I Can't Believe It! What an O-mazing Dividend Machine

NEW YORK ( TheStreet) -- Realty Income ( O) calls itself "the monthly dividend company." Its planned acquisition of American Realty Capital Trust ( ARCT) will make that slogan as true as ever.

The company said Wednesday that it has agreed to acquire American Realty Capital Trust in a deal valued at $2.95 billion. When the deal closes in the fourth quarter of this year, Realty Income will be the 18th largest REIT in the U.S., based on total pro forma equity market capitalization. It will be twice as large as the next largest net lease REIT.

Realty Income will finance the purchase by issuing $1.9 billion of common stock to American Realty Capital Trust shareholders. It will assume about $526 million in debt and immediately repay about $574 million of outstanding debt and transaction expenses.

Under the terms if the deal, American Realty Capital Trust shareholders will receive 0.2874 Realty Income shares for each share of American Realty Capital Trust common stock they own. Based on Realty Income's closing stock price of $42.48 on Sept. 5, that's $12.21 per share. When it's over, American Realty Capital Trust shareholders are expected to own 25.6% of Realty Income's shares.

Realty Income CEO Tome A. Lewis said in a statement that the acquisition will help him achieve the strategic objectives of increasing revenue from investment-grade tenants and further diversifying the company's portfolio outside of the retail industry.

He expects the transaction to generate 20 to 22 cents per share per year in additional funds from operations -- and to allow him to increase annualized dividends by some 13 cents to approximately $1.94 per share per year.

The Dividend Machine is Bullet Proof

The acquisition should also benefit Realty Income shareholders considerably. The overall credit quality of the portfolio will improve, which will improve the stability and consistency of its rental stream.

With the addition of the new properties, the share of Realty Income's pro forma rental revenue from the company's 10 largest industries declines to 64% from 73% and the share from its 15 largest tenants declines to 42% from 49%. Its share of revenue from retail properties declines to 77% from 86%.

The added diversification further strengthens the sources of the lease revenues that support the payment of monthly dividends.

Also, the portion of pro forma revenue generated by Realty Income's investment-grade tenants increases to 34% from approximately 19%, and Realty Income's average remaining lease term will increase to 11.4 years after the transaction from 11.1 years before it. The transaction modestly increases occupancy to 97.7% from 97.3%.

The transaction is immediately accretive, and, upon closing, Realty Income would have a pro forma enterprise value of approximately $11.4 billion and a pro forma total equity market cap of $7.6 billion, based on current prices.

Currently Realty Income's stock is overvalued at 21 times funds from operations and a significant premium to net asset value. While this is not great for investors looking to enter today, it makes an all-stock deal very compelling to Realty Income because their overvalued stock is cheap currency.

Realty Income is using that cheap currency to reinforce its already bulletproof model.

Thanks to the deal, Realty Income has said it will be able to raise its dividend by over 7% to $1.94. From an ARCT perspective, their dividend yield has fallen to a sub 5% yield from a 6% yield, but they are being paid a premium -- 12% based on closing value -- to do so. They are also getting the best management in the business.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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