American Realty Capital Trust, Inc. (ARCT)

9 Months Ended

Sep. 30, 2013

American Realty Capital Trust, Inc. (ARCT)

American Realty Capital Trust, Inc. (ARCT)

4.         American Realty Capital Trust, Inc. (ARCT)

A.  Acquisition

On January 22, 2013, we completed our acquisition of ARCT for approximately $3.2 billion.  Each outstanding share of ARCT common stock was converted into the right to receive a combination of: (i) $0.35 in cash and (ii) 0.2874 shares of our common stock, resulting in the issuance of a total of 45,573,144 shares of our common stock to ARCT shareholders, valued at a per share amount of $44.04, which was the closing price of our common stock on January 22, 2013.  In connection with the closing of the ARCT acquisition, we repaid and terminated the amounts then outstanding of approximately $552.9 million under ARCT’s revolving credit facility and term loan.

The acquisition of ARCT is expected to provide immediate and long-term benefits to Realty Income, including accretion to net earnings, growth in the size of our real estate portfolio, diversification of industries and property type, increase in the percentage of investment grade tenants, and larger size and scope of our Company, which increases competitive advantages in the net-lease marketplace.

With this acquisition, we added 515 properties to our portfolio.  The preliminary allocation of the purchase price reflects aggregate consideration of approximately $2.1 billion, as calculated below (in thousands):

Consideration associated with equity issued (1)	$	2,027,753
Cash consideration paid to previous owners of ARCT	56,216
Total purchase consideration	$	2,083,969

(1) Includes the value associated with the issuance of the Tau Operating Partnership units discussed in 4.C. below.

We have accounted for the ARCT acquisition in accordance with ASC 805, Business Combinations, and are in the process of completing our allocation of the purchase price for this acquisition, which we expect to finalize later this year.  The following table summarizes our preliminary purchase price allocation, which represents our current best estimate of acquisition date fair values of the assets acquired and liabilities assumed (in thousands):

Assets:
Real estate	$	2,672,053
Acquired lease intangible assets	562,339
Cash and cash equivalents, accounts receivable, and other assets, net	42,275
Total Assets	3,276,667
Liabilities:
Lines of credit payable	317,207
Term loan	235,000
Mortgages payable	538,960
Acquired lease intangible liabilities	78,711
Accounts payable, accrued expenses, and other liabilities, net	22,820
Total Liabilities	1,192,698
Estimated fair value of net assets acquired	$	2,083,969

The final allocation of the purchase price will be based on our assessment of the fair value of the acquired assets and liabilities using both Level 2 and 3 inputs.  The final purchase price allocation may be different from the estimates above.  Measurement period adjustments were made to the first two quarters of 2013 to adjust preliminary real estate values to reflect new information obtained about facts and circumstances that existed as of the acquisition date.  We consider these measurement period adjustments to be immaterial to our consolidated financial statements.

Investments in Real Estate Properties. We will estimate the fair value generally by applying an income approach methodology using both direct capitalization and discounted cash flow analysis. Key assumptions include capitalization and discount rates. Our valuations will be based, in part, on valuations prepared by an independent valuation firm.

Acquired Lease Intangibles. The fair value of in-place leases will be calculated based upon our estimate of the costs to obtain tenants in each of the applicable markets. An asset or liability will be recognized for acquired leases with favorable or unfavorable rents based on our estimate of current market rents in each of the applicable markets. Our valuations of the intangible assets will be based, in part, on valuations prepared by an independent valuation firm.

Debt. The fair value of debt will be estimated based on contractual future cash flows discounted using borrowing spreads and market interest rates that would be available to us for the issuance of debt with similar terms and remaining maturities.

B.  Transaction Costs

In connection with our acquisition of ARCT, we expect to incur total merger-related transaction costs of approximately $21 million, which include, but are not limited to, advisor fees, legal fees, accounting fees, printing fees and transfer taxes. During the first nine months of 2013, we incurred $12.9 million of the estimated $21 million of total merger-related transaction costs, which are included in income from continuing operations.  In 2012, we incurred $7.9 million of these total merger-related transaction costs.

C. Noncontrolling interests and preferred units

Consideration associated with equity issued includes the value of common and preferred partnership units issued in Tau Operating Partnership, L.P., or Tau Operating Partnership, the consolidated subsidiary which owns properties acquired through the ARCT acquisition.  Since the date of acquisition, Realty Income and its subsidiaries hold a 99.3% interest in the Tau Operating Partnership.

The common units do not have voting rights, are entitled to monthly distributions equal to the amount paid to common stockholders of Realty Income, and are redeemable in cash or Realty Income common stock at our option and at a conversion ratio of one to one.  Noncontrolling interests with redemption provisions that permit the issuer to settle in either cash or common stock, at the option of the issuer, were evaluated to determine whether temporary or permanent equity classification on the balance sheet was appropriate.  We evaluated this guidance and determined that the common units meet the requirements to qualify for presentation as permanent equity.  See note 12 for the change in the carrying value of these common units from January 22, 2013 through September 30, 2013.

The Tau Operating Partnership preferred units have also been recorded at fair value as of the date of acquisition.  Since they are redeemable at a fixed price on a determinable date, we have classified them in other liabilities on our consolidated balance sheet.  Payments on these preferred units are made monthly at a rate of 2% per annum and are included in interest expense.  As of September 30, 2013, the preferred units have a carrying value of $6.75 million.

D.  Litigation

See note 23 for a discussion of certain legal proceedings related to our acquisition of ARCT.