|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|
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.
|Entry||02/24/2014 08:26 AM|
Thanks for the idea.
It looks like ARCP is more leveraged / has weaker credit stats than its net-lease REIT comps that have prefs outstanding. Rough numbers (using Bloomberg) below:
Is it possible that the credit quality differential between the various issuers explains the wider spread of the ARCP Pref?
|Entry||02/24/2014 09:17 AM|
Its a pretty slight difference in leverage (when thinking about the overall capital structure and equity cushion below the debt) and the asset quality at ARCP is higher. I dont think ERP is a good comp -the issue was priced vs. O/NNN.
|Subject||RE: RE: Leverage|
|Entry||02/24/2014 07:12 PM|
I am sorry, could you explain the math behind your cap-rate calculations? What are you using as your numerator / denominator in each calculation? EBITDA of $1,564 over the Pref + Debt?
"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." -- don't really understand this statement, what precisely would need to climb, to impair the Preferred? Cap-rates?
In other words, I am not sure I understand why if cap-rates widen dramatically, how this impacts credit & coverage ratios?
Sorry if I am missing something incredibly obvious. Not feeling particularly smart today.
|Subject||RE: relative value|
|Entry||02/26/2014 11:02 PM|
why is this cheap?
there is no discussion why this is cheap on relative value or absolute value basis.
why would you own this at 7.5% yield vs. other reit preferreds?
to say that this would have to widen out to 15% implied cap for the pref to be covered is completely irrelevant
the question is is this good relative value
why would you own this vs. gpt preferred at par at 8.13% with almost ZERO leverage
this should not trade at par and never will given the leverage
there are a bunch of reit preferreds trading at similar discounts with lower leverage that are much better credit risks
I do not mean to be combative so please do not be offended I just fail to see the relative or absolute value case.
|Subject||RE: RE: relative value|
|Entry||02/28/2014 07:32 PM|
sorry to have put you in a bad mood with my incredibly boring preferred stock writeup, but I appreciate you coming out guns 'a blazing!! let me try to answer some of your questions:
1) i think I made a pretty clear argument that this is cheap in my mind because it was priced correctly at $25 to yield the same thing as the two comparable issuers who own the exact same type of assets (albeit a bit lower quality in my view) as compared to ARCP. I also make a simple argument that there was a dynamic that caused it to trade at a discount so we know what has created the opportunity. not to give too much credit to investment bankers but there was obviously a fairness opinion issued, which showed that the consideration issued to the seller in the ARCT-IV transaction was a par value security and not an overvalued security. Obviously, insiders liked the value enough to buy it themselves.
2) "the question is is this good relative value?" see 1) above, yes because it trades at a wide spread to the yield of the most comparable issuers
3) "why would I own this vs. gramercy capital preferred"? well, I dont know much about gramercy capital, but let me give a few reasons based on my 3 minutes of research on bberg. a) it doesnt trade enough volume for me to be interested so from a practical perspective i could not own it and there is likely a reasonable liquidity discount. b) it appears to be currently callable at $25 so its unlikely to trade above $25 otherwise you run the risk of buying at a premium and then getting called out - quite likely given as you say the low debt and gramercy's likely cost of debt capital. it is currently trading at $25.12 so buying today you are already running the risk of getting called out and thus making a negative return. so there is only potential for it to depreciate, not really any potential to appreciate - the best you will ever do is 8% vs. the potential high teens in ARCP Preferred since it trades at a discount to liquidation preference such that you have the optionality of getting called out at $25 in a few years. c) doesnt look like Gramercy pays a dividend on its common, so theoretically they would be free today to stop paying dividends on the preferred and let them just accrue - have not read the preferred doc, but thats what I would expect.
4) "this should not trade at par and never will given the leverage". never say never credit guy. I will be updating my post the day this trades at $25!
5) "there are a bunch of reit preferreds trading at similar discounts with lower leverage that are much better credit risks". please propose a few - i'd be happy with other risk adjusted returns like this one.
6) "I do not mean to be combative so please do not be offended I just fail to see the relative or absolute value case". I am not offended, but a little amused by the passion inspired by my admittedly boring thesis.!!
have a good weekend!!
|Subject||RE: RE: RE: relative value|
|Entry||10/29/2014 01:32 PM|
Finally some volume in the Pref.. .curious if you have added here given that the dividend on the common would have to disappear for them to not pay a Pref dividend..
|Subject||RE: RE: RE: RE: RE: relative value|
|Entry||10/29/2014 02:48 PM|
conference call at 3p - perhaps we will learn more
Wednesday, October 29, 2014 | 3 p.m. ET/12 p.m. PT
Domestic Dial-In Number: 1-888-317-6003
International Dial-In Number: 1-412-317-6061
Canada Dial-In Number: 1-866-284-3684
Conference ID: 3415920
Participants should dial in 10-15 minutes early.
|Subject||RE: RE: RE: RE: RE: relative value|
|Entry||10/29/2014 02:49 PM|
It's not even cheap is the problem. It's didnt even fetch a par ever when things were good. Its yield is blah.
I love the belated conf call. Given the circumstances and that they obviously hadnt planned on having it in the first place, I think there is a good chance that this call is a total debacle.
|Subject||RE: RE: RE: RE: RE: RE: relative value|
|Entry||10/29/2014 03:24 PM|
call starting 20+ min late and the speaker got cut off 2 min in to the talk.. a clown show