Figuring out Schorsch’s latest deal – or how 1 + 1 = 3

Nicholas Schorsch’s empire of nontraded real estate investment trusts, retail broker-dealers, asset managers and wholesalers are interconnected, like a set of Russian matryoshka dolls, sitting snugly one inside the other.
American Realty Capital makes the nontraded REITs; another company, RCS Capital Corp. (RCAP) sells and distributes the REITs through hundreds of independent broker-dealers; and another — the giant, publicly traded net lease REIT, American Realty Capital Properties Inc. (ARCP) — has so far acquired two of Mr. Schorsch’s nontraded REITs, to the delight of advisers and their clients.
Let’s begin with outlining his various roles. Months after ARCP shareholders rejected a bonus reward plan that would have netted him tens of millions of dollars, Mr. Schorsch stepped down Oct. 1 as chief executive of ARCP and remained as its chairman. He is executive chairman of RCAP and CEO of American Realty Capital (ARC).
The vast Schorsch domain got a bit more tangled at the start of the month when RCAP announced it was buying another nontraded REIT sponsor, manager and wholesaler of net lease REITS, Cole Capital, from — you guessed it — the aforementioned ARCP. Mr. Schorsch recused himself from the deal-making process.
Any transaction between two related companies raises certain questions. Has the deal been fairly valued? And is one company getting the better end of the bargain?
After completing the $700 million transaction, which could reach $830 million if Cole Capital reaches certain future performance figures, Mr. Schorsch’s companies will control more than half the sales of the $20 billion per year nontraded REIT business. To put it bluntly, Mr. Schorsch is no longer the biggest player in the nontraded REIT industry; the Cole Capital transaction means that Nicholas Schorsch pretty much is the nontraded REIT industry.
David Kay, the new CEO of ARCP, in an interview on Thursday preached that the deal represented simplicity, not complexity. Splitting Cole Capital from ARCP, and therefore subtracting Cole’s army of wholesalers from the net lease giant, would streamline the REIT’s main business of acquiring and managing net lease real estate, he asserted. At the same time, as part of the merger, ARCP and RCAP will share Cole Capital’s acquisition and asset management fees 50/50.
“This is truly a one plus one equals three transaction,” Mr. Kay said in an interview Thursday. When asked to clarify, he said: “I mean when you put one business together with another business, you just don’t add the numbers and say it equals two. In this case, both companies will expand.”
RCAP was also pleased with the deal. “We approached this as a trade with both companies interested in achieving a goal, with a process that was followed rigorously,” RCAP CEO Michael Weil said in an earlier interview.
In particular, RCAP will benefit from re-entering the net lease REIT business, Mr. Kay said. It abandoned that business in the summer of 2013, months before ARCP announced in October that it was buying Cole Real Estate Investments Inc., a giant net lease REIT that was also RCAP’s former heated rival in packaging and selling net lease REITs through independent broker-dealers. That’s how Mr. Schorsch got his hands on Cole Capital in the first place.
Dolls within dolls, wheels within wheels, REITs inside REITs.
Meanwhile, ARCP will act as subadviser to Cole Capital’s nontraded REITs and acquire and property manage net lease real estate assets for the funds. The new joint venture is a win for ARCP, according to Mr. Kay.
“We are back to being a core fund, a vanilla net lease company but with a little bit of sprinkles” from the subadvisory business, he said.
The Schorsch empire has a worrisome habit of paying top dollar for acquisitions. Last year, RCAP ponied up $1.15 billion — or close to 100% of annual revenue — for Cetera Financial Group Inc., a network of independent broker-dealers that house 6,600 reps and advisers. Essentially, Mr. Schorsch paid two to three times the standard valuation for such IBDs. He later argued that he had to pay top dollar for Cetera because it was a jewel of an asset.
Similarly, ARCP has just put a whopper of a valuation on Cole Capital. According to a filing this summer with the Securities and Exchange Commission, ARCP valued the Cole Capital broker-dealer and asset management business at $800 million, with $244 million from “net identifiable assets acquired” and $556 million in “goodwill.”
A few months later, open another doll, and Cole Capital is now valued at $1.43 billion, according to Mr. Kay.
“For $800 million, we bought a fee stream and a broker-dealer” when ARCP acquired Cole Capital, said Mr. Kay. “What we just sold to RCAP was half the fee stream and the broker-dealer. To calculate the value, if [ARCP] takes the $830 million over a couple of years, and then gets fees for five to seven years [from Cole Capital] and they total $800 million [or $600 million once the fee stream is discounted back to present value], you get $1.43 billion.”
Cole Capital’s price tag clearly raised concerns for some in the industry. “We haven’t seen any sponsor bought out at a price like that,” said Kevin Gannon, managing director of Robert A. Stanger & Co., an investment bank with a focus on nontraded REITs. “That doesn’t mean the price is bad, but it’s big.”
There is no doubt Mr. Schorsch and his REITs have performed well for advisers and their clients. Indeed, he is extremely focused on maximizing shareholder value, and that mitigates concerns over ARC’s aggregation of the nontraded REIT industry, said Mr. Gannon, who added that American Realty Capital is not a client of Stanger.
The true value of RCAP’s acquisition of Cole Capital will play out over time, but it’s clear that — in the Cole Capital deal and the spate of other transactions — Mr. Schorsch, RCAP and ARCP are all betting on the outcome. If the nontraded REIT industry, which is now symbiotic with Mr. Schorsch, continues to sell $20 billion per year of new product, Cole Capital will continue to kick off wholesaling and asset management fees to ARCP that will justify Cole Capital’s $1.43 billion valuation.
On the other hand, if REIT sales falter, if the transactions stop, the intricate parts of the Schorsch empire will no longer fit together so snugly. And that would be bad news for advisers.
Untangling Nicholas Schorsch’s vast web of businesses: