First Capital Realty – Cheap capital

First Capital Realty (TSX: FCR) owns and operates shopping centres. They do so quite profitably, and while not technically an REIT, it does have REIT-type characteristics, including a policy of distributing most of its cash flows through dividends.

When doing some research on this company, I did notice they were able to raise the following debt offering a couple months ago:

First Capital Realty Inc. (TSX:FCR) (the “Company”), Canada’s leading owner, developer and operator of supermarket and drugstore anchored neighbourhood and community shopping centres, located predominantly in growing urban markets, announced today that as a result of investor demand for its public offering of Series Q senior unsecured debentures which was announced earlier today, the size of the offering has been increased by C$75 million to C$175 million. These debentures will bear interest at a rate of 3.90% per annum and will mature on October 30, 2023. The $175 million of debentures were sold at a price of $100.952 per $100 principal amount plus accrued interest, with an effective yield of 3.788% if held to maturity. An aggregate of $300 million of such debentures will be outstanding after giving effect to the offering. The offering is being underwritten by a syndicate co-led by TD Securities, CIBC World Markets Inc. and RBC Capital Markets. Subject to customary closing conditions, the offering will close on May 15, 2013. It is a condition of closing to the offering that the debentures be rated at least BBB (high) with a stable trend by DBRS and at least Baa2 (stable) by Moody’s Investors Service.

This is giving the company 10-year money at 3.8%, which is an amazingly low rate for unsecured debt. If they could raise even more money at this rate, they should – indeed the original offering was for quite less volume. This was at the peak of the market’s thirst for yield.

Something also very different about this company is they have a series of convertible debentures, and a prominent policy of the company states:

It is the current intention of First Capital Realty to satisfy its obligations to pay principal and interest on all of its Convertible Debentures by the issuance of Common Shares.

This is the only corporation I can think of that has this policy.

This leads to some very interesting financial results in terms of shareholder dilution, but it has not impacted the net return to shareholders in the meantime. Glossing through some historical reports, shares outstanding on March 31, 2003 was (split adjusted to present levels) 64.5 million shares, while shares outstanding on March 31, 2013 was 207.3 million. Still, a shareholder on March 31, 2003 would have paid about $7.60 and received at March 31, 2013: a $19 share plus $7.56 in cash dividends. Working the math, that is about 13%/year compounded annually, not a bad haul at all.

The only time I can see this strategy failing is if there is some transient condition where the equity falls below a certain threshold level. Even during the depths of the 2008-2009 economic crisis, the company was fairly resolute in keeping this policy despite the 40% haircut shareholders took from the previous peak.

I won’t be buying into this company (or its debt), but I have to commend their finance crew for a very unconventional policy that does seem to deliver results for shareholders.