Key Takeaways: Yesterday Equity Commonwealth (EQC) finally pulled the trigger and announced a ~$3.4bn all-stock acquisition of Monmouth Real Estate Investment Corporation (MNR), beginning its transition into the industrial / logistics sector. By way of background EQC was the product of an activist campaign several years ago, which resulted in the elimination of an externally-managed structure and gradual sell-down of the legacy office business. EQC had been sitting on a $2-3bn pile of cash for several years, essentially functioning as a perpetual-lived real estate SPAC with plans to do a transformational deal. The pressure on uses of funds versus returning cash to shareholders had been building for some time. While the "melting ice cube" effect of sitting on that much cash is now in the rearview mirror, we think the deal is underwhelming for EQC shareholders on a few fronts. With the stock down ~4.5% yesterday on the announcement, the market agrees:
- First of all, EQC with ~$3bn of net cash using all stock / no debt to acquire an under-levered MNR (with plans to lever up post-closing to in-line with other industrial REITs) is ridiculous and a direct transfer of value to selling MNR shareholders. Post-close and before issuing any new debt, the debt-to-cap ratio will be in the low-to-mid teen range. A cash and stock deal funded with debt would (1) still allow for ~$2.5bn of retained cash post-close to grow through acquisitions, but more importantly (2) be clearly less dilutive to EQC holders
- We think EQC is effectively paying a ~4.6% cap rate for MNR, with about half of the leases being lower-growth flat structures similar to STAG. The question is, wouldn't it be better to pay even a sub-4% cap rate for higher growth and turn those assets into a 6%-yielding portfolio ultimately selling for sub-4%? Not a great allocation of capital generally in our view, especially not funded 100% with equity
- Finally from a qualitative standpoint, it is an interesting strategic move given Sam Zell's (who will remain Chairman) past and very vocal criticism of the industrial sector's recent success and propensity for overbuilding. We would never ever bet against The Grave Dancer, but it definitely represents a very sudden (a perhaps rash?) pivot by EQC
