“Turnarounds” can be a great place for investors to find big time gains and profits. That is, if the turnaround is successful. More often than not, these special situations end up costing more than investors bargained for and fall into the dreaded “value-trap” category. Finding good companies that can actually turn the ship in the positive direction is easier said than done. It takes the right combination of assets, businesses and leadership to get the job done.
However, VEREIT (VER ) may be one of the companies in this camp.
To say that the real estate investment trust (REIT) fell on hard times would be glossing over the situation. After rising to the top of REIT crop, VER made some huge mistakes—namely getting embroiled in an accounting scandal. Subsequently kicking its former management to the curb, VER seems to be on the right track to regaining its previous glory. That includes resuming its formerly juicy dividend payments.
For investors, VER offers exactly what makes a great turnaround situation possible
The Initial Issues at VEREIT
VEREIT’s story starts with real estate mogul Nicholas Schorsch. Schorsch had his hand in many different real estate ventures—including American Realty Capital Trust (ARCT) which was acquired by REIT giant and dividend stalwart Realty Income Inc (O ). Arguably his biggest project was American Realty Capital Properties (ARCP). ARCP was created through a series of two multi-billion-dollar mergers occurring in less than four months. The combination of assets made ARCP one of the largest triple-net leased and single property REITs in the country. All in all, ARCP owned more than 4,600 different properties.
Add in the firm’s monthly dividend policy to its huge size and investors flocked to shares thinking that they had another Realty Income in the making.
Then October 2014 happened. The firm disclosed that it had purposely covered up an accounting error. That sent shares of ARCP plunging 27%. Executives were punished and ousted—including Schorsch—the ARCP’s credit rating was cut, and that juicy dividend was suspended. Incidentally, Schorsch has also had issues and a bankruptcy filing with another one of his ventures RCS Capital Corp (RCAP).
As a REIT without a dividend, ARCP was basically left for dead by the investing public.
Where It Gets Interesting for VEREIT
As a zombie REIT, ARCP needed direction—and it got it in new CEO Glenn Rufrano. Rufrano has had a long history of turning around dying REITs and commercial real estate operations. After renaming ARCP as VEREIT, Rufrano got to work on transitioning the company.
To start, Rufrano began combining through VER’s huge network of properties. The REIT sold off nearly $1.4 billion worth of buildings, particularly those tied to Darden’s (DRI ) recently spun-off Reb Lobster chain. The restaurant was VER’s top holding and accounted for more than 12% of its annual rents. That’s about double what Realty Income and other net-leased rival National Retail Properties (NNN ) receive from their top tenants. Rufrano recently announced plans to dump another $600 million worth of Red Lobster-tied properties, as well as additional non-core buildings. Many of these buildings come with multi-year flat leases, which is a problem during a period of rising interest rates.
The key has been to pay down debt acquired during these sales and needed to conduct the two mega-mergers that created VER. Those debt pay downs are necessary as VEREIT lost its investment grade rating during the scandal and today features a high debt-earnings ratio. Reducing that debt and having access to cheaper capital is a must for the REIT as it takes big, big, big deals to move the needle at a firm with 4,600 different buildings already under its wing.
Aside from pruning VEREIT’s portfolio, Rufrano has gone to work repairing its Cole Capital investment arm. One of the reasons why VER was able to grow so big so fast was that it acquired Cole for $11.2 billion. Cole was a sponsor and manager of non-listed REIT funds which are sold by broker-dealers. Schorsch purchased and rolled many of Cole’s property funds into ARCP/VER. Today, VER still controls the arm that sponsors new and existing non-listed REIT funds.
The beauty is that Cole’s funds could be managed in such a way that they “fit” with VER’s current holdings. That means the parent could step in and buy-out those properties from Cole, just like before. Additionally, VER could also sell Cole outright if it needed to free-up cash for debt reduction or other expansion efforts.
The Turnaround Is at Hand
The real thing for VEREIT is that the plan appears to be more than “smoke and mirrors,” and is actually working. All of these efforts have resulted in a reinstatement of the REITs dividend, a real reduction in net debt and a better overall property mix. These are the vital and fruitful steps in VER’s much-needed turnaround plan.
As Rufrano continues to prune, sell and work on beefing-up its tenant quality, they’ll be more room for VER to grow. Optimistically, VER’s CEO predicts that they’ll have a plan for growth by the end of the year. That’s a tall order—given the company’s size—but the direction is still very positive.
And yet, the market is still worrying about the past issues and not believing this is fast enough. VER shares fell 12% in 2015, and are down about 7% so far this year. VER can be had for an 8% dividend yield.
More importantly, the price drop has made VER insanely cheap. VER can now be had for less than book value and a dirt cheap Price-FFO metric of around 10. That’s a steal given that the company’s turnaround plan is actually becoming a winning one. For investors, VEREIT could have exactly the goods needed to turn this dud into a real winner.
