty Capital (SRC) in an all-stock transaction valued at $9.3 billion, or roughly 17% of O's enterprise value. The deal is expected to close in the first quarter of next year and is subject to Spirit shareholder approval.

Spirit shareholders will receive 0.762 of newly-issued Realty Income shares for each Spirit share owned, representing a 15% premium to Spirit's stock price prior to the deal's announcement. 

Realty Income shareholders will own approximately 87% of the combined company, with Spirit shareholders accounting for the remaining 13%.

Investors don't seem to be impressed with the announcement, with Realty Income's stock falling around 5% today. Possibly because Spirit has a slightly worse debt profile and less exposure to investment-grade tenants (20% of rent compared to 40% for O).

Even so, the deal is expected to be over 2.5% accretive to Realty Income's AFFO per share, a metric similar to earnings for REITs, within the first year, and the firm's payout ratio should remain below 80%.

Additionally, management has stated the deal will not affect the REIT's current dividend policy. As such, we are reaffirming Realty Income's Safe Dividend Safety Score.

Furthermore, while Realty Income will assume Spirit's outstanding debt, there will be little change to the REIT's overall debt profile, with less than 15% of the combined firm's fixed-rate date maturing in the next three years.

In addition to the modest AFFO per share growth the merger provides, the decision to combine seems to be driven by a desire to increase scale, have more favorable financing options down the road, and deepen relationships with overlapping tenants.

The two REITs have very similar portfolios with solid occupancy rates of 99% and many overlapping tenant relationships.

This merger keeps Realty Income focused on convenience, essential, service, and low-cost-oriented tenants with recession-resistant qualities better suited to combat the rise of internet retailers. The combined firm's exposure will maintain a similar tilt toward the retail (80% of rent) and industrial (15%) sectors.

This strategy has helped Realty Income pay dividends without interruption for over 50 years while becoming the fourth-largest REIT in the S&P 500 (post-acquisition).

Overall, while higher interest rates (see our recent note here) and the souring outlook for the American consumer could slow growth in the years ahead, Realty Income looks well-positioned to endure these worsening economic conditions while continuing its low single-digit dividend growth trend. 

We'll continue to monitor for developments on the Spirit transaction and the overall outlook for Realty Income, providing updates as needed.