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Re-Visiting American Realty Capital Trust III Merger with ARCP

October 9, 2019

Re-Visiting American Realty Capital Trust III Merger with ARCP

October 7, 2019 | James Sprow | Blue Vault

American Realty Capital Properties, Inc. (“ARCP”), was a Maryland corporation incorporated on December 2, 2010, that qualified as a real estate investment trust for U.S. federal income tax purposes beginning in the year ended December 31, 2011. On September 6, 2011, the Company completed its initial public offering and its shares of common stock began trading on the NASDAQ Capital Market (“NASDAQ”) under the symbol “ARCP” on September 7, 2011.

American Realty Capital Trust III, Inc. (“ARCT III”) commenced its IPO on March 31, 2011, for up to 150 million shares of common stock at a price of $10.00 per share. The REIT sold 20,000 shares of common stock to American Realty Capital III Special Limited Partnership, LLC, an entity wholly owned by AR Capital, LLC (“ARC”), the REIT’s sponsor. On September 28, 2012, ARCT III announced the closure of the IPO following the successful achievement of its target equity raise of $1.7 billion, including the shares reallocated from the DRIP.

On December 14, 2012, American Realty Capital Trust III, Inc. (“ARCT III”) entered into a merger agreement with an operating partnership of ARCP. On February 26, 2013, the shareholders of ARCP voted to issue shares of ARCP to the shareholders of ARCT III pursuant to the merger agreement. Also, on February 26, 2013, ARCT III shareholders voted on the merger. The proposal was approved by both REITs’ shareholders. The merger was effective on February 28, 2013. Under the terms of the merger agreement, each share of common stock of ARCT III was converted into the right to receive (i) 0.95 of a share of common stock of ARCP, or (ii) $12.00 in cash for shareholders who made a cash election pursuant to the merger agreement. ARCT III was sponsored by AR Capital, LLC, (“ARC”). ARCP retained ARC Property Advisors, LLC, a wholly owned subsidiary of ARC, to manage its affairs on a day to day basis and, as a result, was generally externally managed. Hence, both ARCT III and ARCP were managed by ARC, implying that the merger agreement was not necessarily an “arms-length” transaction. (see discussion below under the “Pricing Process”)

On March 1, 2013, following the close of the merger, 154,017,661 shares of ARCP common stock were outstanding and ARCP began trading on the NASDAQ Global Select Market on February 28, 2013.
The merger constituted an “investment liquidity event” and as a result, the Special Limited Partner, in connection with management’s successful attainment of the 6% performance hurdle and the return to the ARC Trust III stockholders of $557.3 million in addition to their initial investment, was entitled to receive a subordinated distribution of net sales proceeds from the Operating Partnership in an amount equal to approximately $98.4 million.

Upon the closing of the merger, on February 28, 2013, 29.2 million shares, or 16.5% of the then outstanding shares of ARCT III’s common stock were paid in cash at $12.00 per share, which is equivalent to 27.7 million shares of ARCP’s common stock based on the 0.95 exchange ratio. In addition, 148.1 million shares of ARCT III’s common stock were converted to shares of ARCP’s common stock, resulting in an additional 140.7 million shares of ARCP’s common stock outstanding after the exchange.

Upon the consummation of the merger, American Realty Capital III Special Limited Partnership, LLC, the holder of the special limited partner interest in the ARCT III OP, was entitled to subordinated distributions of net sales proceeds from ARCT III OP which resulted in the issuance of units of limited partner interests in the ARCT III OP, when after applying the exchange ratio, resulted in the issuance of an additional 7.3 million OP Units. The parties agreed that such OP Units would be subject to a minimum one-year holding period before being exchangeable into ARCP’s common stock.

Upon consummation of the merger, the vesting of the shares of the ARCP’s and ARCT III’s outstanding restricted stock was accelerated. Each share of ARCP’s and ARCT III’s restricted stock outstanding immediately prior to the effective date of the merger became fully vested. For the three months ended March 31, 2013, compensation expense for the restricted shares was $2.6 million, including $2.2 million recognized for the accelerated vesting of restricted shares in conjunction with the merger.

In connection with the consummation of the merger, ARCT III’s Board of Directors resigned, including Nicholas S. Schorsch and Edward M. Weil, Jr. However, the Board of Directors of ARCP as of February 13, 2013, included Nicholas S. Schorsch (CEO), Edward M. Weil, Jr. (COO), and Brian S. Block (CFO). Nicholas S. Schorsch was the Managing Member of AR Capital, LLC (or ARC) in 2012 and was in that role through February 2015. Schorsch resigned as CEO of ARCP on December 12, 2014.

Full-Cycle Performance by American Realty Capital Trust III

In Blue Vault’s Third Edition Nontraded REIT Full-Cycle Performance Study published in 2014, the performance of 35 nontraded REITs that had provided shareholders with full liquidity were analyzed, and compared to custom benchmarks constructed to, as closely as possible, match the holding periods, asset types, geographic diversification and leverage of each full-cycle nontraded REIT.

The merger of American Realty Capital Trust III with ARCP provided shareholders with full liquidity, either via their ability to sell the 0.95 shares in ARCP received for each share of ARCT III, or the $12.00 in cash that some shareholders opted to receive. Based upon the closing price for ARCP shares on the first trading day following the merger, ARCT III shareholders who received the ARCP shares could liquidate their shares for an equivalent of $12.57 per common share of ARCT III.

Calculating the estimated holding period return for ARCT III investors who purchased shares in the first quarter of the REIT’s offering (“Early Investors”) Blue Vault reported a conventional annualized IRR or rate of return of 14.63% without DRIP reinvestments, and 18.34% with reinvestment via the DRIP. Over the life of ARCT III as a REIT, the property types held in the REIT’s portfolio, averaged using their respective gross book values, were 57.6% retail, 31.2% industrial and 11.2% office. Comparing the ARCT III shareholder returns to the custom benchmarks constructed to match the REIT’s investor holding period, asset type, geographic diversification and leverage, the REIT outperformed both the returns to the NCREIF-based (institutional portfolios) benchmark (13.96%) and the FTSE-NAREIT based (listed REIT) benchmark (13.86%). 

Due to the significant capital gains based upon the initial offering price of $10.00 and the liquidating value of $12.57, investors who utilized the DRIP to purchase shares at a discount, as well as investors who purchased shares later during the offering which closed on September 28, 2012, had higher average annualized rates of return than early investors who did not reinvest in shares via the DRIP.

When ARCT III early shareholder returns are compared to the custom benchmarks, shareholders did quite well. Those who utilized the DRIP, beat both the NCREIF benchmark and FTSE-NAREIT benchmark by over 4% annualized. The timing of the REIT’s life-cycle, beginning in a relatively low-valuation CRE environment in 2011 and liquidating in a relatively higher valuation environment in 2013 was very favorable, especially given the relatively short holding period for its investors.

The Pricing Process for the ARCT III Merger with ARCP

According to the transcript from the ARCP Investor Conference Call on December 17, 2012, Nicholas Schorsch, CEO of both ARCP and ARCT III, stated that UBS began a marketing process with the board of ARCT III and there were “obviously a number of bidders in the process.” According to Schorsch,

“We looked at our ability to pay and what our capability was to deliver different aspects of this. We looked at the investors’ needs in the underlying company, and we crafted a transaction that we believed was full and fair value, delivering our investors full and fair value because of the transformative nature of the deal and the size it would give us. So we came in very strong with what we believed was a nice package that allowed for cash component, which was important to some investors, and also allowed for, which creates a floor under the stock. And we also came in with a stock component, which allowed upside and a tax efficiency for the existing investors.”

“So it was a very well thought out process that was done with Bammel and Merrill Lynch team, as well as our external counsel. The independent directors met extensively and crafted a transaction that would give us these tremendous results that we have today so that our dividend is fully covered from a much smaller balance sheet.”

Merrill Lynch, Pierce, Fenner and Smith, Incorporated, provided the Board of Directors of ARCP an opinion regarding the price to be paid for ARCT III. In that letter, dated December 12, 2012, they stated:

“In arriving at our opinion, we have assumed and relied upon, without independent verification, the accuracy and completeness of the financial and other information and data publicly available or provided to or otherwise reviewed by or discussed with us. As you are aware, ARCP and ARCT III are each managed by the same affiliated external manager and we have relied upon assurances of such manager that it is not aware of any facts or circumstances that would make such information or data inaccurate or misleading in any material respect. With respect to the ARCT III Forecasts and the ARCP Forecasts, we have been advised by the external manager, and we have assumed, with the consent of ARCP, that they have been reasonably prepared on bases reflecting the best currently available estimates and good faith judgments of such external manager as to the future financial performance of ARCT III and ARCP.”

In a letter dated December 14, 2012, UBS provided the Board of Directors of ARCP an opinion as to the fairness, from a financial point of view, to the holders of ARCT III common stock of the merger consideration to be received.

“In connection with our review, with your consent, we have assumed and relied upon, without independent verification, the accuracy and completeness in all material respects of the information provided to or reviewed by us for the purpose of this opinion. In addition, with your consent, we have not made any independent evaluation or appraisal of any of the assets or liabilities (contingent or otherwise) of ARCT III or Parent, nor have we been furnished with any such evaluation or appraisal. With respect to the financial forecasts, estimates, and pro forma effects referred to above, we have assumed, at your direction, that they have been reasonably prepared on a basis reflecting the best currently available estimates and judgments of Capital Advisors and Properties Advisors as to (i) the future financial performance of the respective companies they manage and (ii) such pro forma effects. In addition, we have assumed with your approval that the financial forecasts and estimates referred to above will be achieved at the times and in the amounts projected.”

According to the VEREIT, Inc. (F/K/A American Realty Capital Properties, Inc.) 2015 Annual Report,

“The Company (ARCP) and ARCT III, from inception to the ARCT III Merger Date, were considered to be entities under common control. Both entities’ advisors were wholly owned subsidiaries of ARC. ARC and its related parties had significant ownership interests in the Company and ARCT III through the ownership of shares of common stock and other equity interests. In addition, the advisors of the Company and ARCT III were contractually eligible to receive potential fees for their services to both companies, including asset management fees, incentive fees and other fees, and continued to receive fees from the Operating Partnership, on behalf of the Company, prior to the Company’s transition to self-management. Due to the significance of these fees, the advisors and ultimately ARC were determined to have a significant economic interest in both companies in addition to having the power to direct the significant activities of the companies through advisory/management agreements, which qualified them as affiliated companies under common control in accordance with U.S. GAAP.”

AFFO Forecasts and Actual Results

In a conference call on December 17, 2012, Brian S. Block, then CFO of ARCP, projected fully-diluted AFFO per share of approximately $0.93 for 2013 and $1.08 for 2014. This represented a growth rate of about 16% year to year. In the annual report for the year ended December 31, 2014, actual AFFO per share was reported as $0.87 for 2013 and $0.90 for 2014.

On October 29, 2014, ARCP filed a Form 8-K reporting that the Audit Committee had concluded that the previously-issued financial statements and other financial information contained in its 2013 Annual Report on Form 10-K and its Quarterly Reports on Form 10-Q for the first two quarters of 2014, as well as the Company’s earnings releases and other financial communications for these periods, should no longer be relied upon.

Brian S. Block resigned as CFO on October 28, 2014.  Nicholas S. Schorsch resigned on December 12, 2014.

For the years 2013 through 2015, ARCP’s Cash Flows from Operating Activities totaled $1,381 million, consolidated AFFO totaled $1,734 million and distributions paid for that same period totaled $1,429 million. In 2014, the Company declared distributions of $1.08 per share. On December 23, 2014, in connection with the amendments to the Credit Facility, the Company agreed to suspend the payment of dividends on its common stock until it complied with periodic financial reporting and related requirements. It resumed paying dividends for the 3rd and 4th quarters of 2015 at an annualized rate of $0.55 per share.

ARCP became VEREIT, Inc. effective July 28, 2015. On February 24, 2016, VEREIT, Inc., filed its consolidated financial statements for the fiscal year ended December 31, 2015, reporting AFFO per share of $0.87 for 2013, $0.90 for 2014, and $0.84 for 2015. In VEREIT’s annual report for 2018, AFFO per diluted share from continuing operations was reported as $0.78 for 2016, $0.70 for 2017, and $0.72 for 2018.  Dividends per common share in 2016, 2017 and 2018 were at the rate of $0.55 per share. On February 20, 2019, VEREIT’s board of directors declared a quarterly cash dividend at an annualized rate of $0.55 per share. 

Blue Vault’s Conclusions

In fairness to all concerned, hindsight is, as the saying goes, “20:20.” Did ARCP pay the shareholders in ARCT III too much in the merger? The returns to ARCT III’s early investors outperformed our custom benchmarks and placed ARCT III’s full-cycle returns among the top nontraded REITs in the Blue Vault’s Nontraded REIT Full-Cycle Performance Study. It is not clear from the SEC filings and conference call transcripts regarding the merger that the merger terms were “fair” to the shareholders of ARCP, given the lack of transparency about valuations and the reliance of UBS and Merrill Lynch on the management of both REITs to provide financial projections. The fact that the projections for AFFO did not materialize doesn’t prove anything. Still, it appears that the same team was effectively managing both REITs, and had a vested interest in providing shareholders in ARCT III with a good return. The success of future capital raising by nontraded REITs sponsored by ARC and its affiliates was probably enhanced by the results of the ARCT III full-cycle event.

The accounting scandals that eventually brought a conviction for fraud and large settlements by VEREIT, Inc. in class action lawsuits are well documented, and a sad episode that damaged the industry as well as ruining individual lives. Hopefully the industry has learned from the mistakes that were made and has more transparency and accountability today.

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Derek Hayes
Blue Vault's Services
April 14, 2016

BlueVault saves a lot of time and effort in obtaining good numbers for analysis and provides good insights to compare against my own.