|Shares Out. (in M):||42||P/E||0.0x||0.0x|
|Market Cap (in $M):||937||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||0||EBIT||0||0|
|TEV (in $M):||0||TEV/EBIT||0.0x||0.0x|
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ARCP Preferred is a simple, timely and low risk opportunity for those investors/funds who have cash to deploy and wouldn’t mind making a high single digits return with a likely shot to make a low 20s IRR. American Realty Capital Properties (“ARCP” or the “Company”) is a large but not well covered REIT that has become the largest owner of net lease properties in the United States over the past 12 months through an ambitious strategy of merging and acquiring various smaller portfolios of net lease properties.
In the course of one of these acquisitions, in early January (a month or so ago) ARCP issued $1 billion of 6.70% Series F Preferred Stock (the “Preferred”), which is a very timely opportunity and the subject of this writeup. The investment thesis on the Preferred is as follows:
(i) The Preferred has been subject to technical selling pressure since its issuance in early January. The retail shareholders who were issued the Preferred have been aggressively liquidating it, causing it to immediately trade down well below its Liquidation Preference of $25/share and providing the opportunity to invest today at a very attractive high 7s current yield.
(ii) As an indicator of the favorable opportunity in the Preferred, ARCP insiders immediately started buying shares of the Preferred in the open market within days after its issuance as it traded below Liquidation Preference. Multiple insiders purchased a total of over $1 million of the Preferred.
(iii) The Preferred is a very safe security given the favorable combination of its place in ARCP’s capital structure (over $11 billion of equity value behind it in the capital structure) as well as the extraordinarily stable/investment grade nature of the Company’s income producing properties
(iv) Given the spread between the Company’s cost of debt and the current yield on the Preferred, and given the Company’s excess borrowing capacity, there is a significant capital structure opportunity for ARCP to buy back shares of Preferred and capture the spread.
(v) This is a great risk reward, with extremely low chances of loss and the potential to make a low 20s IRR as the gap to Liquidation Preference closes over the next year. In our downside scenario we essentially clip the high 7s current yield, which is a pretty nice absolute return in what we view to be a risky environment for investing.
What Does ARCP Do?
As an owner of net lease properties, ARCP owns a portfolio consisting primarily of freestanding single tenant net lease properties that are largely inhabited by very high quality (frequently investment grade) tenants.
A quick look through the list of ARCP’s biggest tenants gives one a very good picture of the type of assets they own – the top 5 tenants include Walgreens, AT&T, CVS, Dollar General and Fedex. The largest of these tenants, Walgreens, represents only 3.5% of the rent roll for the Company and the top 10 tenants represent 23.7%. 49% of the Company’s rent is generated from investment grade tenants which is a higher metric than peers O (40%) and NNN (22%). The Company is also highly diversified geographically, with the largest concentration of properties in Texas (13%), Illinois (6%), Florida (6%), California (6%) and Georgia (6%). The average remaining lease term is 11 years and occupancy is at 99%. ARCP owns a total of 3,732 properties representing 102 million square feet (suggesting an average property size of around 27,000 square feet).
ARCP has been created over the past year through a series of large portfolio acquisitions, financed with a sensible mixture of debt and equity. These acquired portfolios include
(i) most notably the $11 billion acquisition of Cole Real Estate Investments, which had previously been the largest owner of net lease properties in the US (with a portfolio of 1,014 properties consisting of 43.1 million square feet
(ii) the $826 million acquisition of a portfolio of net lease properties from GE Capital
(iii) the $972 million acquisition of a portfolio of net lease properties from Fortress
(iv) the $3 billion acquisition of a portfolio of net lease properties from ARCT-IV
(v) the $2.3 billion acquisition of a portfolio of net lease properties from Inland
It is the $2.2 billion acquisition (equity value) of ARCT-IV that closed on January 5, 2014 that gave rise to the Preferred stock issuance. This acquisition was financed through a combination of cash ($640mm), ARCP common stock ($475mm) and the Preferred ($1.04 billion). ARCT-IV was a “non-traded REIT”; for those not familiar with non-traded REITs, they are vehicles that raise money from small retail investors and then go out and buy up a bunch of property in a REIT structure. They are sold to retail investors by a network of retail financial advisors, who collect small investments (as little as $2,500 at a time) from their retail investor clients. As you might expect, these financial advisors earn a healthy dose of fees when these entities are created and sold to retail investors. The problem with these entities (amongst other problems which I won’t get into), is that the investor owns a security with limited liquidity. So, you probably get the picture by this point – you have a bunch of retail shareholders who are sold this security, may not like it or understand it, and have limited ability to sell it. Then what happens? ARCP comes along and provides liquidity for these shareholders by issuing them an even more confusing cocktail of Preferred, common stock and cash. Many of the retail investors who have been locked up just want to sell whatever they have. Similarly, the financial advisors have a strong financial incentive to churn their clients out of those securities and recycle their clients’ capital into the next non traded REIT so they can earn another fee. Anyhow, this dynamic is what creates the setup for a great opportunity to put capital to work here in a very attractive way.
Notably, on Jan. 6 the Ladenburg analyst who covers ARCP wrote with respect to the common stock of ARCP that “ARCP could encounter some near term selling pressure as newly enriched retail holders seek liquidity and their advisors look to recycle capital into other non-traded REITs”. If the analyst thought there would be pressure on the common stock (which only has a tiny percentage of total shares owned by former ARCT-IV holders), it begs the question of how much technical selling pressure there would be in the new Preferred.
I expect that this process of retail investors churning out of the Preferred will take place over a few more weeks or months and allow for a nice opportunity to put capital to work here. Once that overhang goes away, I would expect the spread to liquidation preference to narrow considerably if not completely. Certainly, the Preferred was designed (a month ago) to be a par security so what has happened strikes me as an anomalous trading pattern. As I write this I am noting that the spread has already started to close a bit, but I still think there is plenty of room to make a nice return.
Lets briefly review ARCP’s capital structure and credit metrics.
|Capitalization Summary||Cap Rate|
|Amount||% of EV||12/31/2014|
|Total Enterprise Value||$22,078.2||100.0%|
The table above shows the basic categories of ARCP’s capital structure including the implied cap rate at each cumulative point in the capitalization. The key point here for us is that there is $11.4 billion of equity market capitalization that is junior to the Preferred in right to dividends and liquidation proceeds, representing over half of the capital structure. In addition, the implied cap rate on ARCP’s post corporate NOI stream is 7.1% through the equity, but that figure would have to climb to 14.7% in order for the Preferred to be impaired. Given the quality of ARCP’s assets, stability of rent stream and quality/diversity of tenant base, this strikes me as being a very safe place in the capital structure. It is also interesting to note that the Preferred trades at a higher dividend yield currently than the common stock despite being in a far more favorable position in terms of priority of dividend payment than the common and also despite the fairly aggressive payout ratio on the common stock today in the high 80s % range.
|Mortgage Debt||3,970.0||4.800%||190.6||6.5 years|
|Term Loan||940.0||1.810%||17.0||4.0 years|
|Senior Unsecured Notes||1,300.0||2.000%||26.0||3.0 years|
|Senior Unsecured Notes||750.0||3.000%||22.5||5.0 years|
|Senior Unsecured Notes||500.0||4.600%||23.0||10.0 years|
|Convertible Notes||403.0||3.750%||15.1||6.9 years|
|Convertible Notes||598.0||3.000%||17.9||4.5 years|
|CapLease Senior Notes||19.0||7.700%||1.5||13.6 years|
|CapLease Trust Preferred||31.0||7.750%||2.4||22.0 years|
|Credit Faciliy||1,068.0||1.560%||16.7||3.0 years|
The chart above details ARCP’s debt structure. Of note is the wide spread between the overall cost of debt at 3.473% vs. the current yield on the preferred of 7.53%. This suggests a substantial opportunity to earn an attractive spread to the benefit of stockholders by using available borrowing capacity to repurchase the Preferred.
The form 8-A filed by ARCP on 1/3/2014 contains the key terms of the Preferred, which include the following:
The key preferred stock issuances of comparable companies are shown below, providing support for the thesis that ARCPP was priced correctly at its $25 issue price to yield 6.7% and the current price represents a clear discount to fair value.
|Preferred Stock Comps|
|Realty Income Corporation||Class E Preferred||$24.90||6.78%||$220.0|
|Realty Income Corporation||Class F Preferred||$24.83||6.67%||$408.8|
|National Retail Properties||Series D Preferred||$24.10||6.87%||$287.5|
|National Retail Properties||Series E Preferred||$20.87||6.83%||$287.5|
|American Realty Capital||Series F Preferred||$22.20||7.55%||$1,055.0|
This is a very safe way to clip a high 7s coupon and potentially make a ~20% plus return; given the low risk level inherent in this security I think that is a very attractive proposition in a risky market environment. The circumstances that created this opportunity are clear due to retail shareholders desire for liquidity and their advisors incentive to push them in that direction. I think the catalyst for this investment working favorably will simply be the end of selling pressure from retail holders as well as a potential buyback by the Company.
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