What started out as a $100 million IPO almost four years ago turned into a nightmare for investors just around ten months ago when VEREIT, Inc. (VER), formerly American Realty Capital Properties, disclosed that the management team had fudged the books.
Some saw the cracks forming early as the previous CEO (and founder) Nicholas Schorsch - the ringleader - began to transform the small-cap REIT into the “world’s largest net lease company”. By orchestrating high-level financial engineering, Schorsch set his sights on trophy transactions racking up a showcase of acquisitions including CapLease, Cole Capital, Inland (assets), and the latest prize, $1.5 billion of Red Lobster properties.
With very little focus on quality, Schorsch and his team grew into a massive net lease machine, adhering to a management style of always putting management first.
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As a dedicated REIT analyst, I was on the ground examining all of the components of VER, trying to assess the durability of the enterprise. Admittedly, that was a difficult task, almost like trying to work on a racecar while sitting in the back seat when moving over 200 miles per hour.
I was fortunate to stay focused on meaningful analytics and just six days before the accounting scandal broke, I hit the brakes as explained “enough already”. On October 23, 2014 I wrote, “I will not be suckered into a trap where my principal is not safe…Mr. Market has warned me by providing a signal that I should proceed with caution. I'm sitting on the sidelines for now”. I warned, “I'm not investing another nickel in ARCP until I see more clarity”.
Then on October 29th (just 6 days after my harbinger article), the music stopped as VER’s Audit Committee disclosed accounting irregularities. The company’s dividend payout ratio was already at an elevated level, but with the mis-stated earnings disclosed it was clear that the organization was cooking the books.
What had taken around four quick years to create was suddenly shattered – shares in VER fell around 25 percent in one day and the finger pointing game commenced. Within a matter of weeks the CEO, CFO, and COO were released and the chairman and founder, Nicholas Schorsch, went absent without leave.
As a normal course of events most of the retail investors ran for the hills and the activist hedge fund investors began to circle the wagons. The shares became cheap and when the Board decided to suspend its monthly dividend payments the fear grew.
With no real leader steering the distressed vessel the Board attempted to guide the wreckage until a CEO was named.
Then on March 1st VER announced that Glenn Rufrano would be named CEO effective April 1. In the course of four months Rufrano worked to restore confidence in the shaken-up REIT. As part of that effort, American Realty Capital Properties announced a corporate name change and a re-branding strategy that removed all ties with the founder (Schorsch) and his related businesses, converting the name to VEREIT, Inc.
The name VEREIT (pronounced "ver-REIT") is the blend of veritas, the Latin word meaning truth, and REIT. In a prepared statement the CEO said,
Changing the name of the Company was high on my list of priorities as we work towards establishing a new business foundation and organizational culture.
Last week VER announced second quarter earnings and Rufrano’s mission – putting the pieces together again – were addressed in detail.
Part of VER’s troubles, sparked by the aggressive behavior of the former regime, was high leverage and accordingly the new CEO plans to de-leverage the balance sheet and replace short-duration debt with longer-term liabilities. To accomplish this task Rufrano announced a substantial asset sale strategy that is proposed to remove around $1.8 billion to $2 billion of assets by year end 2016.
Arguably, asset sales will be dilutive but the benefits of reducing exposure with longer-term leased properties (like CVS and Red Lobster) seem logical given the reduced profits (spreads) likely to weigh on rising interest rates. In addition, VER should improve its cost of capital when the balance sheet improves and the company’s investment grade credit ratings are restored (VER is rated BB by S&P and Ba1 by Moody’s).
One huge accomplishment discussed by Rufrano last week was restoring the dividend. VER has announced a dividend of $.1375 per quarter that translates to $.55 per year. That is higher than I forecasted but Rufrano explained “we thought long and hard (about the dividend) and the payout ratio (around 64% of AFFO)”. He said that AFFO would likely come down with future dispositions.
Given the positive news on the earnings call I was expecting to see shares move a tad; however, the impact has been marginal. VER shares are now trading at $8.69, well below NAV levels (my estimate is around $9.50 before planned asset sales) and the price to funds from operations (or P/FFO) multiple of 10.4x is screaming bargain.
Yet, in light of all of the pieces (high leverage, high exposure with Red Lobster, monetization of Cole Capital, litigation costs, etc..), Rufrano has more work to do. I caught up with him today and he responded (by email), “The primary goal is to improve critical metrics for investment-grade rating by reducing total debt through strategic dispositions in 2015 and 2016, while reducing net debt to EBITDA to 6 to 7 times from the current 7.5 times.”
I have put VER back on my research list (Forbes Real Estate Investor newsletter) although I have no recommended price target at this time. Although speculative, this may not be a bad bet. The dividend yield of 6.3% is attractive and if Rufrano and VER live up to their words “the truth REIT”, there could be a nice payday down the road. In other words, as leverage comes down, the share price should go up.
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Brad Thomas is the Editor of the Forbes Real Estate Investor and writes for Forbes.com and Seeking Alpha. He is also a frequent guest on Fox Business and he is currently writing a book, Truth About Trump, about U.S. presidential candidate Donald J. Trump.
Source: SNL Financial
Author does not own VER.
