Darden Spins Off Four Corners REIT

DardenTuesday marked the debut of Four Corners Property Trust (FCPT), the REIT spun off by Darden Restaurants (DRI). Shareholders received one share in Four Corners for every three shares of Darden that they owned. So how interesting does this spinoff look anyway?

The REIT owns 424 Darden properties across 44 states, with about three quarters of that property in the well-known Olive Garden chain, with the rest comprising Longhorn Steakhouse, Bahama Breeze, and two other smaller chains. Virtually all of the properties – 418 – will be re-leased right back to Darden, a typical sale-leaseback transaction. It’s a triple net lease, so Darden is on the hook for virtually all expenses. The REIT gets 1.5% escalators on its leases, most of which averaged 15 years.

Rent appears well covered, at 4.2x EBITDAR, better than the peer average of 2.7x. While Darden has been challenged for growth recently, its chains are still solid, if unspectacular, performers. You can find more details on the spinoff, including the helpful investor presentation, in the recent spinoffs tab.

As part of the spinoff Darden received $315 million from the REIT, and along with cash on hand, that will be used to pay down about $1 billion in debt, leaving the restaurant chain with just $450 million in debt and no maturities until 2035. Of course, that cash doesn’t come from thin air, and Four Corners issued a $400 million term loan, which is fully drawn, and established a $350 million credit facility, which is undrawn. The REIT will have net debt/cash EBITDA of 4.6x, not too high but not low either.

One of the things that spooks investors about sale-leaseback REITs such as this is that initially the REIT is 100% exposed to the operations of its tenant. The market is unwilling to provide a fair valuation given such a risk. So Four Corners will quickly want to diversify its risk away from Darden. I understand Bob Evans (BOBE), among many others, is looking to unload some property. Ultimately it will take at least a couple years for the REIT to remove that concentration risk enough so that it gets a fair valuation.

Purging distribution
As is typical in this type of REIT spinoffs, the REIT will need to make a purging distribution, effectively distributing its earnings and profits. The company revealed in its filing that it expects to declare the distribution in 2016 and pay it no later than January 31, 2017. Management estimates that the distribution will be paid at least 20% in cash and the remainder in newly issued stock. Those figures are pretty typical for a REIT spinoff. The distribution is estimated at between $300 and $400 million, and that will create a tax liability for Four Corners shareholders.

What does that mean for investors? Effectively, the company will perform a stock split that is taxable and provide investors with about enough cash to pay the tax. I expect the stock to go down in the meantime as investors bail out of the tax liability. However, maybe the stock will go up following that purging distribution. Given the long horizon on that payout, 2016 may not be that interesting for Four Corners investors.

Valuation
A quick look at the valuation: the company will pay a dividend of $1.35 per share, so at the current stock price of $21.17, that’s a yield of 6.4%. Not bad, especially if the company can grow.

What about on a cash flow basis? The company estimates pro forma AFFO for 2014 of $80.2 million. With a market cap of $898 million, the price to AFFO is 11.2x, and the payout ratio to AFFO is 71.4%, or about 80% of cash available for distribution. That’s about what some other high-quality net lease REITs trade for today, without the concentration risk or the upcoming taxable purging distribution. Other net lease peers also have better escalators.

So why bother with Four Corners? Wait a while and see what happens as 2016 wears on.

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