ACC: Debt Covenants and Dividend Cuts

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American Campus Communities (NYSE:ACC) is a real estate investment trust (a “REIT”) that bills itself as “…one of the nation's largest developers, owners and managers of high-quality student housing communities.” I believe ACC will be forced to reduce the dividend to 26¢ per share (or lower) in the next few weeks in order to remain in compliance with certain debt covenants.

I am not suggesting that student housing is a bad line of business. Investors tend to get hung-up on what a company does rather than how well it does it. My analysis is focused on ACC’s financial condition and the dividend as a function of Funds From Operations (“FFO”) per their debt covenants. (The analysis in this paper uses “FFO”, a metric defined by NAREIT, “…in order to promote an industry-wide standard measure of financial performance.” However, I believe FFO to be a metric based on false assumptions and I do not use it to evaluate REIT performance. (See my article “REITs and the Fallacy of FFO” for more information.) Nevertheless, I use this metric in this analysis because ACC’s debt covenants use this metric.) In addition, I believe that ACC has very serious problems with its capital structure and, therefore, the common stock is severely overpriced, fundamentally weak and an excellent short opportunity. I believe this could be the greatest short opportunity of 2009.


My analysis is based on the following assumptions:

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

I think these assumptions are fair. First, Q1-2009 FFO should not be significantly higher than Q4-2008 since the student housing (dorm) business is focused around the university calendar. Most students enroll in August and September, so I would expect that dorm revenues will not increase significantly in the first quarter. If anything, I would expect first quarter revenues to fall since some students will drop out. In any case, for my analysis I will assume that FFO will simply remain stable from the fourth quarter of 2008. Second, I think it is fair to assume that ACC’s debt covenants will not be modified since it is in the best interest of lenders not to allow payouts to junior equity. Lenders will want ACC to remain as well capitalized as possible to ensure full loan repayment.


My thesis is based on the following language from the “Second Amendment to the First Amended and Restated Credit Agreement” that was filed as Exhibit 10.1 to ACC’s 10Q filed on November 10, 2008:

By deleting subsection (i) of Section 5.02(g) of the Loan Agreement in its entirety and inserting in lieu thereof the following: “(i) no Default or Event of Default shall have occurred and be continuing at the time of declaration or payment thereof and the aggregate amount of such Cash dividends or distributions, together with the aggregate amount of Cash dividends or distributions made during the applicable period pursuant to the immediately following clause (ii), (NYSE:A) do not exceed 115% of Funds From Operations for the current four fiscal quarter periods of Parent Guarantor ending September 30, 2008 and December 31, 2008, (NYSE:B) do not exceed 110% of Funds From Operations for the current four fiscal quarter period of Parent Guarantor ending March 31, 2009, (NYSE:C) do not exceed 100% of Funds from Operations during any other four consecutive fiscal quarters of the Parent Guarantor thereafter, and (NYSE:D) do not exceed 100% of Funds From Operations during any one fiscal quarter for the fiscal quarters of the Parent Guarantor ending on December 31, 2008 and March 31, 2009,” [emphasis added]

So what exactly does this all of legal mumbo-jumbo mean? Since we just finished the quarter ending March 31, 2009 (2009-Q1), we only need to concentrate on the underlined text. That text basically requires that the upcoming dividend plus the previous three dividends cannot be more than 110% of FFO for Q1-2009 and the previous three quarters.


The above referenced covenant can be expressed mathematically as the following equation:

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

d₁ = Aggregate Dividend announced Q2-2009
d₂ = Aggregate Dividend announced Q1-2009
d₃ = Aggregate Dividend announced Q4-2008
d₄ = Aggregate Dividend announced Q3-2009
f₁ = Aggregate FFO for Q1-2009
f₂ = Aggregate FFO for Q4-2008
f₃ = Aggregate FFO for Q3-2008
f₄ = Aggregate FFO for Q2-2008
Using distributive property, it can be restated as:

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

Most of these variables are now known constants since these numbers have been previously released by ACC in their SEC filings. The only remaining unknown variables are d₁ and f₁. However, since we can reasonably estimate f₁ by assuming it will be constant from Q4-2009, we can solve for d₁ by rearranging the equation and plugging in our other constants.

Here are the constants that we know (per 10k dated):
d₁ =
Aggregate Dividend announced Q2-2009 =
d₂ =
Aggregate Dividend announced Q1-2009 =
d₃ =
Aggregate Dividend announced Q4-2008 =
d₄ =
Aggregate Dividend announced Q3-2009 =
f₁ =
Aggregate FFO for Q1-2009 =
f₂ =
Aggregate FFO for Q4-2008 =
f₃ =
Aggregate FFO for Q3-2008 =
f₄ =
Aggregate FFO for Q2-2008 =

The amounts shown above were compiled from quarterly and annual SEC filings.

The amount shown for f₁ assumes stable quarterly FFO from 2008 Q4.

Since we know (or can reasonable assume) all variables other than d₁, we can solve for d₁ by plugging in our constants to the above equation as follows:

d₁ + $14,276,250 + $14,403,000 + $12,517,000 ≤ 1.10 or restated as:

$41,196,250 + d₁ ≤ $52,167,500 or restated as:

d₁ ≤ $10,971,250

This means that the aggregate dividend must be less than or equal to $10,971,250. Since there are 42,355,283 shares outstanding as of February 25, 2009, I believe the dividend will have to be cut to:

$10,971,250 ÷ 42,355,283 = 25.9¢ per share

Since it appears that ACC may be raising cash by selling common shares (see Form S-3 filed with the SEC on March 16, 2009), the dividend could be cut further by reason of dilution on both the dividend and common equity. For example, if ACC sold an additional four million common shares, the dividend will be further diluted and cut to:

$10,971,250 ÷ (42,355,283 + 4,000,000) = 23.7¢ per share

Also, if FFO decreases for the quarter, the dividend will have to be cut even further.

I want to emphasize that although this is the highest allowable dividend per the debt covenants, I believe that the amount is still too high given the state of ACC’s business. Given current and anticipated cash flows, I believe the current payout rate is unsustainable and should be further reduced if the board of directors is serious about maintaining the long-term health of the company. I believe that ACC maintains an unreasonably high dividend merely to inflate the price of the stock as a hybrid income instrument.

As I previously stated, I believe the stock is fundamentally overpriced. In fact, using management’s assumptions as provided in the last conference call (which I think are aggressive and unrealistic), I have applied discounted cash flow analysis to determine the stock is worth $2.63 at most… but that’s another article.


There are a few events that could invalidate the above analysis. Broadly, any event that undermines my key assumptions could invalidate the analysis. Some of these might include:

1) FFO increases significantly in the first quarter of 2009: Again, I think this is unlikely. A significant increase in FFO would either require a significant increase in revenue, a significant decrease in costs or both. As I previously stated, I cannot envision revenue growing significantly in this type of business. Similarly, I believe ACC is operating at long-term margin levels so a significant decrease in its cost structure is also unlikely. Another way that ACC could increase FFO is through acquisition to increase depreciation reversal. This is called “bootstrapping”. I don’t believe that ACC’s balance sheet would support such a move, particularly in the current economic environment.

2) ACC is able to amend its debt covenants: I doubt ACC would be able to amend its debt covenant given its financial condition, the state of commercial real estate and the debt markets. It would only serve a lender to allow such an amendment if they believe that buoying the common stock would allow the company to raise enough additional capital to further secure the lender’s senior rights. Then again, if the lenders are also underwriting the current secondary offering for fees, this is entirely possible. In any event, if ACC is able to amend its debt covenants they will be required to file such amendments with the SEC. Look for such filings if ACC does not lower the dividend.

3) ACC disregards the debt covenants: It is possible that ACC could disregard its debt covenants and simply pay the inflated dividend in violation of its credit agreement. An action like this could trigger a default and would be a violation of fiduciary duties by the board of directors. I believe this is a very unlikely possibility given the legal exposure the board of directors would face.


I believe it is likely that ACC will reduce its dividend to 26 cents per share (or lower) in the coming weeks. Since dividend paying stocks are hybrid equity-income instruments, the stock price should fall after the announcement of such news as investors discount for the cut. One can profit by shorting the stock. Ideally, the position would be opened going into a period of downward price momentum (preferably at a significant level of upper resistance). Since any short position involves unlimited exposure to upside moves, an appropriate stop-loss orders must be employed.

Disclosure: Short: ACC, ARE, PLD, HCP, VTR, KRC, WRI, KIM. Long: TLT, Gold, Silver.