Here’s What to Do With American Realty Capital Properties

Last week, American Realty Capital Properties (ARCP) announced some accounting mistakes, where it overstated Adjusted Funds from Operations (AFFO) by 4 cents per share for the first half of 2014.

americancapitalrealtyThe reason why ARCP stock price declined by a third, however, was that there was a mistake done in the first quarter, and there was an attempt to conceal that mistake in the second quarter. The attempted cover-up made many investors nervous, mostly because they fear that this could be an indication of a bigger cover-up.

I viewed American Realty Capital Properties as a company with promise, which wanted to grow enough to gain the scale and prominence of Realty Income (O). After my purchase however, ARCP grew its size very rapidly. As a result of the very rapid acquisitions of companies and properties, the hefty compensation package proposals for Nicholas Schorch, as well as the warning that the above average yield provided, I was beginning to question my investment in American Realty Capital Properties.

After reviewing the press release, as well as the conference call transcript, I have identified three options for my investment in American Realty Capital Properties.

American Realty Capital Properties Possibilities

1) Sell, and never look back

Accounting issues are always a red flag. If you cannot trust the numbers, this means that you cannot properly value the business. If management produced bad numbers, this means that internal controls over financial reporting are probably very weak. Those who are selling are likely believing that the insane are running the asylum — in other words the tone at the top is bad, which has cascaded down into a rotten organization at its core.

If the current accounting irregularities are just the tip of the iceberg, and there are more things uncovered, it is quite possible that share prices will fall further, the dividend will be cut, and more losses could be in store. Things can cascade down pretty quickly in a wave of investigations, credit downgrades and management would have to focus on those fires, rather than focusing on the core operations.

Even if the company survives, it would be unable to grow given the fact that cost of equity is prohibitively expensive at 11%, and the cost of debt could be even higher with possible credit rating downgrades.

2) Hold

While accounting irregularities are bad, and the dividend could be in jeopardy, the company looks cheap relative to others. While the bad publicity somewhat justifies a discount relative to the likes of Realty Income, W.P Carey (WPC) and National Retail Properties (NNN), I still believe that there are real revenue streams under long dated leases with quality tenants for American Realty Capital Properties.

In addition, American Realty Capital Properties is a real estate investment trust, which means that it has to pay dividends as long as it generates enough income. Therefore, even if the dividend is cut, ARCP could still prove to be a decent long-term holding as long as it continues sharing its cash flows with shareholders and as long as it does not uncover more irregularities. The portfolio of properties is worth something, and some dividends will be paid out. If the company survives, the investor that will come out ahead will be the one who held on and might have even reinvested dividends.

3) Add more

We all know the saying that investors should buy when there is blood on the streets. There is some blood on the American Realty Capital Properties streets. I have been contacted by a lot of scared American Realty Capital Properties shareholders, who don’t know what to do. The fact that ordinary investors and probably even top management at American Realty Capital Properties don’t know the full extent of all problems is scary.

However, it could be an opportunity given the low valuation of the assets on a price to book level. The problem is that this is now not dividend growth investing, but value investing with a dose of speculation. And I do not have the guts to add to this position. But I know some are adding to American Realty Capital Properties because of the low valuation.

Bottom Line

Overall, I am going to hold on to American Realty Capital Properties for the time being, which I can afford as ARCP is less than 1% of my diversified dividend portfolio. Even if ARCP was to cut dividends, I would violate my sell rule and keep holding because as long as the REIT doesn’t go bankrupt, it will deliver dividends to shareholders.

I will be able to hold through SEC Investigations, further declines in the stock price and even a dividend cut. I might however do some tax-loss harvesting at year end. I would do this either by buying a call option, and then selling the shares in taxable accounts after 31-32 days. Alternatively, I could buy one more share for each share in a taxable account I already hold and then buy a protective put for the additional shares. In about 31 – 32 days, I will sell the original shares and generate tax-losses.

However, I made a mistake buying American Realty Capital Properties in the first place as I violated my principles for sound investment.

Full Disclosure; Long O, ARCP.


Article printed from InvestorPlace Media, https://investorplace.com/2014/11/heres-what-to-do-with-american-realty-capital-properties/.

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