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Quick Covenant Review on Realty Income (O) and Comparison to American Campus Communities
As a quick follow-up to "Reggie Middleton on the Recent Ackman Short - Realty Income "O"", I took a look at the likelihood of O tripping their covenants in an attempt to keep the dividend intact.
Regarding Realty Income’s debt covenants - there is a bank owned credit
facility of $355 million but as of July 21, 2009, the Company had no
outstanding balance under it. Since, per the cash flow analysis linked
above, it was observed that the Company will not face serious liquidity
pressures in the next year unless the rental income declines severely
(we assumed 5% consecutive decline for the next two fiscal halfs), the
Company may not need to utilize the credit facility.
However, the Company is required to fulfill the debt covenants of the
senior unsecured notes of $ 1,350 million. The table below summarizes
the requirements under the debt covenants and the Company’s actual
position as of June 20, 2009
| Note Covenants
|
Actual
|
| Debt to total adjusted assets should be less than 60%
|
38.7% |
|
Secured debt to total adjusted assets should be less than 40% |
0.0% |
|
Debt service coverage ratio should be greater than 1.5x |
3.5x |
|
Total unencumbered assets to total unsecured debt should be more than 150% |
258.0% |
Now, contrast this to the situation in the company below...
American Campus Communities Research Note
As highlighted in the 2Q09
results preview, ACC is expected to face a shortage (after considering
operating cash flows, capex, debt repayments and dividend distribution) of $146
mn, $83 mn and $239 mn in 2H09, 2010 and 2011, respectively. (Detailed
assumptions are enclosed in ACC 2Q-09
results preview: ACC
2Q09 results review 2009-08-12 01:25:50 110.50 Kb).
Although the company has a few alternatives with which to pull itself out
of a GGP-like solvency spiral (see GGP
and the type of investigative analysis you will not get from your brokerage
house), we believe that all practically available options will be earnings-dilutive
in some way or the other. Dividend cut: Although,
on its face, a dividend cut seems like the easiest way out, it would not be
sufficient to make up for the entire shortfall. In addition a cut in dividend
could endanger the company's REIT status and harm investor sentiment. There is
the possibility of an all stock dividend announcement, but eventually even the
slowest of investors will wise up to this game of dilution in the face of
lessening cash flows. What cash dividend investors want more stock of a company
as a dividend when said company couldn't pay its cash dividend in the first
place? Unfortunately, the answer to this question could be alarming.
(see attached image filef for cash shortage chart)
Additional borrowing under
the existing revolving credit facility: During
August 2009 and September 2009, ACC closed on a Revolving Credit Facility which
would increase total facilities by $65 mn and $125 mn, respectively. We
believe that additional borrowing under revolving credit facilities would be
the most likely scenario for ACC. However, increase in short-term borrowings
could result in asset liability mismatch and result in higher interest expense
for the company. Moreover, borrowings under revolving credit facility are
short term in nature and would only postpone the problems till 2011, given the
expected meager cash flows in the near-to-medium term.
Refinancing with long term
debt / issue of new capital : We believe that the
only way ACC could avoid shortfall problems is through issue of new capital and
/or assumption of additional debt. Capital markets are (in our opinion) too far
away from recovery to raise additional financing on amenable terms, and even if
the company manages to raise finance through this option, it would lead to
dilution of existing shareholders' earnings. Issue of long debt for REIT looks
highly unlikely considering dearth of demand for CMBS.
We believe that the company,
apart from short term borrowing through credit facilities, will make up for the
shortfall by curtailing their new development capex and through sale of few of
their existing properties at distressed prices that would put pressure on
earnings. It has been quite some time since the company first started marketing
its properties in an effort to raise capital, and to our knowledge, they have
yet to find a taker. This is a testimony to the extremely soft commercial and
residential real property markets.
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There I was at the party getting blind drunk on the punch having the time of my life, and along you come telling tales of someone pissing in the punchbowl.