Monday, April 04, 2011

If You Can't Beat Them, Join Them - Part II
I received the following comment on my previous post:
I read the filing differently. First, looking closely at ARCT’s 10K, the entire award to management is 1.5 million shares ($15 million). Not sure how you are arriving at $75 million. Second, only half the award is time vested. The other half is purely performance based and is paid only after the investor receives 100% of his/her capital back plus a non-compounded annual 6% return on capital. Finally, no vesting occurs at all for two years, and the award vests over a five year period. My take is that the independent board made the stock award based on management’s exemplary performance to date. Seems to me there is a big difference between this type of award and an internalization fee which seeks to retain management, irrespective of performance. At the end of the day, ARCT’s restricted stock plan is pay for performance. It merely recognizes the results achieved.
American Realty Capital Trust (ARCT) initiated the restricted stock awards program in January 2010.  The initial amount available for restricted stock awards was 1% of the amount of shares being offered or 1,500,000 shares, which totaled $15,000,000.  In the post effective amendment filed on March 11, 2011, the amount appears to have been changed to reflect no more than 5% of the shares outstanding, up to a maximum of 7,500,000 shares or $75,00,000 if all ARCT shares in the offering are sold.  At February 28, 2011, the amount of shares outstanding was 74,854,000.  So, 5% of 74,854,000 is 3,742,700 shares available under the incentive restricted share plan, which at $10 per share is $37,437,000.  Obviously, the amount of shares outstanding, and therefore amount available under the incentive restricted share plan, will increase as more shares are sold and ARCT moves towards the close of its offering period.

It is hard for me not to correlate the dropping of internalization fees in June 2010 and the recent, potential five times increase in shares available under the incentive restricted share plan.

The incentive restricted shares are not immediately vested.  Half the shares are paid over a four year period.  Half the shares have a subordination feature.  The subordination feature is not like the one described in the comment above, although that would be excellent if it was.  The incentive (subordination) feature is follows:
50% vest only to the extent our net asset value plus the distributions paid to stockholders equals 106% of the original selling price of our common stock.
I think it is best to use an example to how these shares may vest.  The 106% of the original offering price is $10.60 per share, which is the amount by which the combined net asset value and cumulative distributions must exceed before ARCTs' incentive restricted shares are allowed to vest.

ARCT is required to make a net asset value calculation eighteen months after it closes its offering.  Assuming ARCT closes its offering on June 30, 2011, it would have to provide a net asset valuation by December 31, 2012.  For illustration purposes, I'll use a net asset value of $8.85 per share, which is just the offering price of $10.00 per share less ARCT's offering costs, which are competitive with other non-traded REITs.   It is probable that the net asset value will differ from this amount.   Next you need to add ARCT's cumulative distributions to the net asset value.  (I don't read anything in the description above that reflects the timing of distributions.)  ARCT paid a 6.7% distribution in 2009.  In 2010 it paid 6.7% for three months and 7.0% for nine months.  If it continues to pay a 7% distribution in 2011 and 2012, it will have paid cumulative distributions of $2.74 per share by the end of 2012.   If the cumulative distributions of $2.74 are added to the $8.85 net asset value, and this totals $11.59, which is greater than the $10.60 share price that triggers the vesting.  The following table uses the paid distributions and the $8.85 per share net asset value price estimation:

2009  $0.65
2010  $0.69
2011  $0.70
2012  $0.70
Cumulative Distribuiton  $2.74
NAV at 12/31/2012  $8.85
NAV + Distributions  $11.59

Finally, I'd want to address the exemplary management comment.  I want ARCT's management to be exemplary, and this post or the previous post are not disparaging ARCT.  The non-traded REIT industry needs ARCT's management to be exemplary.  But to me, I think it is too early to bestow awards for excellent management, whether for ARCT or any REIT still in its offering phase.  Olympic gold medals in the 100-meter dash are not awarded after twenty yards, the Lombardi Trophy is not awarded at the end of the first quarter, and I have never heard of a baseball owner giving a manager a performance bonus in the middle of May.  A non-traded REIT (or any investment product) should not award multi-million dollar, dilutive, stock grants, whether restricted or not, to management while the REIT is still in its offering phase and while it is still investing investor capital.

1 comment:

Anonymous said...

The frustrating part about ARCT providing their management team with an incentive bonus is that the fund, according to 2010 10K, has MFFO cover of 104% & FFO coverage of 200%. They've incentivized themselves before they actually cover their distribution. Not only that but they collect their back end participation fee (disposition fee) even if they underperform. You mentioned that ARCT needs to provide the shareholders with a return of 106% of their original investment before they collects the disposition fee, but their already supposed to be paying a distribution north of 6% (which, by the way, has never been covered from operations). Therefore, if they're paying more than a 6% distribution and all they have to return to investors is a 6% positive return, that allows them to purchase properties that never appreciate and yet they would still collect their disposition fee. That doesn't seem like good management to me, and it certainly doesn't show me that they have confidence in the real estate they purchased.