Schorsch REIT merger may not be in the best interest of shareholders

A proposed deal to merge two nontraded real estate investment trusts by a company controlled by former nontraded REIT czar Nicholas Schorsch is under scrutiny by industry observers who question whether it is in the best interests of shareholders.

American Finance Trust Inc., or AFIN, on Wednesday said it intended to acquire the common stock of American Realty Capital-Retail Centers of America Inc. for $1.4 billion in AFIN stock and cash. Both nontraded REITs were sponsored and have advisers controlled by AR Global Investments, which in turn is controlled by Nicholas Schorsch and his partners.

AFIN also has a highly unusual 20-year management contract with its adviser that will allow Mr. Schorsch and his partners to get paid management fees for years to come.

One question that stands out in this proposed merger is when will ARC-Retail Centers investors know when they will be able to fully cash out their shares, one consultant said.
“This is definitely not a liquidity event. It’s a merger,” said Nathaniel Webster, president of Point Loma Investment Management, a consultant. “I think investors need to scrutinize this to see if it’s in their best interest.”

Investors bought ARC Retail Centers of America for $10 per share during its initial public offering from 2011 to 2014. However, investors will receive only 95 cents for each share of ARC-Retail Centers — along with 0.385 shares of AFIN stock — they own, according to the merger agreement. The merger values AFIN shares at $10.26 per share based on its net asset value published at the end of last year.

If the deal is approved by shareholders, investors will not be able to sell their shares on an open market and potentially liquidate their positions.

“For an investor getting 95 cents in cash, the bigger question is what’s the plan for AFIN,” Mr. Webster said. “Investors are being asked to approve a transaction where the future is unknown. ARC-Retail [Centers] investors are being rolled into another REIT. But what’s its plan for liquidity?”

Rolling a nontraded REIT into a publicly listed REIT was the hallmark of previous mergers that Mr. Schorsch and his firm maneuvered in 2013 and 2014, when the so-called REIT czar was flying high. His ability to liquidate his nonlisted REITs quickly and profitably was a key element of his pitch to brokers who sold his nontraded REITs.

A spokesman for AR Global, Jesse Galloway, did not return calls on Thursday to comment. In its press release announcing the deal, AFIN pointed to a number of “strategic and financial benefits of the merger,” including: an improved capital structure; broader diversification of retail tenants; and savings in fees of $10.9 million starting next year.
In April, InvestmentNews reported that Mr. Schorsch’s AR Global was attempting to consolidate more than half a dozen nontraded REITs with almost $10.5 billion in assets. The AFIN/ARC Retail Centers merger is subject to the approval of shareholders from both REITs. The transaction is expected to close in the first quarter of next year, the companies said in a statement.
Mr. Schorsch is the former CEO and chairman of AFIN and ARC-Retail Centers. The REITs, respectively, had $2.16 billion and $1.26 billion in assets at the end of June.
Another concern among industry observers is that the proposed merger eliminates key charter provisions that protected investors.
“ARC-Retail Centers had several protections built into its charter that protected the shareholders from overtures by the adviser and its affiliated REITs,” said Kevin Gannon, managing director at Robert A. Stanger & Co. Inc., an investment bank that focuses on nontraded REITs.
“The board (at ARC Retail Centers) had solicited proxy votes of the shareholders over the last several months to eliminate these protections, but the proxy vote failed, indicating that investors did not want these protections removed,” Mr. Gannon said. “Now comes a transaction proposed by the special committees of ARC-Retail [Centers] and AFIN, which circumvents these important protections, including a revision of the terms and duration of the advisory agreement from one to twenty years.”
Other pitfalls for investors include the insertion of a potential fee for internalization of the ARC Retail Centers adviser of over $110 million as well as the removal of roll up protections, Mr. Gannon noted. Those are protective features that would have required AFIN to offer dissenting shareholders 100% in cash rather than the mostly stock component, he noted.
“Given the recent failure by the (ARC-Retail Centers) board to get the proxy approval on these features, the proposed transaction seems somewhat tone deaf to the voice of the shareholders,” Mr. Gannon said.
(More: How Nick Schorsch lost his mojo)