Citigroup slaps ‘buy’ rating on RCAP as Moody’s lowers ARCP debt to junk status

Citigroup Global Markets Inc. on Tuesday upgraded its rating on shares of RCS Capital Corp. to “buy” from “neutral” one day after executive chairman, nontraded real estate investment trust czar Nicholas Schorsch, stepped down as chairman of American Realty Capital Properties Inc.
ARCP, a giant traded REIT, revealed near the end of October a $23 million accounting error in the first half of the year that was intentionally not corrected. Moody’s Investor Services on Tuesday downgraded $2.5 billion of ARCP unsecured debt to junk status, lowering the debt to a rating of Ba1.
Moody’s downgraded the senior unsecured debt rating for ARCP with a negative outlook “due to ARCP’s announcement that its chairman Nicholas Schorsch resigned on Dec. 12 and its CEO David Kay and president and chief operating officer Lisa Beeson resigned on December 15,” Moody’s said Tuesday. “Moody’s rating reaction reflects the continued uncertainty surrounding the unsecured debt rating from the accounting, legal and investment banking reviews.”
RCAP is a broker-dealer holding company with two main lines of business: retail wealth management and advice through a network of more than 9,000 registered reps and advisers and a wholesaling broker-dealer for nontraded REITs and other alternative investments, for the most part sponsored by AR Capital, another company Mr. Schorsch controls.
(More: Schorsch exits key company in his REIT empire)
RCAP shares Tuesday afternoon were up 29 cents, or 2.8%, at $10.75 after climbing as high as $11.28.
William Katz, an analyst with Citigroup, said he was raising his target price for RCAP shares to $19 per share from $13. The upgrade follows a meeting with RCAP management last Friday in New York, a meeting that did not include Mr. Schorsch but other key executives at RCAP, including chief executive Mike Weil and Larry Roth, CEO of Cetera Financial Group, the retail wealth management and financial arm of RCAP.
(More: See Citigroup’s statement.)
“We came away from our meetings with management constructive around” the stability of the broker-dealer and its ability to drive stronger margins into 2015 and the “viability of the wholesale/investment banking platforms,” Mr. Katz wrote. There is also the “expectation that management will make additional moves to alleviate perceived franchise conflicts of interest.”
“We believe a key investor concern around the RCAP story is the impact of recent headlines on the Cetera/broker-dealer business including potential damage to recruitment, retention and production,” Mr. Katz wrote. “Following our conversations with management and select Cetera advisers, we see no reason to believe the ‘core’ broker-dealer business will be materially impacted by the ARCP headlines and slowdown in nontraded REITs,” he wrote.
RCAP is trading at roughly half the median price-to-earnings ratio and cash flow multiple versus key peers, Mr. Katz noted. That extreme discount will moderate due to RCAP’s execution on finding synergies across its network of broker-dealers, additional recovery in selling agreements as more broker-dealers begin selling AR Capital REITs, and further moves to reduce the complexity of the franchise, Mr. Katz noted.
(More: With stock off sharply, Schorsch’s RCS Capital says ‘We’re not ARCP’)
Certain key risks still hang over RCAP, Mr. Katz added. According to Mr. Katz, those include: uncertainty of fiduciary responsibilities and complexity of management structure; a failure to achieve the discussed synergies; continued weak nontraded REIT sales; and a forecast loss of 9 cents per share in the company’s fourth quarter earnings.