STIFEL: Rtl REIT - Regency Centers to Acquire Equity One - Making the Case Bigger Is Better Inbox x

FULL REPORT

Regency Centers to Acquire Equity One – Making the Case Bigger Is Better

Regency Centers (REG, $69.86, Hold) and Equity One (EQY, $27.87, Hold) have agreed to merge in a $15.6 billion transaction. The transaction combines the portfolios of two of the highest quality shopping centers REITs, in our view. The transaction is 100% stock in which each EQY shareholder will receive 0.45 of REG shares, implying a price of $31.44, a 13% premium to yesterday’s closing price. REG is acquiring a high quality/infill portfolio with above-average NOI growth and redevelopment opportunities. REG is paying full price for the EQY portfolio and it could take an extended period of time for REG to realize the associated synergies given the inherent challenges integrating the large national portfolio, in our view.

 

  • REG and EQY have agreed to merge in a $15.6 billion transaction. Both REITs own portfolios of high quality shopping centers and the transaction increases REG’s presence in some of its core markets, including San Francisco, Los Angeles, San Diego, Southeast Florida, Washington D.C., and metro New York. REG will acquire EQY for $31.44 per share based on fixed exchange ratio of 0.45 – an implied 4.7% cap rate and a slight premium to our $30 Hold-rated target price.

 

  • The transaction creates a high quality shopping center portfolio with 429 properties totaling 57 million sf. REG is planning to dispose of some centers following the completion of the merger. REG has actively recycled capital throughout its history, selling lower quality or slowing growing centers and recycling the proceeds into higher quality acquisitions and/or its development/redevelopment pipeline.

 

  • REG is estimating $27 million of annualized cost savings from the transaction by 2018. The savings will mostly come from the elimination of duplicative corporate and property-level operating costs. However, it could take time for REG to fully realize the operational efficiencies created by combining the two portfolios given the significant time and effort it can take to fully merge two portfolios.

 

  • EQY’s portfolio of high quality shopping centers as well as its substantial redevelopment pipeline in dense infill markets provides REG with a number of compelling value-creation opportunities. EQY planned to spend $1 billion on development/redevelopment opportunities through 2025 with much of the planned spend targeted at 12 of its larger, market dominant centers in dense infill markets. EQY’s largest in-process redevelopment is the redevelopment and expansion of Serramonte Center in Daly City, CA with an estimated cost of $109.1 million. The combined entity will have over $450 million of development and redevelopment projects in-process.

 

  • While some of the projects in EQY’s redevelopment pipeline have the potential for mixed-use components, REG is focused on the retail-only portion of these opportunities. REG will bring in partners for any mixed-use densification opportunities. Construction-in-process as a percentage of enterprise value of the combined entity is only 3%.

 

  • The transaction is expected to close in 1Q17 or early 2Q17. REG expects the transaction to be accretive to core FFO due to the cost savings, NOI growth benefits in addition to GAAP accounting adjustments. We await additional exposure on the acquisition benefits.

  • Both REG and EQY have strong balance sheets, in our view. EQY’s net-debt-to-EBITDA was 5.2x and REG’s was 4.4x on a trailing 12-month basis. Both REITs have been paying off mortgage debt as it matured and have taken advantage of the low interest rate environment to issue debt at lower rates and redeem debt at higher interest rates. REG estimates the combined entity will have a net-debt-to-EBTIDA ratio of 4.8x and a 4.1x fixed charge coverage ratio. REG will have to term out roughly $540 million of EQY’s bank debt and is assuming $700 million of new unsecured debt with three, four, and ten year terms, likely raising interest costs for REG.

 

  • Legacy REG shareholders will own 62% of the combined entity while EQY shareholders will own 38%. Gazit-Globe, EQY’s largest shareholder at 34%, will own ~13% of the combined entity. REG’s Board of Directors will increase to 12 members from nine and include Chaim Katzman, EQY’s Chairman and Gazit-Globe’s CEO, who will join REG’s investment committee. The two additional board members will come from EQY’s Board of Directors.

 

  • The all-stock transaction allows EQY shareholders to share in the upside of the value-creation opportunities within the combined portfolio. However, the sale price is a 6% discount to the 52-week high EQY shares traded at on August 1st, but we don’t expect a topping bid. Gazit-Globe has pledged to vote for the transaction and likely pushed for the merger, in our view. The combined entity has more liquidity than EQY and gives Gazit-Globe the ability to effectively reduce its ownership stake. Gazit-Globe will be subject to standstill provisions, but more information regarding Gazit-Globe’s ownership stake and provisions will be in the proxy.

 

  • Additional transaction details, such as the breakup fee, should be disclosed in the proxy that is expected to be filed in mid-December. REG plans to release initial 2017 guidance in January and will likely provide an update on the transaction and expected timing on cost synergies at that time.


 

EQY – Target Price Methodology and Risks:


Our $30 target price is based on a 7% premium to our $28 NAV at a 5.25% cap rate. Risks to our target price include a broad-based economic downturn or recession, interest rate movements, and general market risk, including weakening of commercial real estate fundamentals. Company-specific risks include weakening of commercial real estate fundamentals and balance sheet risk.