American Realty Capital Properties (NYSE:VER) delivered strong results in the second quarter as it topped the expectations of Wall Street, and saw its adjusted funds from operations rise by 26% during the last year.
But the reality is, while the results were impressive, there is much to learn about this rapidly expanding company. In one year's time, it has seen its stock issued rise from 185 million shares to 902 million shares. The management team provided five helpful bits of insight on the conference call as to where the company is headed.
1. The reason for the massive growth
According to David Kay, ARCP President:
My experience at ARCP this past 7-1/2 months has been amazing. I could not be more excited about my senior management team and the future prospects of this Company. From afar, it may appear at times our rapid growth is hard to understand. I can assure you, however, that everything we do is directed toward a singular objective: to create value for our shareholders.
David Kay will officially be appointed as the new CEO of American Realty Capital Properties, so his opening remarks on the conference call are important to note. As noted previously, one of the most striking things about ARCP during the last year is the incredible growth it has undergone. Yet, to know this has been done with the sole purpose "to create value for [its] shareholders" is a bit of relief.
Only time will tell if this growth actually does create lasting value, but knowing the intention of it all is to benefit shareholders is a welcome sign.
2. A better grasp on Red Lobster
Lisa Beeson, ARCP COO said:
Yesterday, we closed a $1.5 billion sale leaseback transaction for Red Lobster. This transaction was structured whereby we selected the best locations and divided the properties into multiple lease pools with long-term cross-defaulted leases with financial covenants and restrictions on leverage and assignability. We spent a significant amount of time not only underwriting the real estate but working with Golden Gate and the Red Lobster management team to understand their business plan.
At first glance, the purchase of 500 Red Lobster properties -- the physical locations, not the actual restaurants and operations therein -- by American Realty Capital Properties is a touch concerning. After all, while it has since been sold to a private equity group, as my colleague John Maxfield noted, Red Lobster was spiraling out of control. And, as a result of the deal, Red Lobster now represents 11% of the revenue ARCP brings in. This means that ARCP has a true interest in the ultimate success of the restaurant, even if it's just ensuring the company pays its rent.
But knowing a significant amount of due diligence was done in researching not only the properties, but the course of action for the restaurant itself, is an encouraging sign. And the financial covenants tied into the deal mean there is less risk. The Red Lobster deal is still a bit worrisome, but it's encouraging to know a proper amount of action was taken before the deal was actually signed.
3. Diversity is key
David Kay, ARCP President, also said:
Moreover, our pricing advantage also lies in the diversity of properties in which we invest: the mixture of traditional investment-grade long term leases; high-quality non-investment-grade tenanted properties; and medium-term vintage leases which afford us relatively higher yields in a broad spectrum of industry creates better overall returns, broader diversity, and ultimately, better portfolio metrics.
Although ARCP is heavily tied to Red Lobster, it's important to note it still has a wide range of diverse tenants who rent from it. In fact, despite the fact its top tenant -- Red Lobster -- accounts for 11% of its revenue, the top 10 in total represent 31%. By comparison, National Retail Properties (NYSE:NNN) has nearly 39% of its revenue concentrated in its top 10 tenants.
It's also important to note that 46% of the revenue that National Retail Properties brings in is from tenants who are considered to be investment grade -- meaning they have high or medium credit ratings from the agencies -- whereas just 20% of the rent National Retail Properties receives is from investment grade companies.
Even with the somewhat troubling reality of the concentration it now has in Red Lobster, it's key to remember that it still has a wide range of safe tenants.
4. The growth will slow down
Another quote from David Kay:
Our focus is really on sticking to what we said we were going to do, which is we believe our leverage levels at the $4.5 billion number are the right number. We are not going to raise equity for the remainder of this year.
Through the first six months of the year, American Realty Capital Properties purchased more than $4 billion worth of properties, representing nearly 95% of the $4.5 billion target it set at the beginning of the year. With that in mind, the natural question became, will the company really purchase "just" the $250 million it had remaining on its budget to hit its target? As we can see in the remarks above, that is indeed the answer. As David Kay affirmed, the company will stick to its previous goals.
In many ways, this could be both a good thing and a bad thing. A good thing because it means the company will be able to slow down and catch its breath, and also that it isn't just buying property for the sake of buying property. But there's also the reality that if a great deal presented itself, one would hope the company would be able to capitalize on it.
I'm not exactly sure where I stand on the issue, as I can see the benefits of both sides. But with all the changes that have occurred, a slowdown will be a nice time for investors to regroup and truly understand the rebuilt company's dynamics.
5. Their goal is our goal
Lastly, Kay said:
Certain circumstances require hard decisions and there will be many more in the future. Our decisions will always come back to the same fundamental first principle: Are the steps we're taking designed to improve shareholder returns while managing risk appropriately?
Taking it full circle, we have no idea if the new CEO of American Realty Capital Properties will be able to meet the goal stated above; but it is certainly encouraging to know that improving shareholder returns, while appropriately managing risk, is the "fundamental first principle" that will guide his actions.
It's far too early to tell just how well the company will succeed at meeting this goal. But it's undeniably a great place to start.
Patrick Morris has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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