What Is The World's Largest Net Lease REIT Worth?
Jan. 29, 2015 7:00 AM • ver
- The margin of safety is the essence of value investing, because it's the metric by which hazardous speculations are segregated from bona fide investment opportunities.
- Green Street Advisors has devoted considerable resources to the NAV-based tool, and the company said "it has always been the driver of (its) valuation conclusions".
- After adding back in the cash balance (from the ARCP filing dated June 30, 2014), I arrive at an estimated Net Asset Value for ARCP of $8.48 per share.
Examining a potential investment based on its underlying valuation is a critical element for determining whether or not the subject security promises safety of principal and satisfactory return. As the legendary investor Ben Graham explained (The Intelligent Investor ):
Operations not meeting these requirements are speculative.
Accordingly, it's that distinction - between investment and speculation- that lies at the heart of Graham's investment philosophy and its primary impetus behind his development and promotion of the "margin of safety" principle. As Graham suggested, the value investor's purpose is to capitalize upon "a favorable difference between price on the one hand and indicated or appraised value on the other."
That's why the margin of safety is the essence of value investing - because it's the metric by which hazardous speculations are segregated from bona fide investment opportunities.
As many frequent readers know, I typically analyze a REIT security based upon historical earnings (or Funds from Operations) and dividend performance. For me, Price-to-Funds from Operations (or P/FFO) is a relative valuation metric, because it provides a clear picture of where the company has been, where it is now, and where it's headed in the future.
The other widely accepted REIT valuation metric is Net Asset Value (or NAV) - an analysis of underlying real estate designed to asses valuation of any REIT relative to its sector-level peers. It's much more difficult for a business journalist or independent analyst to determine with accuracy the valuation of a company, since there are many variables involved. Conversely, Green Street Advisors has devoted considerable resources to the NAV-based tool, and the company said "it has always been the driver of (its) valuation conclusions". See Green Street NAV paper HERE .
I simply don't have the resources dedicated to appraising various REIT assets, and when I need to determine market pricing for a REIT security, I will typically rely on the dedicated research team from a well-known brokerage firm.
What's ARCP Really Worth?
As noted above, I typically don't provide NAV-based pricing, since my preference is to focus on earnings trends. In addition, REITs are rarely liquidated, so the use of the NAV model is less meaningful for the average retail investor. Many of you reading this article are looking to find an adequate "margin of safety" in which you can buy a cheap stock with strong growth potential.
However, many readers have asked me to provide an asset based measuring stick for American Realty Capital Properties (ARCP). Over the last few months, investors have witnessed a series of missteps for ARCP, which has resulted in a lack of clarity. Consequently, it's virtually impossible for any analyst to provide a true valuation of the shares, since the last public quarterly filing was issued on June 30, 2014. Therefore, I am coming out of retirement (not in a literal sense) to make available a purely academic valuation of the "The World's Largest Net Lease REIT".
You will see my disclaimer noted at the bottom of this article, and I will summarize it here: My NAV-based model includes run-rates that are subject to opinion, and should not be relied upon in any way. Investors should conduct his or her own due diligence.
Now, let's get started.
To arrive at a quarterly run rate, I located the latest publicly available rental revenue in the Q2-14 supplemental. I took that number (
$315 million), and after the additions and deductions (noted below), I arrived at an annualized run-rate of
Then, I added back in ARCP's Q2-14 acquisitions (Source: ARCP September 2014 Investor Presentation ) worth a total of
$834 million. The company stated the cash cap rate is 7.9%, so then I annualized the rental revenue to derive a run rate of
Then, I deducted the revenue that was related to ARCP's Multi-Tenant portfolio. I estimated that number to be approximately $135 million (based on the company's March 2014 Investor Presentation ).
I added back in the Red Lobster portfolio that was acquired after Q2-14:
Now, as you can see, the valuation is more subjective, since there is no publicly available data regarding activity in Q3-14 and Q4-14. So all I can do is come up with "my best guess". Previously, ARCP stated that it would close around $4.5 billion in 2014, and after deducting Q1-14 and Q2-14 transactions ($1.9 billion) and Red Lobster ($1.5 billion), my "guess" is that the company would have closed around $1.1 billion in Q3-14 and Q4-14, had the train not gone
off the track. Therefore, I'm using $800 million as my plug number. Again, this is merely a guess.
Now, utilizing the estimated Net Operating Income (NOI) annualized run rate of around
$1.337 billion, let's determine how the cash is allocated to the company's diverse platform.
This part of the valuation process becomes more difficult, since I can only rely on the latest filings. Here's what the company reported as the Top 10 Tenants in an Investor Presentation on June 2014. As you can see, I added back the categories and the approximate percentage allocated to the retail, office, and industrial asset sectors.
In order to originate market cap rates (net income dividend by purchase price) on the top tenants and other assets, I decided to utilize to top net lease brokers (I used the The Boulder Group and NNNetAdvisors ). Also, I asked a leading investment broker about the pricing on Red Lobster, and he said these assets would likely trade "in the high 7s". I agree with that number, especially since we know that the tenant (a Golden Gate entity) is private equity and has very little "skin in the game". However, I opted to use a 7.5% cap rate for the purpose of this NAV model.
Now my NAV model is just about finished, but in order to arrive at the estimated shareholders' equity, I must deduct debt ($9.72 billion as of Q2-14), deduct the multi-tenant debt and add in Red Lobster, the estimated acquisitions, and the preferreds.
Now, after adding back in the cash balance (from the ARCP filing dated June 30, 2014), I arrive at an estimated Net Asset Value of $8.48 per share for ARCP .
I have written extensively on ARCP, so it should come to no one's surprise that I place a minimum value on Cole Real Estate. It's simply impossible to provide an accurate valuation for a company that has declining equity sales and significantly diminished brand equity. Without financials to rely on, there's no way that I can accurately estimate the value of Cole, if any. There are limited buyers for Cole, and I suspect that two possible candidates could be Northstar Realty Finance Corp. (NYSE:NRF ) or the founder, Chris Cole (or perhaps a combination of the two).
Also, when considering the liquidation value for ARCP, keep in mind that my model did not include the massive unwinding of debt associated with ARCP. As noted above, my model is representative of a more academic exercise, therefore I do not have enough information to forecast the costs associated with the prepayment fees and yield maintenance (for the CMBS loans). Given ARCP's high level of secured debt, I believe that the company will be forced to sell off assets to pay down debt. (The lenders are in control, and selling assets will take time - also a cost to consider).
Another question (and potential cost) for ARCP is litigation. Again, I have no data to estimate the cost of the litigation, but investors should consider that as part of their due diligence exercise.
Remember, most REITs trade at a premium of 15% or so above their NAV pricing. Here's how ARCP is trading (remember, no CEO is steering the ship now):
Finally, I recently wrote an article about a few possible REIT buyers for ARCP assets, and since that time, I have been pondering the idea of a REIT merger. More recently, I have become fixated on the idea of a reverse merger with National Retail Properties (NYSE:NNN ). Clearly, NNN has a fortress balance sheet with a vetted management team in place. ARCP could sell its bigger boxes to Realty Income (NYSE:O ), W.P. Carey (NYSE:WPC ), Chambers Street Properties (NYSE:CSG ), or Lexington Realty Trust (NYSE:LXP ), among others.
Anyway, that gives us all something to chew until March 3rd. at which time investors will have more clarity and begin to find out whether Mr. Market agrees or disagrees with my valuation of the common shares of ARCP. Keep in mind that there are two catalysts that could move the share price immediately - a new CEO and the sale of Cole. Until next time. I'll close my NAV analysis with this classic Ben Graham quote:
You are neither right nor wrong because the crowd disagrees with you. You are right because the data and reasoning are right.
Disclaimer: This article is intended to provide information to interested parties. As I have no knowledge of individual investor circumstances, goals, and/or portfolio concentration or diversification, readers are expected to complete their own due diligence before purchasing any stocks mentioned or recommended. INVESTORS SHOULD NOT RELY ON THE NET ASSET VALUE MODEL PREPARED BY THE AUTHOR. CONDUCT YOUR OWN DUE DILIGENCE .
Disclosure: The author is long O, DLR, VTR, HTA, STAG, CSG, GPT, ROIC, HCN, OHI, LXP, KIM, WPC, DOC, UDF, EXR, MYCC, BX, TCO.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.