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Realty Income's Latest Acquisition a Departure From Norm

ARCT would improve cash flow and reposition the portfolio, but longer-term risks emerge.

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 Realty Income (O) will acquire publicly traded American Realty Capital Trust (ARCT) for $3 billion--$1.9 billion of Realty Income shares with the rest in debt. The transaction achieves management's goals of diversifying further into nonretail assets and with investment-grade tenants, but it represents a substantial departure from Realty Income's normally patient and measured approach to acquisitions. The deal is expensive and huge, and there is a minimal margin of safety, in our opinion.

What Is Realty Income Buying?
Realty Income is paying a dear price for a ready-made portfolio that helps it achieve management's diversification goals. We estimate that 45%-50% of the portfolio is in nonretail assets (such as distribution, manufacturing, other industrial, and office properties) while 75% of revenue is from investment-grade tenants. This supports management's strategy of positioning the firm for a possible future with rising interest rates (i.e., toward investment-grade tenants) and weakness among U.S. consumers (i.e., toward nonretail properties). Regardless of one's view on the merits of this diversification strategy, this deal is in keeping with the strategy management has outlined.

Todd Lukasik does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.