It’s the start of June—one of three best months to be alive—and yet, I’m stuck reading through the shenanigans that CEO Nicholas Schorsch is pulling at American Realty.
I’m still sorting through it all, but my initial impression is this: it appears that he can receive $92 million over the next five years simply for delivering 7% total returns and beat a group of selected peers by six percentage points annually over that time frame. As a reference point, the REIT pays out a $0.0833 monthly dividend, which is a dividend yield of 8.05% based on current prices. In other words, if the price of the stock remains static and the dividend payout remains the same, the first leg of that performance hurdle would be automatically met right now.
Really, the scary thing is that, Schorsch was unrepentant when reached for comment by the Wall Street Journal. Describing his $10 million base pay (not even speaking about the low hurdle performance bonuses), he offered this:
“It’s not like I’m making $10 million for showing up, staying at the office until 11 a.m., drinking a few cups of coffee and then playing golf the rest of the day.”
Someone who is incapable of experiencing shame is not someone to whom you want to give your money. If someone acts embarrassed when it is discovered that they have engaged in wrongdoing, they are still redeemable. Moral pressure and social expectations apply to them, and the memory of losing that respect can stick with them and lead to reformed behavior. But when someone is truly apathetic to what you think about them when they are rewarding themselves in an outlandish way, then the only restraint on their animal spirits is an outside force: a large activist shareholder stepping in and forcefully saying, “Knock it out!” But if you are dealing with someone incapable of imposing any restraint upon himself, you are going to get into trouble, then shareholders are at risk of losing significant value because there is no real self-policing mechanism at work.
And it’s not like you’re getting super high-quality assets in return either: Schorsch recently took on over 500 different Red Lobster locations as tenants. In other words, American Realty investors have to deal with an executive that treats shareholder equity as a giant piggy bank to shake at will while part of the cash flow generated for shareholders is going to hinge on Red Lobster paying its rent.
Not exactly a stock you’d buy if you followed the Warren Buffett advice of pretending you get a punchcard that only lets you make twenty investments over the course of a lifetime, eh?
To be fair, because this is real life and not an Aesop fable, there is a rationale for why American Realty could prove a workable investment over the next 5-10 years. First, even though I think the social fabric of America will not be torn the day Red Lobster goes under, there is no indication that the restaurant chain won’t be able to pay its rent in the near future. And secondly, Red Lobster is only a small part of American Realty’s overall assets. Thirdly, Schorsch has proven himself to be a good manager, and so it is hard to predict the results of what happens when a good manager receives outrageous compensation. And fourthly, this mini-scandal has allowed American Realty to trade in line with its 2011 valuation, suggesting the possibility that its discounted trading to cash flow per share generation is proof of investor overreaction and an opportunity for better-than-expected returns going forward. Those are the nuances that we have to fairly take into account.
It’s just…there are so many easier ways to make money. I can’t see, even in a realistic best case scenario, how American Realty could outproduce a basket of stocks that include Visa, Nestle, Johnson & Johnson, and Colgate-Palmolive over the next 15-25 years. Given that, why embrace the significant downside and the questionable morality that makes you wonder if the businessman at the top is fleecing you with dubious assertions of his economic worth to the company? If you stick with good brands led by management teams that are not outrageously diluting shareholders, you avoid the heartache.
Personally, I give American Realty the Hester Prenn treatment—in my files, the Scarlet Letter for American Realty simply says, “Don’t go there.” It’s so easy to capture the potential upside of American Realty without taking on its potential downside. This is basic risk management.
Originally posted 2014-06-01 19:57:16.
I say for the next year or 2… ARCP is likely going to be more profitable then PG, CL, KO… 15 to 25 years I don’t know and I don’t subscribe to the buy and hold, but rather buy and monitor.
This is the real crime:
http://seekingalpha.com/pr/10016043-american-realty-capital-properties-announces-full-exercise-of-underwriters-option-to-purchase-additional-shares
Share dilution at $12 a pop. Glad I’m not a shareholder.
ARCP offers the great combination of sustainable yield (8%) (check the overall portfolio not just the last move) and the possibility to grow its dividend 5 to 10% per year. It is receiving lots and lots of negative publicity which usually means is the moment to buy it.
As per the excessive paycheck… are Coca-cola directors regretting its compensation plan??? Are they more morally conscious despite the company was built many, many years ago and all they have to do is mainly show up? (which is what that CEO was referring in the interview despite the out of context extract)
ARCP has more risk that the ones you mention although quite limited since we are talking about a very diversified portfolio in the triple net area (ones of the most defensive). The problem is the stocks you mention are way overvalued and not something Ben Graham would have bought right now. And most likely not even Warren Buffet despite its quality due to the expensive entry price. If you buy a stock that pays 2,5% per year and grows its dividend 5-6% like Johnson&Johnson… you are trading “quality” for very poor returns using a rear mirror view.
Besides I do remember the author recommending picking up a bunch of REITs when they approach a 10% yield, so that when properly diversified even if one fails, the overall yield would allow to buy other “quality” companies that grow faster.
I also do remember the author advising on separating reputational risk from the numbers, which seem a portfolio of properties quite similar to Realty Income (on the author’s list) in terms of diversification, and the AFFO far exceeding the dividends.
So, the moral judgement of a stock based on a CEO’s comment without making further dilligence is never good advice. It is way too easy to follow the crowd and say a stock is bad when is at its lower point of a year, by very often in this kind of situation it might well pay-off to be a contrarian as my experience has told me once and again, and again, and again.
Whatever you do, make sure you perform further dilligence on a stock before taking a decision and not based your decision on the moral judgement of a sentence that is out of context. That is the advice I would have liked to read.
smartinv If you find the dividend yield sustainable, then yes, American Realty would be compelling as a source of income.
But from my point of view, I just don’t see the high probability of sustainability–the company isn’t even generating $1 per share in funds from operations to pay the current dividend. In other words, the REIT must issue new shares, make new acquisitions, or increase profitability at current spaces to meet its current dividend obligations (without even factoring in growth).
Is there a point at which executive compensation would cause you to sell? Or is that neither here nor there in the analysis of your own investing decisions?
TimMcAleenan smartinv
1 usd is the dividend not the AFFO.
First quarter AFFO was 0,26 usd, although that has been corrected to 0,28 usd according to a recent reconciliation form dated 19th may. Guidance for the company is AFFO for 2014 between 1,13 usd and 1,20 usd.
That guidance seems achievable if we look at first quarter AFFO, although some analysts are predicting 1,10 usd due to the last share dillution. As per 2015 estimated AFFO is around 1,28 usd which is 16% growth. Even if investors get a 5%-10% growth is still very good.
Whilst it is true that some investors have recommended voting against the compensation plan for the board it is also very interesting to note that with the last issuing of the shares, many stable institutional investors entered to buy the stock. In addition there was also some insider buying recently and I doubt directors want to throw their money away in its own stock.
I’m with you on this one Tim. This just seems like a classic case of it works until it doesn’t. Wheeler dealers can look good for a long time, but then the inevitable happens. Time will tell if we’re wrong. Maybe 10 years from now long term owners will have laughed all the way to the bank and we’ll be eating crow.