It’s never a good sign when a company’s CFO and top accountant abruptly resign at the same time “accounting irregularities” are announced, but that’s exactly what happened at American Realty Capital Properties Inc (ARCP) this morning.
An audit committee said, in a nutshell, that every quarterly report put out by American Realty Capital Properties this year should be discarded and that the number from last year’s annual report shouldn’t be relied upon.
This is the sort of thing that makes investors dump a stock first and ask questions later. At time of writing, ARCP was down about 30% on the day after being down significantly more.
Given the extent of today’s stock implosion, I would consider this a buying opportunity in ARCP — albeit a risky one. In the interests of full disclosure, I added to my existing position in ARCP at prices ranging from $8.22 to $8.48, and we’re a little above those levels now. But I believe that ARCP could easily deliver total returns including dividends of 50% or more in the next six months if the accounting irregularities end up being anything short of catastrophic.
Let’s take a look at the numbers.
Based on the preliminary reports, the 2014 Q1 adjusted funds from operations (“AFFO”) of 26 cents would be cut to 23 cents, and the Q2 AFFO of 24 cents would be cut to 22 cents. The audit committee believes the 2013 numbers are probably accurate, though they still are nvestigating.
The worst aspect is that there are allegations that management — or at least the CFO — knew about the irregularities and knowingly abetted them.
Still, let’s keep this in perspective.
We’re talking about a difference of 5 cents per share over two calendar quarters. Still, as Brad Thomas, editor of iREIT Investor, noted in an update to readers this morning, this doesn’t cover the 8.3-cent monthly dividend — which could mean that a dividend cut is a real possibility.
I’m not too worried about a dividend cut in the next six to 12 months. American Realty Capital Properties should have plenty of access to cash to sustain that dividend, though it probably won’t be growing it much.
But the biggest reason I am inclined to give ARCP the benefit of the doubt is that company insiders have been steadily accumulating the shares throughout 2014. Ten different insiders — including the company’s general council—have purchased a combined $3 million since January of this year.
Is it possible that they’ve all been bamboozled by a crooked CFO who had been cooking the books? Sure. Stranger things have happened. But I’m not betting on it.
The most likely scenario here is that, due to incompetence and not malintent, ARCP’s now departed CFO and chief accounting officer botched their reporting by a few cents. That’s bad — really bad.
But not quite bad enough to justify lopping off a third of the company’s market cap.
Bottom Line
Use this selloff as an opportunity. I should reiterate that this is a risky investment. The auditors could come back and find that the accounting irregularities go deeper than originally reported, in which case American Realty Capital Properties would potentially see a lot more downside.
But given the extent of the selloff and the steady insider buying in ARCP, it’s a risk I’m comfortable taking.
Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. As of this writing, he was long ARCP. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays.
