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Shares of Mid America Apartment Communities (MAA) fell a bit after the REIT announced it will merge with Colonial Properties Trust (CLP). The deal creates a Sunbelt-focused, multi-family REIT which is intended to boost the value for all stakeholders involved.

Investors are not super excited about the deal despite the expected synergies. One has to wonder how much upside there is investing in REITs given the historically low rent vacancy rates, strong rental yields and low interest rate environment.

The Deal

Mid America announced that it has reached a definitive agreement under which the firm itself and Colonial Properties Trust will merge. Shareholders in Colonial receive 0.36 in newly issued shares in Mid America for every share they currently hold. All in all, they will combined hold 44% of the new company with the remainder of shares being held by current shareholders in Mid America.

In a response to the deal, shares of Colonial rose by 5% to $23.37 per share on Monday, valuing the company at $2.07 billion. Shares of Mid America fell 3% to $65.89 following the announcement, valuing the firm at $2.82 billion.

Following the merger, the combination will have an equity value of $5.1 billion, based on Friday's closing prices, and an enterprise value of $8.6 billion. The merged company will have 85,000 multi-family units in 285 properties, most of them in the Sunbelt. The deal has been structured so it will be tax-free.

For the year of 2012, Colonial Properties generated annual revenues of $393.5 million, up 11.4% on the year. The company reported a $21.6 million profit as a result of gains from discontinued operations. The company ended the year with $50 million in cash and restricted cash and $1.83 billion in total debt, for a net debt position of $1.78 billion. The equity portion of the deal values Colonial at 5.3 times annual revenues.

Following the merger, the combination expects to save $25 million in general and administrative expenses per year. These synergies can be expected 18 months following the closing of the deal. Notably the cost of a duplicate public listing and leveraging of technology systems should drive cost savings.

The deal is subject to shareholder approval of the majority of shareholders in both companies. The board of directors of both companies have already unanimously approved the merger. If all goes well the deal should be closed in the third quarter of this year.

Valuation

Mid America ended its first quarter of 2013 with $9 million in cash and equivalents and $1.69 billion in short and long term debt for a net debt position of around $1.68 billion.

The company generated annual revenues of $497.2 million in 2012, up 15.4% on the year before. Net income more than doubled to $105.2 million. This values the company's equity at 5.6 times annual revenues and 26-27 times annual earnings.

The company pays a decent quarterly dividend of $0.695 per share for an annual dividend yield of 4.2%.

Some Historical Perspective

Mid America Apartment Communities has created quite a bit of value for its shareholders over the past decade. Shares, excluding dividend returns, have gained some 150% over the past ten years. Shares doubled from $30 in 2003 to $60 in 2006, to fall to lows of $25 during the financial crisis. A solid recovery brought shares back to $75 earlier this year, after which shares have seen a 12% correction.

Between 2009 and 2012, Mid America has increased its revenues by a cumulative 39% to $497.2 million. Net income nearly tripled to $105.2 million in the meantime.

Investment Thesis

Investors are not overly enthusiastic following the announcement of this latest deal, despite an estimated $25 million in annual synergies resulting from the merger.

Combined the companies generated annual revenues of $890 million for 2012, on which they reported pro-forma earnings of around $125 million. Pro-forma earnings could increase toward $140 million as a result of the expected synergies. Based on the current $4.9 billion valuation of the combined equity, the combination is valued around 5.5 times annual revenues and 35 times annual earnings.

It is easy to understand why shareholders in Colonial Properties Trust are enthusiastic about the deal. They stand to receive an 11% premium for their shares and participate in the synergies following the deal.

Other multiples are pretty fair, except that Colonial Properties is less efficient compared to Mid America. The equity of the firm values Colonial Properties' 35,200 units at $59k per unit, while Mid America's 49,600 units are valued at $57k per unit. Both firms have a 96% occupancy rate and average rents are quite comparable, just under $1,000 per month.

Combined, the REIT hopes to better take advantage of the housing recovery and the rental boom in recent years. Lack of access to credit for house purchases and increased demand for housing has pushed up rents in recent years and vacancy rates down.

Obviously shareholders in Colonial Properties should be happy with the deal as they receive a fair premium and do participate in future synergies following the deal. For shareholders in Mid America this is a different story. Obviously they stand to benefit from expected synergies as well. Still the high valuations combined with low vacancy rates and relative strong rents make me wonder how much more positive the external environment could get to further boost earnings.

At these premium valuations I see few reason to hold the shares. The valuation has become too high as investors which are starving for yield have pored too much money in REITs.

Source: Investors Not Enthusiastic About Mid America's REIT Deal With Colonial Properties Trust