Choosing good stocks is hard, even for investment professionals. There are numerous quantitative and qualitative factors to consider, such as a company’s earnings power, management capability, the fundamentals of the industry it operates in, and the regulatory environment, to mention a few. Although stock prices should, in theory, reflect all of this information, we believe there are pockets of inefficiency in the equity markets that can be exploited. One such opportunity is mimicking the buying patterns of hedge funds.
During the fourth quarter of 2013, many hedge fund managers increased their holdings or purchased new shares of American Realty Capital Properties, Inc. (NASDAQ:ARCP), such as Richard McGuire of Marcato Capital Management (who is the seventh largest shareholder), Doug Silverman and Alexander Klabin of Senator Investment Group and Michael Thompson of BHR Capital. Other shareholders include Michael Blitzer of Kingstown Capital Management, Alok Agrawal of Bloom Tree Partners and Jay Petschek and Steven Major of Corsair Capital Management.
American Realty Capital Properties, Inc. (NASDAQ:ARCP) is a $2.7 billion market cap diversified real estate investment trust (REIT) that owns single tenant, freestanding commercial real estate that is net leased (leasing arrangements where lessees pay taxes and insurance in addition to rent) on a medium-term basis, primarily to investment grade credit rated and other creditworthy tenants. It has a history of growth through acquisitions, the most recent of which was its $7.3 billion purchase of Cole Real Estate Investments, Inc. in February 2014.
In March 2014, the company announced plans to spin-off its multi-tenant shopping center business into a separate REIT, American Realty Capital Centers, Inc. (or ARCenters), that is expected to trade on the NASDAQ under the symbol ARCM sometime during the second quarter of 2014. Similar to other companies that have divested their shopping center assets, ARCP management intends to unlock shareholder value with the transaction while retaining 25% ownership in ARCM, which is expected to generate more than $139 million in net operating income on a stand-alone basis during 2014. Financial benefits of the spin-off include $400 million of proceeds (reducing ARCP’s balance sheet leverage), $0.05 (4%) accretion to Adjusted Funds From Operations (FFO) per share in 2014, higher dividends ($1.073 per share from both companies on an annualized basis versus $1.00 per share currently for ARCP only) and lower capital expenditures for ARCP. Despite these positives, investor reaction to the news was fairly muted, with the shares rising 1% on the day of the announcement and declining 8% subsequently.
American Realty Capital Properties, Inc. (NASDAQ:ARCP) trades at a forward EV/EBITDA multiple of 10.6X versus 14.9X for its peer group of diversified REITs, while its dividend yield of 7.4% is higher than the 5.0% for peers, reflecting low market expectations for the spin-off. Despite the cheap valuation, the stock seems fairly valued, given its high debt levels and history of acquisitions, which tend to be financed with additional debt and equity issuances. A high dividend yield will compensate investors willing to wait for better visibility into the performance of the two separated entities, which could serve as a positive catalyst for the stock. However, for those seeking capital appreciation in addition to income with less risk, there are better opportunities in the REIT space.
The article has been written by Jason Seo of Insider Monkey.