Accounting Irregularities Knock Down ARCP: Buying Opportunity or Enron Part 2?

ARCP: American Realty Capital Properties logo
ARCP
American Realty Capital Properties

Submitted by Sizemore Insights as part of our contributors program

Accounting Irregularities Knock Down ARCP: Buying Opportunity or Enron Part 2?

by Charles Lewis Sizemore, CFA

Relevant Articles
  1. Beating S&P500 BY 11% YTD, What To Expect From Travelers Stock?
  2. Up 50% Over The Last 12 Months, Is Hyatt Stock Still Attractive?
  3. Capital One Stock Gained 44% In The Last 6 Months, What’s Next?
  4. Up 8% Year To Date As 5G Gains Traction, What’s Next For Verizon Stock?
  5. Up 32% In The Last 12 Months, Where Is BNY Mellon Stock Headed?
  6. Rallying 30% YTD, What’s Spurring The Rally In Applied Materials’ Stock?

It’s never a good sign when a company’s CFO and top accountant abruptly resign at the same time “accounting irregularities” are announced, but that’s exactly what happened at American Realty Capital Properties (ARCP) this morning.

An audit committee said, in a nutshell, that every quarterly report put out this year should be discarded and that the number from last year’s annual report shouldn’t be relied upon.

This is the sort of thing that makes investors dump a stock first and ask questions later.  At time of writing, ARCP was down about 30% on the day  after being down significantly more.

Given the extent of Wednesday’s stock implosion, I would consider this a buying opportunity in ARCP—albeit a risky one.  In the interests of full disclosure, I added to my existing position in ARCP at prices ranging from $8.22 to $8.48, and we’re a little above those levels now.  But I believe that ARCP could easily deliver total returns including dividends of 50% or more in the next six months if the accounting irregularities end up being anything short of catastrophic.

Let’s take a look at the numbers.  Based on the preliminary reports, the 2014 Q1 adjusted funds from operations (“AFFO”) of $0.26 would be cut to $0.23, and the Q2 AFFO of $0.24 would be cut to $0.22. The audit committee believes that the 2013 numbers are probably accurate, though they are still investigating.

The worst aspect is that there are allegations that management—or at least the CFO—knew about the irregularities and knowingly abetted them.

Still, let’s keep this in perspective.  We’re talking about a difference of 5 cents over two calendar quarters.  Still, as Brad Thomas, editor of iREIT Investor, noted in an update to readers this morning, this doesn’t cover the 8.3-cent monthly dividend—which could mean that a dividend cut is a real possibility.

I’m not too worried about a dividend cut in the next 6-12 months.  ARCP should have plenty of access to cash to sustain that dividend, though it probably won’t be growing it much.

But the biggest reason I am inclined to give ARCP the benefit of the doubt is that company insiders have been steadily accumulating the shares throughout 2014. Ten different insiders—including the company’s general council—have purchased a combined $3 million since January of this year.

Insider
Position
Date
Buy/Sell
Shares
Trade Price
Cost
Stanley William G Director 7/11/2014 Buy 10,000 $12.66 $126,600
Stanley William G Director 6/25/2014 Buy 18,000 $12.39 $223,000
Silfen Richard A EVP and General Council 6/25/2014 Buy 4,850 $12.34 $59,800
Silfen Richard A EVP and General Council 6/11/2014 Buy 7,500 $11.80 $88,500
Stanley William G Director 5/23/2014 Buy 24,000 $12.35 $296,400
Bowman Scott J. Director 5/21/2014 Buy 10,000 $12.27 $122,700
Bowman Scott J. Director 5/16/2014 Buy 10,000 $13.08 $130,800
Weil Edward M Jr. Director 4/21/2014 Buy 7,500 $13.28 $99,600
Beeson Lisa COO 3/28/2014 Buy 3,500 $13.88 $48,600
Weil Edward M Jr. Director 3/28/2014 Buy 10,000 $13.80 $138,000
Schorsch Nicholas S Chairman of the BoD and CEO 3/27/2014 Buy 50,000 $13.78 $689,000
Block Brian S EVP, Treas, Secy and CFO 3/27/2014 Buy 20,000 $13.8 $276,000
Kahane William M Director 3/27/2014 Buy 25,000 $13.78 $344,500
Kay David S President 3/27/2014 Buy 15,000 $13.78 $206,700
Michelson Leslie D Director 1/28/2014 Buy 700 $13.94 $9,800
Michelson Leslie D Director 1/17/2014 Buy 6,900 $13.53 $93,400

Is it possible that they’ve all been bamboozled by a crooked CFO who had been cooking the books?  Sure.  Stranger things have happened.  But I’m not betting on it.

The most likely scenario here is that, due to incompetence and not mal intent, ARCP’s now departed CFO and Chief Accounting Officer botched their reporting by a few cents.  That’s bad—really bad.  But not quite bad enough to justify lopping off a third of the company’s market cap.

My advice: Use this selloff as an opportunity. I should reiterate that this is a risky investment.  The auditors could come back and find that the accounting irregularities go deeper than originally reported, in which case ARCP would potentially see a lot more downside.  But given the extent of the selloff and the steady insider buying, it’s a risk I’m comfortable taking.

Disclosures: Long ARCP

Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays.

This article first appeared on Sizemore Insights as Accounting Irregularities Knock Down ARCP: Buying Opportunity or Enron Part 2?