SPIRIT REALTY CAPITAL, INC. - 10-Q filing on 2013-11-12

Merger with Cole II

9 Months Ended

Sep. 30, 2013

On July 17, 2013, the Company and Cole II merged, with Cole II continuing as the Surviving Corporation and adopting the name Spirit Realty Capital, Inc. The Cole Operating Partnership also merged with and into the Spirit Operating Partnership, with the Spirit Operating Partnership continuing as the surviving partnership. After consideration of all applicable factors pursuant to the business combination accounting rules, the Merger resulted in a reverse merger in which (a) Cole II was deemed the "legal acquirer" because Cole II issued its common stock to the Spirit Realty Capital stockholders and (b) the Company was the "accounting acquirer." The Company’s prevailing influence over New Spirit, including a majority of its Board of Directors remaining and its surviving senior management, was a key factor in the Company obtaining control and being deemed the accounting acquirer. With the Merger, the Company added 747 properties and 69 secured mortgage loans to its portfolio.

At the effective time of the Merger, each share of common stock, par value $0.01 per share, of the Company (“Company Common Stock”), issued and outstanding immediately prior to the effective time of the Merger on July 17, 2013 was canceled and converted into the right to receive 1.9048 shares of common stock, par value $0.01 per share, of New Spirit (“New Spirit Common Stock”). Upon receiving the converted shares of New Spirit Common Stock, the stockholders of the Company held an equity interest of approximately 44% of New Spirit.

The consideration transferred was computed on the basis of the Company’s closing stock price of $18.50 on July 17, 2013, multiplied by the inverse of the Merger Agreement exchange ratio (0.525) multiplied by the number of Cole II shares of common stock outstanding at the close of the Merger.

The preliminary allocation of the purchase price consideration of approximately $2.0 billion is calculated below as of the July 17, 2013 closing date (dollars in thousands, except per share amounts):



Cole II shares outstanding	208,570,007
Inverse of exchange ratio	0.525
	109,499,254
Spirit Realty Capital share price	$	18.50
Consideration paid	$	2,025,737

The Company has accounted for the Cole II merger in accordance with ASC 805, Business Combinations, and is in the process of completing the allocation of the purchase price for the Merger, which the Company expects to finalize later this year. The following table summarizes the preliminary purchase price allocation, which represents the current best estimate of acquisition date fair values of the assets acquired and liabilities assumed (in thousands):



Assets
Investments:
Real estate investments:
Land and improvements	$	944,060
Buildings and improvements	2,204,704
Real estate investments under direct financing leases, net	58,765
Loans receivable, net	81,433
Intangible lease assets	482,321
Net investments	3,771,283
Cash and cash equivalents	9,400
Deferred costs and other assets, net	12,278

Total assets	$	3,792,961

Liabilities
Revolving credit facilities	$	324,111
Mortgages and notes payable, net	1,512,029
Intangible lease liabilities	190,330
Accounts payable, accrued expenses and other liabilities	30,809

Total liabilities	$	2,057,279

Estimated fair value of net assets acquired	$	1,735,682

The final allocation of the purchase price will be based on the Company's assessment of the fair value of the acquired assets and liabilities using both Level 2 and 3 inputs, as summarized below. The final purchase price allocation may differ significantly from the estimates above.

Real estate investments

The fair value of real estate is generally calculated by applying an income approach methodology using both direct capitalization and discounted cash flow analysis. Key assumptions include capitalization and discount rates. Our valuations are based, in part, on valuations prepared by an independent valuation firm.

Lease Intangibles

The fair value of in-place leases are calculated based upon our estimate of the costs to obtain tenants in each of the applicable markets. An asset or liability is 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 are based, in part, on valuations prepared by an independent valuation firm. Total lease intangibles acquired had a weighted-average remaining amortization period of 15.7 years. Included in lease intangibles are in-place leases, above market leases, and below market leases which, upon acquisition, had weighted-average remaining amortization periods of 14.1, 11.1, and 21.0 years, respectively.

Debt

The fair value of debt is 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.

Merger Costs

In connection with the Merger, the Company incurred and expensed merger costs of approximately $45.1 million and $56.6 million during the three and nine months ended September 30, 2013, respectively, which included legal, accounting and financial advisory services, debt financing related costs, and other third-party expenses. Goodwill is allocated to the Company at an enterprise level, which is representative of the reporting unit.

Goodwill

Goodwill of $290.1 million was recognized as part of the preliminary purchase price allocation. The Merger and integration of the Cole II portfolio provides for several potential benefits and synergies that include, but are not limited to, the following; the Merger will double the size of the total portfolio, further diversify the portfolio geographically and by industry, reduce tenant concentrations, improve overall credit quality of the portfolio, and increase operating efficiency. The Merger is also expected to significantly improve the Company’s access to the capital markets and allow for more advantageous acquisition opportunities.

Pro Forma Information

The following unaudited pro forma information presents our operating results as though the Merger had been consummated as of January 1, 2012. The pro forma information does not necessarily reflect the actual results of operations had the Merger been consummated at the beginning of the period indicated nor is it necessarily indicative of future results. Additionally, the unaudited pro forma condensed consolidated financial statements do not include the impact of all the potential synergies that may be achieved from the Merger or any strategies that New Spirit's management may consider in order to continue to efficiently manage the on-going operations of New Spirit. The actual results for the three and nine months ended September 30, 2013 include total revenues and net income attributable to common stockholders from the acquired properties of $52.3 million and $8.3 million, respectively, from the close of the Merger (July 17, 2013) through September 30, 2013.



	Three Months Ended September 30,				Nine Months Ended September 30,
	2013		2012		2013		2012
Total revenues	$	148,100	$	133,924	$	420,712	$	402,058
Income from continuing operations	26,280		16,264		57,799		38,976

The Company incurred nonrecurring pro forma adjustments to operations directly attributable to the merger consisting primarily of legal, accounting and financial advisory services, debt financing related costs, and other third-party expenses, as follows:



	Three Months Ended September 30,					Nine Months Ended September 30,
	2013		2012			2013		2012
Nonrecurring pro forma adjustments	$	44,952	$	(4,338	)	$	71,369	$	(14,888	)