Thursday, January 24, 2013

Ka-Ching! Realty Income just gave me a 19% raise

Realty Income Corp. (O) announced last week that it will be increasing its monthly dividend from  $0.15175 per share to $0.1809167  (yeah, that's a lot of numbers beyond the decimal). This is a whopping increase of 19.2% and gives Realty an effective annual yield of 5%, up from 4.2%.

So how did a company with a 5 year average dividend growth rate of under 3% manage to make such a large increase? Realty's recent successful bid to acquire American Realty Capital Trust (ARCT) allowed them to make such a move. The buyout was announced this past summer, but shareholders of ARCT were not happy with the initial offer. It took some sweetening on Realty's end to get the job done, including a one-time cash payment of $0.35 / share to ARCT investors, but the overall deal looks like a good one for Realty shareholders.

Typically when one company buys out another it takes a little time for the benefit to be seen in the combined company's bottom line. This is not the case with Realty and ARCT. Since Realty and ARCT are REITs, we are not as concerned with the company's net income as we are with Funds From Operations (FFO). FFO is a REIT's version of cash flow and the ARCT deal immediately increases Realty's FFO which allows for the large increase in the dividend.

Another reason I like this deal is that it was funded with the issuance of Realty stock (other than the additional $0.35 cash payment) rather than debt. ARCT shareholders received 0.2874 shares of Realty Income stock for each share of ARCT common stock owned. So even though Realty increased the number of shares outstanding by 45.6 million shares, it was still able to increase its monthly dividend paid to each of those shares by 19.2%. That is an incredible deal for Realty and a no-brainer for management.

The additional FFO isn't the only thing that ARCT brings to Realty. ARCT owns 515 commercial properties which are net-leased primarily to investment-grade (financially sound) tenants. Some of ARCT's biggest tenants include FedEx (FDX), Walgreen (WAG), CVS (CVS), the Government Services Administration, Dollar General (DG), Express Scripts (ESRX) and PNC Bank (PNC).

Including these new properties, Realty Income will own a total of 3,528 properties leased to 202 tenants doing business in 48 industries. Approximately 34% of the anticipated lease revenue will be generated by investment grade rated tenants, vs 19% prior to the ARCT acquisition.  These new tenants also increase the diversification of Realty's tenants among more companies and industries.

This past summer I had sold part of my position in Realty to initiate a position in Hasbro (HAS). The reason I had done this was because, at the time, Realty appeared to be overvalued and their dividend growth rate was violating my Rule #4. Needless to say the recent acquisition and dividend increase has reaffirmed by belief in Realty and I have no intention of selling any more of my position in the near future. The stock is still valued higher than most of its peers based on several metrics, but with deals like the ARCT buyout management has proven that it is a top-tier REIT and should be valued as such.

Disclosure: I am long O

Related Articles:
Sold Some O to buy HAS
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