Description

Executive Summary:

Short Global Net Lease (“GNL”), a poorly managed REIT with a highly-levered portfolio of challenged office assets and an at-risk dividend the company hasn’t covered since its IPO (despite accounting chicanery) trading at a 40% premium to NAV. $14 price target.

• Quick Overview: GNL owns 327 net leased commercial properties in the US and Europe, 58% office, 33% industrial and 9% retail. Actual remaining wtd. avg. lease term  is under 8 years.
• GNL is a value trap. Looks cheap until you read the fine print. Portfolio is not nearly as strong as advertised by a promotional management team that plays fast and loose with the facts. EXAMPLES...
• Lease terms are misstated and deliberately misleading. Mgmt. publishes a wtd. avg. lease term calculated by SF rather than rent/NOI like every other peer. This is because when measured by SF, the lease term is ~1 year longer. More importantly, the wtd. avg. lease term does not account for tenant termination options, despite indications from the company to the contrary. Large properties with known termination options include: Nissan (2023 vs. 2028), Provident (2025 vs. 2035) and Sandoz (2021 vs. 2026, albeit w/ a very large penalty). Both Nissan and Provident are curious because in previous disclosures, mgmt. displayed remaining lease term through the termination option. Now the remaining lease terms are shown irrespective of the termination option, which adds 5 and 10 years to the remaining term. In other words, in 2014, GNL showed remaining lease term for the Provident property as 11.1 years, but in 2018, it is showing the remaining lease term as 17.6 years. Likewise with Nissan. There is no way to know how many more of these exist because disclosure is so poor.   
• Many tenants GNL lists as “investment grade” are actually junk credits. In 2017, GNL had a tenant that it previously internally rated “investment grade” a few years earlier default on a lease. One of its largest tenants, Tokmanni, is advertised as investment grade based on a five year bank guaranty? In a recent acquisition, a small, private equity-owned steel company received an “investment grade” rating. The portfolio is littered with examples like this. In short: don’t believe GNL’s internal credit ratings or puffery regarding tenant credit quality versus peers. In February they had to retract a statement re: credit quality from the conference call in an 8-K.
• One material tenant that GNL likely also deemed credit-worthy filed for BK within 18 months of GNL’s $34 million acquisition of its headquarters building. During the bankruptcy process, GNL’s rent and lease term were cut. Management did not disclose any of this to shareholders. Buried in a 10-Q was a footnote that the expiration date had been modified...nothing else.  
• It appears one of GNL’s largest properties (Harper Collins UK, 3% of total rents) is currently dark/unoccupied. Yet mgmt. has never fully disclosed this to investors. Only one casual reference was made on a call re: one dark asset in the UK. There has been no follow-up or mention of this since.   
• Several large properties are leasehold interests and not fee simple (subject to a ground lease and thus should trade at a big discount). Based on pertinent details withheld, it is tough to gauge a value for these 11 leasehold properties. One leasehold property is the ING building, representing 4% of rent. Even though the ground lease is prepaid, the lack of fee simple interest in the property means a higher cap rate since at the end of the ground lease, all of the improvements revert to the ground lessor (not GNL). I believe the Finnair assets (4% of rent) are also leasehold.   
• High credit quality is concentrated in office assets with the shortest remaining lease term where not much value is ascribed to tenant credit. Meanwhile, the assets with the lowest quality credit have the longest remaining lease term.
• At the end of the day, the external manager has a tight grip on the assets with a 20 year term so the vehicle should trade at a discount similar to the RMR controlled REITs (e.g., SIR).
• I peg NAV at $14 based on an 8.5% cap rate on current cash NOI. EV is adjusted to incorporate the external manager termination fee ($61 million) and cash NOI is adjusted to account for forex leakage ($10 million annual). This is also within the range of where I believe the assets would be priced on a granular level if they traded on the market free and clear.
  • I believe the 8.5% cap rate is appropriate (and possibly conservative) given: i) high concentration of office assets with 3-8 years of remaining lease term and above-market rent where the residual will be extremely challenging; ii) several large properties are leasehold interests; iii) there are undisclosed tenant termination options on large properties; iv) Puerto Rico retail portfolio (1.5% of rent) likely impaired; v) low quality oil & gas portfolio (classified under industrial) with poor credit and low residual values; vi) GSA assets subject to modified gross leases; and vii) large UK portfolio, Brexit risk.
  • Of the five largest properties (20% of rent): two are leaseholds subject to a ground lease, one is a suburban office complex with less than seven years of term and rent above $30/SF, and one appears dark (unoccupied). So four of GNL’s five largest properties would likely trade well above an 8% cap in the private market.
  • Given the deliberately misleading non-disclosure by management since the IPO who knows what other issues are lurking?
• On an FFO/AFFO multiple basis, the $14 target equates to a multiple roughly 7.0x, certainly a discount to the wider net lease sector (avg. 13.5x/13.6x) but one that is warranted based on lack of growth potential/leverage (almost 9x EBITDA), portfolio issues and low earnings quality. The 7.0x multiple is reflective of a shorter duration to the cash flows/earnings given predominance of office assets with under 8 years of term that will see rent roll-downs and require substantial capex and is roughly in-line with levels seen at other externally managed or challenged REITs.  
• On an EV/EBITDA basis, the current multiple/yield is 15.6x/6.4%. GNL does not screen cheap.
• On dividend yield, the $14 target equates to a 15% yield. While some may view this as providing downside support, there are two important considerations...
• First: the company has never covered its dividend since inception, even with aggressive short-term financing. As such, I believe there is a risk that the dividend is cut. I am not assigning a high probability, but there is a chance that they are forced to cut. If this were to happen, the stock would really sell off. There are numerous examples of this across the REIT/MLP universe. The downside skew from this factor alone makes the short very interesting.
• Second: there are many examples in the current market of REITs trading with yields of 10%-20% where there isn’t necessarily an expectation that the dividend is unsustainable. This typically occurs with fundamentally growth challenged companies where there is a misalignment of interests.  
• GNL has repeatedly missed guidance throughout its life as a public company (2015 AFFO, 2016 AFFO, investment grade credit rating, etc.) despite using FX hedges as a piggy bank for AFFO add-backs and borrowing short to juice earnings. Its solution was to stop issuing guidance.
• Leverage is high, 7.5x-9.0x depending on how you look at it, and GNL has been overly dependent on using temporary financing (less than 5 years) to juice earnings. The average rate on recourse and non-recourse debt is 2.8%/2.9% and the average maturity is 3.6 years with 48% of the debt rolling in the next 3 years. 17% of debt is floating.
• Eventually, the company will have to refinance/extend its short-term debt, further pressuring earnings.
• Assuming a more normalized wtd. avg. rate of 4.0% (vs. 2.8% currently) would increase annual interest expense by 41% ($19 million/$0.28 per share). 2017 FFO was $1.98, so this would represent an earnings reduction of 14%.
• In near-term, assuming the maturing secured debt is rolled over the next two years to a 10 year term, wtd. avg. rate would increase to 3.4% (a $10 million hit/$0.15 per share).   
• The debt is mostly secured (64%). This type of financing can contain inflexible prepayment terms and onerous yield maintenance. This encumbers the company’s real estate portfolio and negatively impacts the value of many of the underlying assets because they could not be freely sold to a third party without considerable breakage costs/penalties.  
• Given leverage and GNL’s limited ability to raise accretive capital, GNL will struggle to grow earnings and support its outsized dividend moving forward. As of now, mgmt. is steaming ahead with dilutive acquisitions at an estimated 7.00% cash/initial cap rate (~8.00% GAAP) financed by preferred equity at 7.25% and possibly some common equity at an implied cash cap rate north of 7.50%. These deals are only increasing GNL’s leverage.
• Heavy management turnover (6 CFOs in 5 years, 3 CEOs) and frequent accounting errors/restatements are red flags. Former CFO has been convicted of securities fraud and former CEO Nick Schorsch, is mired in lawsuits accusing him of fraud and plundering the REITs he managed.
  • D&O insurance alone costs shareholders more than $5 million per annum due to the scandal riddled history of the external advisor.
• However, what should be most troubling for current investors are the egregious accounting games being played since the IPO. This is particularly brazen considering the similarities to the ARCP accounting scandal (manipulating AFFO to meet earnings guidance). In 2Q 2015, losses/gains on derivatives were added back to AFFO. Then in 3Q 2015, GNL changed the treatment of forex hedges to get to a more favorable AFFO number in a desperate attempt to meet aggressive guidance. Then in 1Q 2016, they changed the treatment again to only keep the realized forex change in earnings. This new methodology seemingly allows mgmt. to use the hedges to manage earnings each quarter because they have discretion on realizing forex contracts. This is exactly the type of thing that got ARCP in trouble. Did I mention that the same people behind ARCP (Nick Schorsch/ARC/AR Global) control GNL?
• Aside from the accounting issues and lack of disclosure, the underlying value of GNL’s properties will continue to erode as more lease term burns off, especially for their largest office properties with above-market rents.
• I view GNL as a great short because of its inability to grow earnings and the decaying underlying value of its assets. A potential dividend cut is the kicker. The risk-reward skews favorable, especially in a rising rate environment where even the best REITs sell off.
• To reduce interest rate/factor risk, can pair trade (with combo of LXP/STOR or REIT index on other side). While many people don’t like pairs, given the difficulty pegging the intrinsic value in a vacuum (rates and relative value matter), I think this method makes the most sense.

Background:

Global Net Lease is a net lease REIT externally managed by AR Global. GNL trades on the NYSE (Ticker: GNL) with a recent market cap of $1.4 billion. Triple net lease/net lease/NNN REITs own primarily single-tenant free-standing properties in which the tenants pay all the expenses, with the landlord receiving a check each month with minimal mgmt. responsibilities. Expenses include taxes, insurance and opex. Some leases stipulate that the tenant must pay capex as well, but it is impossible to know the details of each lease. Lease terms of 5-15 years are common. Typical NNN leases provide for an annual rent bump of 1-2% per annum, in some cases this is tied to CPI increases. The net lease REIT space has grown significantly in the past 5+ years with a number of new publicly traded players. Since the ARCP accounting scandal in 2014, the non-traded net lease REIT space has been much less active. Non-traded REITs (“NTRs”) were notorious for their huge fees, conflicts of interest and overall indifference to shareholder value. These securities were sold to “mom and pop” retail investors, not bought, with broker commissions often above 7%. While seemingly earning an attractive 6%-8% dividend, investors in these vehicles often pay massive upfront fees, receiving only 85 cents of real estate for every dollar invested. The massive ongoing fee load increased with asset size, so managers typically paid up to add inferior assets and increase the fee base.

Like ARCP (now VER), GNL originated as a non-traded REIT sponsored by American Realty Capital (“ARC” now “AR Global”) and went public in 2015. Upon listing on the NYSE, the external manager tightened its control of the REIT through a 20 year advisory contract rife with conflicts and containing few protections for the actual owners of the REIT (shareholders). Typically, REITs would internalize management when going public to enhance marketability and reduce governance concerns and conflicts. For good reason, externally managed REITs trade at a discount to internally managed REITs.

Portfolio:

GNL is somewhat unique relative to peers in its exposure to European real estate. The portfolio is split 49%/51% between the U.S. and Western Europe. By property type, assets are split 58% office, 33% industrial and 9% retail. As of 1Q 2018, GNL owned 327 properties which were 99.5% leased. GNL reports a wtd. avg. remaining lease term of 8.6 years and portfolio tenancy that is 78% investment grade, however as will be discussed below, these metrics are deliberately overstated to obfuscate the true quality of GNL’s portfolio relative to peers. Note that portfolio occupancy is less relevant for net lease REITs as vacant properties are typical sold at a loss upon lease expiration. As a result, most net lease REITs print occupancy of 96%-100%.

Given GNL’s lack of disclosure, I do not believe investors realize the valuation discount which should be attached to many of GNL’s properties. GNL’s portfolio includes 11 leasehold properties (subject to a ground lease), which trade at materially higher cap rates than fee simple. One of GNL’s largest properties (ING, 4% of rent) is a leasehold. It appears the Finnair property (4% of rent) is also leasehold. Based on disclosures in the 10-K, I believe another large property (Harper Collins, 3% of rent) was dark as of 12/31/17 (mgmt. mentioned one of the 40+ assets in the UK was dark in passing on the 3Q 2017 conference call - there was no follow-up or mention that it related to a top ten tenant). Dark properties are typically assigned a huge discount in the private market. Most of GNL’s large office properties have less than 8 years of lease term remaining. Office properties with such short remaining term trade at a huge discount in the private market and are difficult to finance, especially when rents are above market levels.

Since the remaining lease term of GNL’s properties are critical to valuation, it is frustrating that this information is obfuscated. Mgmt. publishes a wtd. avg. lease term calculated by SF rather than rent/NOI like every other peer. This is because when measured by SF, the lease term is ~1 year longer. More importantly, the wtd. avg. lease term does not account for tenant termination options, despite indications from the company to the contrary. Large properties with known termination options include: Nissan (2023 vs. 2028), Provident (2025 vs. 2035) and Sandoz (2021 vs. 2026, albeit w/ a very large penalty). Both Nissan and Provident are curious because in previous disclosures, mgmt. displayed remaining lease term through the termination option. Now the remaining lease terms are shown irrespective of the termination option, which adds 5 and 10 years to the remaining term. In other words, in 2014, GNL showed remaining lease term for the Provident property as 11.1 years, but in 2018, it is showing the remaining lease term as 17.6 years. Likewise with Nissan. There is no way to know how many more of these exist because disclosure is so poor.

GNL vs. Net Lease Peers:

GNL’s peers include office/industrial/diversified net lease REITs (SIR, LXP, GOOD, GPT, WPC, VER) and to a lesser extent the retail focused net lease REITs (O, NNN, STOR, SRC, ADC). For these comparisons, I am excluding SIR and SRC because each are going through spin-offs which create noise. GPT, which has become primarily an industrial REIT (78% industrial), recently received a take-out bid from Blackstone at a ~6% cap rate. I will make comparisons to the wider net lease group where applicable, but note that GNL’s true office-oriented net lease peers are LXP, GOOD and SIR. Of this group, SIR and GOOD are externally managed. WPC is an outlier due to its non-traded REIT business. WPC no longer raises capital for new funds, but still manages assets which aren’t owned on its balance sheet. GPT also has an advisory business. As a result, valuation multiples for these REITs will be less informative.

Property Type:

Diversified net lease REITs (non-retail focused)
% Office / % Industrial / % Retail:
LXP: 50% / 49% / 1%
GPT: 18% / 78% / 4%
GOOD: 65% / 32% / 3%
VER: 19% / 17% / 64%
WPC: 25% / 49% / 27% (industrial includes self-storage)

GNL’s mix of 58% office / 28% industrial / 9% retail compares most directly to LXP (EV of $4 billion) and GOOD (EV of $1 billion). Industrial has been the hot property type over the last several years, especially with the difficulties seen in the retail sector. Suburban office has performed poorly over the past cycle, with many REITs suffering from significant capex requirements and difficulty re-leasing. Properties with above-market rents have seen big rent roll-downs upon lease expiration. These properties erode significant value as lease term burns off. As a result, most REITs have shifted the portfolio from office to industrial, most notably GPT. GNL and each of its peers have stated an intention to reduce their office concentration. In terms of valuation, NNN REITs with a larger industrial or retail property mix tend to trade at a premium to office.

Geography:

GNL’s U.S. portfolio mix at 49% compares to the wider net lease peer average of 95%, with WPC at 66% and GPT at 90% (LXP, VER and GOOD each at 100%). There isn’t a pure play comp for European exposure, but GNL has stated they want to skew more towards US. GNL’s FX volatility and hedging program has negatively impacted its valuation.

Tenancy:

There is a big divergence between how GNL mgmt. presents their tenancy relative to peers and where things stand in the real world. GNL’s tenant mix is largely consistent with its peers. Its percentage of tenants which carry actual investment grade credit ratings is 46% vs. peer avg. of 34%. GNL continues to point to the 78% investment grade and “implied” investment grade within their portfolio as best in class. GNL uses the term implied investment grade to include tenants which are subsidiaries of rated parents as well as private or unrated companies which they internally deem investment grade. There is absolutely no possible way that the large percentage of tenants that are rated “implied” investment grade internally by GNL carry credit risk on par with investment grade tenants. The company notes that they use a Moody’s analytical tool to determine the implied credit rating to add legitimacy to their claims. I have used this same tool and you can play with the numbers to produce almost any result that you want. We also have evidence that GNL’s internal ratings are aggressive based on disclosure they have made in the past and recent tenant defaults in their portfolio (one of which was not previously disclosed). In 2017, Axon Energy vacated one of its properties and stopped paying rent. This private company was previously internally rated implied investment grade by GNL. Mgmt. claims that they update their internal ratings on a periodic basis but there is little evidence of this. Note that several other private credits included in the portfolio acquisition were also rated implied investment grade at the acquisition. What is more concerning is that in 2016, C&J Energy, a significant tenant with 2 properties and 221,803 SF, filed for bankruptcy. GNL bought the larger of the two properties in March 2015, a little more than a year prior to when C&J filed for bankruptcy. Management made no mention of the bankruptcy in company filings. The only disclosure relating to the properties was a footnote buried in company filings that noted the lease term was modified from March 31, 2026 to October 31, 2023 in the third quarter of 2016. There was no mention of the reduction is rent which occured. likely that rents were reduced as well. It is particularly concerning that none of this was mentioned on the conference call or in the press release.

To summarize, GNL’s implied investment grade metric is heavily inflated and deeply flawed. The 78% figure mgmt. uses as a comparison to peers includes tenants that are substantially more likely to default than actual investment grade tenants. The company recently issued an 8-K in late February following release of quarterly results to clarify these points after misleading statements were made on the conference call. Mgmt. did not explain how the split of tenant with actual investment grade ratings jumped from 37% at 2017 year-end to 46% at 1Q18. I am viewing that figure with skepticism but either way, within the same range.

Lease Term:

Similar to the above, GNL also provides incorrect disclosure around the portfolio remaining lease term. Since many properties erode value as lease term declines, this is an important metric. The peer avg. remaining lease term is 8.5 years while wider net lease group average is 9.7. Each of the peers calculate the weighted average lease term (“WALT”) by rent/NOI. GNL reports 8.6 years of remaining lease term, however their calculation is based on SF instead of rent/NOI. Every other metric GNL provides is based on rent, not SF. Unsurprisingly, calculating this figure by SF instead of rent shows a WALT that is more attractive. My rough calcs indicate that if calculated consistent with peers, GNL would show a WALT of 7.6 years, about 1 year less than the current 8.6 years. In public filings, GNL continues to mislead investors by noting that peer SIR calculates WALT by SF. In fact, SIR provides by remaining lease calculated by SF AND calculated by rent. In an 8-K on March 8, 2018 (link https://www.sec.gov/Archives/edgar/data/1526113/000114420418013464/image_008.jpg), GNL shows SIR’s lease term incorrectly at 9.3 years (noting that it is calculated by SF). This is not correct. It should be 9.7 years if calculated by SF and 9.3 years if calculated by rent. Another example of GNL’s incompetence and/or deceptive disclosure.

In any event, with under 8 years of remaining term, GNL’s office-heavy portfolio is less attractive than peers with more industrial exposure (less future capex/re-leasing cost). Over the next several years, as GNL’s large office properties approach expiration, don’t be surprised to see significant impairments, rent reductions and capex/re-leasing costs.

Given the high rent levels of many of its office properties, it is particularly concerning that GNL mgmt. has not provided investors with a clear understanding of remaining lease term. For example, the recent 10-K notes that the Provident Financial office property in the UK has a remaining term of 18.1 years with avg. rents of approx. $37/SF NNN throughout the term (add $10-$12 to that to compare to gross market rents). This property actually has an early termination option for the tenant in 2025. The Nissan and Sandoz properties also have early termination options that are not properly footnoted in company filings as well.

I was told that GNL management was asked a question relating to termination options and they said that they calculate remaining lease term by taking the earlier of termination date or lease expiration date. That does not appear accurate per my calculations. Further, one might notice that the remaining lease terms disclosed by individual property are identical in the most recent 10-K (as of 12/31/17) and a recent 10-Q (as of 9/30/17). Obviously, this is impossible since three months has passed. The headline number announced in each quarter was changed, but someone forgot to update the SEC filing.

Capital Structure:

Since IPO, GNL mgmt. has said that they plan to lessen the company’s reliance on short-term debt and term out the capital structure with unsecured debt. On almost every quarterly call since 2015, GNL has said that an investment grade credit rating is imminent. Investors are still waiting.

GNL remains highly levered with an overreliance on short-term debt. While management touts more flattering metrics (e.g., Net Debt/Adj. Annualized EBITDA of 7.4x), Net Debt+Pref/LTM EBITDA is currently 8.8x. Both of these figures compare poorly relative to peers generally in the 5.0x-7.0x range.  

By financing its assets primarily with a short-term bank revolver in GBP and EUR, GNL is trying hard to manufacture earnings at the expense of long-term stability. Since IPO, the wtd. avg. interest rate has been below 3%. When the company is finally forced to match term, interest expense is likely to increase to levels above investment grade rated peers.

GNL is burdened by a prohibitively high cost of capital. As a result, it is unable to create value by acquiring properties on an accretive basis. For example, it a REIT is trading at a 5% cap, it can grow earnings and create value by issuing stock to acquire properties at a 7% cap. (Obviously, leverage plays a role and one would look at WACC but just a simple rule of thumb) Because of GNL’s poor track record and low-quality portfolio, it cannot issue equity at a valuation better than the cash cap rates for properties it would like to acquire. It is essentially “boxed-out” of growth. Note that disclosure of the company’s recent acquisitions and pipeline only indicates the GAAP cap rate (which uses weighted average rent through lease term instead of rent in first year) which is likely ~100bps higher than the cash or initial cap rates for many of the properties. GNL has fallen in love with growing earnings by financing acquisitions with short-term debt. This is coming to an end due to prohibitive leverage without the ability to issue common equity accretively.

Capital structure plays a significant role in valuation because REITs with limited ability to grow should obviously trade at a less attractive multiple. GNL falls in that camp.

Valuation:

-Implied Cap Rate:

GNL currently trades at an implied cash cap rate of 7.4%. Peers trade at an average cap rate of 7.0% with the wider net lease group average at 6.5%. Notably, LXP trades at 7.8% and GOOD trades at 7.5%.

-FFO/AFFO Multiple:

GNL trades at 2018 FFO/AFFO multiples of 9.4x/9.6x vs. peer avg. at 11.5x/11.7x and wider net lease group at 13.5x/13.6x. GNL screens cheap, but its inability to grow makes it a value trap as its current properties erode value.

-Dividend Yield:

GNL trades at a seemingly attractive 10.6% dividend yield vs. peer avg. of 7.2% and wider net lease average of 6.1%. However, GNL’s high yield is based on an uncovered dividend that is at risk of being cut. Peers have significantly lower payout ratios with an average of 81%/83%. The wider net lease group average FFO/AFFO payout ratio is 78%/79%. Neither FFO nor AFFO (which contains questionable add-backs) cover the dividend of $2.13.

Other Tidbits:

Headlines highlight aggregate growth and not the numbers that matter. 2017 AFFO/FFO per share was $2.10/$1.98 which is actually down 6%/13% year-over-year on a PER SHARE basis although you wouldn’t know this from GNL’s disclosure and commentary (they very rarely discuss an unfavorable number in prepared remarks). AFFO is down 15% from the guidance set at IPO in 2015.

A recent slide in GNL’s Feb./March investor deck is a good example of what mgmt. prioritizes, it shows 2017 vs. 2016 metrics and notes AFFO is up 10.8% Y/Y. [N.B. in their press release, they disclose the increase as +10.7%] This ignores PER SHARE amounts. Mgmt. also declines to include the percentage change in shares which at 18.0% is more than 1.5x greater than the change in AFFO. In general, if a figure makes GNL look good, mgmt. is happy to disclose it. If not…

Comparison of GNL at IPO to current:

At IPO

Price: $30.21 (June 1, 2015)

All figures adjusted for split

Financial Metrics:

Target AFFO per share of $2.46 per share by YE 2015 (on run-rate basis)

$2.13 Annual Dividend

Quarterly NAREIT FFO of $47.0 million or $0.79 per share (1Q15)

Quarterly “CORE” FFO of $48.1 or $0.80 per share (1Q15)

Quarterly AFFO of $31.2 million or $0.52 per share (1Q15)

Weighted average interest rate of 2.5%

3.3 years weighted average debt maturity (but this overstates since revolver includes 2x1 year extension options), pro-forma significantly shorter 2.1 years at 9/30/15

Net Debt / EV of 37%

Net Debt / Adjusted EBITDA of 6.1x

Portfolio Metrics: (as of 6/30/2015)

311 Properties

11.4 years of WALT (on SF)

81% (“investment grade”), with 47% actual investment grade

Occupancy 100%

Current:

Price: $20.08 (May 8, 2018)

All figures adjusted for split

Financial Metrics:

Annualized AFFO per share of $2.09 per share (on run-rate basis) vs. $2.48 target at IPO

$2.13 Annual Dividend

Quarterly NAREIT FFO of $0.47 per share (1Q18)

Quarterly “CORE” FFO of $0.49 per share (1Q18)

Quarterly AFFO of $0.52 per share (1Q18)

Weighted average interest rate of 2.8%

3.6 years weighted average debt maturity

Net Debt / EV of 54%

Net Debt / Adjusted EBITDA of 7.4x

Portfolio Metrics: (as of 3/31/2018)

327 Properties

8.6 years of WALT (on SF)

78% (“investment grade”), with 46% actual investment grade

Occupancy 99.5%

Global II Merger:

Problems with external advisors are compounded when the advisor manages multiple funds with the same investment strategy, as was the case with GNL. After mediocre performance in its first year or so in the public markets, GNL mgmt. reshuffled the deck by agreeing to purchase ARC Global II (“Global II”), a non-traded REIT also externally advised by AR Global that was created as a follow-up to GNL. Global II fundraising came to a half post-ARCP scandal and the REIT was paying an unsustainable dividend that would eventually have to be cut. So GNL shareholders paid a premium to buy the struggling Global II, with AR Global receiving substantial fees on each side of the deal. One of the benefits of the transaction, according to mgmt., was that pro-forma Rent/PSF would increase (a head scratcher as this increases risk of rent rolldown upon expiry). Ultimately, Global II shareholders who bought at the initial offering price of $25 fared poorly, receiving 2.27 shares of GNL (pre-split, .76 adjusted) representing ~$17.50 at time of merger.

Management:

Executive turnover at GNL has been almost comical. They have had 6 CFOs in the past 5 years in addition to 3 CEOs. Former CEO Nick Schorsch has a terrible reputation and has run several companies into the ground. Instead of providing a ton of background on Nick Schorsch and his track record, I will include the link below:

http://www.investmentnews.com/article/20150921/FEATURE/150919894/how-nick-schorsch-lost-his-mojo

GNL is growing, as you would expect a group so incentivized...

The Advisory Agreement requires us to pay a base management fee (the “Base Management Fee”) in a minimum amount of  $18.0 million per annum, payable in cash on a pro rata monthly basis at the beginning of each month, and including a variable fee amount equal to 1.25% of net proceeds raised from additional equity issuances, including issuances of limited partnership units in the OP (“OP Units’’) and preferred stock, such as our NYSE-listed 7.25% Series A Cumulative Redeemable Preferred Stock, and an incentive fee (“Incentive Compensation’’), payable 50% in cash and 50% in shares of Common Stock, equal to 15% of our Core AFFO (as defined in the Advisory Agreement) in excess of  $2.37 per share plus 10% of our Core AFFO in excess of  $3.08 per share. The $2.37 and $3.08 incentive hurdles are eligible for annual increases of 1% to 3% based on a determination by a majority of our independent directors, in their good faith reasonable judgment, after consultation with the Advisor and our management. In accordance with this procedure, the incentive hurdles were increased 1% for the twelve months beginning July 1, 2016 and ending on June 30, 2017. The amounts payable to the Advisor each year are capped, based on the level of assets under management, subject to adjustment under certain circumstances.

The Advisory Agreement has an initial term expiring June 1, 2035, with automatic renewals for consecutive five-year terms unless the Advisory Agreement is terminated in accordance with its terms (1) with notice of an election not to renew at least 365 days prior to the expiration of the then-current term, (2) in connection with a change of control of us or the Advisor, (3) by the independent directors in connection with the or the Advisor's failure (based on a good faith determination by our independent directors) to meet annual performance standards for the year based primarily on actions or inactions of the Advisor, subject to notice and cure provisions, (4) with 60 days’ notice by us with cause, subject in some circumstances to notice and cure provisions, or (5) with 60 days prior written notice by the Advisor for any material default of the Advisory Agreement by us, subject to notice and cure provisions. In the event of a termination in connection with a change of control of us or the Advisor’s failure to meet annual performance standards, we would be required to pay a termination fee that could be up to 2.5 times the compensation paid to the Advisor in the previous year, plus expenses.

As a group, Directors and Officers collectively own less than 0.2% of the company.

The current management team does not inspire much confidence as most of the same issues continue. For example, in GNL’s recent investor deck, it only discloses GAAP cap rates vs. cash/initial. This is a step back for a company that previously disclosed initial/cash cap rates. GAAP cap rates make the deals seem more attractive than they are, and give the illusion of accretion. Mgmt. is hoping that investors do not realize that the acquisition cap rates are lower than the company’s cost of capital and destroy value. They appear unable or unwilling to communicate frankly with the investment community. Lastly, misrepresentations/ misstatements, out-of-period accounting adjustments and typos remain rampant (I found several in the 2017 10-K).

Risks:

-Given the circular nature of accretive growth for NNN REITs, it is possible that GNL is able to continue to mislead investors regarding the quality of its portfolio and talk-up its stock to an attractive level from which it can further finance growth.

-EUR and GBP exchange rates could move further in GNL’s favor, aiding headline revenue and coverage metrics, however any gains would be offset by the cost of hedges, which have been significant.

-I do not view the sale of GNL as a significant risk because of the onerous 20 year external mgmt. contract and large required change of control payment to internalize.

-NNN REITs are rate-sensitive, so a sustained decrease in the 10 Year would certainly help the stock.

Conclusion:

I believe GNL is a value trap. It may look cheap on certain valuation metrics, but the portfolio is inferior quality, external mgmt. extracts significant value through fees and prospects for accretive growth are severely limited by high leverage and a prohibitive cost of capital. Weak accounting controls/frequent restatements plus management’s selective nondisclosure of bad news and doctored metrics add risk to the story. Finally, the company continues to payout an unsustainable dividend and a dividend cut would cause a huge sell-off in the stock given retail ownership.

I see 30%+ downside potential and limited upside. Given reliance on interest rates, it is difficult to peg an absolute valuation and I believe this trade works best as a pair or with the RMZ.

THIS REPORT IS FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSTITUTE INVESTMENT ADVICE.

Catalyst

-Quarterly Earnings

-More of a time horizon play