American Campus Communities: Debt Covenants and Dividends, Part II

| About: American Campus (ACC)

On Friday, American Campus Communities (NYSE:ACC) announced that it was maintaining its dividend at the current level. Obviously, my prediction that ACC would cut its dividend to 26 cents was wrong - there can be no excuses. I believe this is attributed to the failure of one of the assumptions that I need to make in order to predict the cut. We can use this new information to reformulate our trading strategy with respect to ACC.

You will recall that in my last article I based my prediction on the following two assumptions:

(i) Q1-2009 FFO will be stable (not higher than Q4-2008)
(ii) ACC will be unable to amend the applicable debt covenant

Since I do not have access to ACC's books, these assumptions were necessary in order to make any prediction about the dividend. Now that we know that the predictive model has failed, it is likely that one of the assumptions failed. If we can figure out which assumption failed, we can use the new information to continue to make trading decisions with respect to ACC. If neither of these assumptions has failed, there are two additional possibilities which I will also discuss.

In the coming weeks, we will be able to use process of elimination to divine the truth. For example, if the announced level of FFO does not support the dividend level, we will know that assumption #1 did not fail. Conversely, if ACC has a blowout quarter, we will know that the assumption did fail and we can get long on the stock. Similarly, if an amendment to the credit agreement is filed with the 8K or 10Q, we will know that assumption #2 did fail. If no amendment to the credit agreement is filed or disclosed, we we have to determine whether ACC is in violation of its debt covenants or whether my methodology is wrong.

Here are the possible scenarios:

Scenario #1 - Assumption #1 Failed (Q1-2009 FFO Was Better Than Stable)

My prediction was based on the basic assumption that the quarterly results would be weak. If the results are not weak, they might be strong and I need to consider getting long in ACC. If ACC has engineered a sudden fundamental reversal in its financial condition, I want to profit too. I am a trader, so I will not be so stubborn as to ignore a turnround if it makes me money.

Since ACC maintained the dividend at the current level, it is entirely possible that they had a blowout quarter. In my original article I had to assume that aggregate FFO would be $15,232,000 in order to derive an answer to the dividend/FFO equation. We can assume that number is wrong since the dividend was not 26 cents. However, since we now know the amount of the dividend, we can plug in the entire dividend side of the equation and derive the expected FFO number for this quarter. You will recall that the equation was as follows:

d1 + d2 + d3 + d4 ≤ 1.10f1 + 1.10f2 + 1.10f3 + 1.10f4

Now that we know d1, the only remaining unknown variable now is f1. We can plug in all of the other constants to figure out f1.

Here are the constants that we know:

Since we know (or can reasonable assume) all variables other than f1, we can solve for f1 by plugging in our constants to the above equation as follows:

$14,276,250 + $14,276,250 + $14,403,000 + $12,517,000 ≤ 1.10f1 + 1.10($15,232,000) + 1.10(6,372,000) + 1.10($10,589,000)

or restated as:

$55,472,500 ≤ 1.10f1+ $35,412,300

By substracting $35,412,300 from both sides of the equation we can restate it as:

$20,060,200 ≤ 1.10f1

If we divide both sides of the equation by 1.10, we get:

f1 ≥ $18,236,545

We will find out whether this was the case when the earnings are released. The company should release the FFO number for the quarter and we will be able to determine whether FFO was more than $18,236,545.

If this is true, it would represent FFO growth of nearly 20% in the middle of the school year. This is the kind of fundamental change that would make me bullish on ACC. If they accomplished this, it is a miraculous turnaround and I will lead the bull charge on the company. This kind of growth could be achieved by increasing revenue, decreasing costs or a combination of both. If they accomplished this in the current economic climate, I have truly underestimated the management team and I give them the highest kudos. As long as the increase is not non-recurring or the result of accounting gimmicks, I would try to get long on a pullback.

How likely is the scenario? In my opinion, given the nature of revenues in the student housing business, I still believe this is not the reason for the lack of a dividend cut. I believe that the lack of a cut is most likely attributed to a failure of my second assumption and ACC was able to amend the applicable debt covenant.

Scenario #2 - Assumption #2 Failed (ACC was able to amend the applicable debt covenant)

I believe this is the most likely explanation for the lack of a dividend cut. It is possible that ACC was able to amend the applicable debt covenant which would allow them to pay aggregate dividends in excess of 110% of aggregate FFO for the last four quarters. Since ACC recently completed a dilutive common offering, the lenders may have allowed them to payout the dividends in excess of the previous debt covenants in order to entice a new injection of capital. If this is the case, my outlook on the company would not change. This type of action will have only bought the company additional time. However, the dilutive increase in the float will put additional dividend pressure on the company going forward and I would still expect a collapse in the stock price eventually. This scenario will not change my opinion that ACC is an overleveraged and will eventually succumb to Gambler's Ruin.

We will know whether this is the factual situation under which ACC is operating very soon. An amendment to the credit agreement might be filed with the 8k on Tuesday. An amendment or waiver might also be disclosed on Wednesday's conference call. In fact, I will email all of the analysts that cover ACC and request that they inquire about such an amendment if FFO comes in below $18,236,545 for the quarter. (I won't hold my breath that such question will be asked on the conference call because I do this type of thing every quarter and analysts routinely ignore me. I think they like to stick to the script.)

If an amendment to the credit agreement is not filed with the 8k or disclosed in the conference call, I will definitely expect it to be filed with the 10Q in the coming weeks. If no amendment is filed by the time the 10Q is filed, I will have many questions for ACC and the market mechanism will have to determine whether my analysis is correct or ACC is violating its debt covenants. I will discuss these possibilities below.

Scenario #3 - The Assumptions are Correct but the Methodology & Analysis Is Incorrect

I am human, therefore it is completely possible that my methodology is wrong. The analysis that I undertook is not simple. I spent over 30 hours reviewing SEC filings in order to come to my conclusions. Although a former law clerk of mine checked my mathematics, nobody else has taken the time to review the documents to check my methodology.

I am hoping that someone will take on the task of proving me wrong. I welcome scrutiny from my readers, the Seeking Alpha community, the academic community and bloggers to prove me wrong. I hope to create a dialogue to discover the truth or falsity of my analysis.

Scenario #4 - ACC is in violation of its debt covenants

Normally, I would dismiss this possibility and simply admit to a failure of my methodology if neither of my assumptions fail. However, in the case of ACC, I believe it is entirely possible that they would willfully or negligently violate their debt covenants. As you may know, ACC acquired GMH Communities Trust last year (GCT). Click here for a link to a press release about the merger.

In April of last year, prior to the merger, GCT settled a class action lawsuit for $8.75M. Click here for a link to the Stanford Law School Securities Class Action Clearinghouse Summary that discusses the settlement. Among other things, the lawsuit alleged:

...GMH Communities Trust and certain of its officers and directors, disseminated false and misleading financial statements in a scheme to inflate the earnings of the Company and issued dividends in violation of loan covenants in order to drive the price of its stock higher. The higher stock price allowed the Company to sell a secondary offering in October 2005 on more favorable terms.

While I know that ACC is a different entity, I also know that they share common board members. While I doubt they would be so bold as to simply ignore a debt covenant, I cannnot completely dismiss the possibility given the past record of GCT. The apple does not fall far from the tree.


If we do not receive confirmation of failure of either of my assumptions with the upcoming release of earnings and the filing of ACC's 8K and 10Q, the mob will have to decide whether scenario 3 or scenario 4 is true. I am eagerly awaiting the release of these results and look forward to feedback from readers.

Disclosure: Author holds short positions in ACC, ARE, KRC; Long positions in IEF, TLT, Gold, Silver

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