CCPT III: To Sell Or Not To Sell

| About: VEREIT Inc. (VER)

On March 20th of this year American Realty Capital Properties (ARCP) offered to purchase Cole Credit Properties Trust III (CCPT III) for $9 billion. On the following day, however, CCPT III rejected the offer "… saying it isn't in the best interests of shareholders and is an attempt to disrupt its business." [Link] Since then, some very intelligent arguments have been made for and against the joining of the two companies. Either way, there is one thing for certain: A merger of the two companies would have created the largest publicly traded REIT in the net-lease sector.

In the current low interest rate environment, net-leased properties have become very popular with investors because of the higher dividend yields they provide. Net-leased properties are leased for long periods of time (usually between 10 to 25 years) and they offer fewer headaches to the lessors (and, consequently, to investors) because the tenants absorb most of the operating costs for the properties.

CCPT III's rejection of ARCP's offer is very suspect, and it raises the question as to whether or not the decision to reject the offer was done with the best interests of the company's shareholders in mind. At the present time, CCPT III is seeking to acquire "Cole Holdings," and, according to the company's Executive Chairman, Christopher H. Cole, and its Chief Executive Officer, Marc Nemer, ARCP's proposal appeared to be "deliberately designed to disrupt the businesses of Cole Holdings and CCPT III." [Link]

It would certainly appear that Mr. Cole has plenty of reasons to not sell the company - in fact, he may have several million of them. According to one of its SEC filings, COLE CREDIT PROPERTY TRUST II, INC defined its intercompany relationships and the fee structure as follows:

We are party to an Advisory Agreement with CR III Advisors whereby CR III Advisors manages our day-to-day operations and identifies and makes investments on our behalf. In return, we pay to CR III Advisors a monthly asset management fee equal to 0.0417% of our average invested assets and reimburse costs and expenses incurred by CR III Advisors in providing asset management services. Such fees and expenses recorded for the year ended December 31, 2011 totaled $20.3 million. We also pay to Cole Realty Advisors up to 2.0% of the contract purchase price of each property or asset that we acquire, along with reimbursement of acquisition expenses. Such payments for the year ended December 31, 2011 totaled $49.9 million, of which $47.7 million were fees and $2.2 million were reimbursement of acquisition expenses. We also pay to CR III Advisors a financing coordination fee equal to 1.0% of the amount available under any debt financing that we obtain and use for the acquisition of properties and other investments. Such payments for the year ended December 31, 2011 totaled $14.9 million. We reimburse the expenses incurred by CR III Advisors in connection with its provision of administrative services, including related personnel costs, subject to the limitation that we do not reimburse CR III Advisors for any amount by which the operating expenses (including the asset management fee) at the end of the four preceding fiscal quarters exceed the greater of (NYSE:I) 2.0% of average invested assets, or (ii) 25.0% ofnet income other than any additions to reserves for depreciation, bad debt or other similar non-cash reserves and excluding any gain from the sale of assets for that period. Such expenses recorded for the year ended December 31, 2011 totaled $2.3 million. Additionally, for substantial assistance in connection with the sale of properties, we pay CR III Advisors or its affiliates an amount equal to up to one-half of the brokerage commission paid on the sale of property, not to exceed 3.0% of the contract price of each property sold; provided, however, in no event may the real estate commissions paid to our advisor, its affiliates and unaffiliated third parties exceed the lesser of the competitive real estate commission or an amount equal to 6.0% of the contract sales price. No such payments were made during the year ended December 31, 2011.

Additionally, we are required to pay to CR III Advisors performance fees based on a percentage of proceeds or stock value upon our sale of assets or the listing of our common stock on a national securities exchange, but only if, in the case of our sale of assets, our investors have received a return of their net capital invested and an 8.0% annual cumulative, non-compounded return or, in the case of the listing or quotation of our common stock, the market value of our common stock plus the distributions paid to our investors exceeds the sum of the total amount of capital raised from investors plus the amount of distributions necessary to generate an 8.0% annual cumulative, non-compounded return to investors. In the event of a sale of our assets, after investors have received a return of their net capital invested and an 8.0% annual cumulative, non-compounded return, then we will pay to CR III Advisors 15.0% of remaining net sale proceeds. Upon listing our common stock on a national securities exchange, we will pay to CR III Advisors a fee equal to 15.0% of the amount, if any, by which (1) the market value of our outstanding stock plus distributions paid by us prior to listing, exceeds (2) the sum of the total amount of capital raised from investors and the amount of distributions necessary to generate an 8.0% annual cumulative, non-compounded return to investors.

CR III Advisors incurs expenses in connection with our organization and our public offering of our common stock. Pursuant to the Advisory Agreement, we reimburse CR III Advisors up to 1.5% of our gross offering proceeds with respect to those expenses. During the year ended December 31, 2011, we recorded $21.6 million related to the reimbursement of such expenses.

Our Advisory Agreement has a one-year term expiring November 30, 2012, subject to an unlimited number of successive one-year renewals upon mutual consent of the parties. Our independent directors are required to


determine, at least annually, that the compensation to CR III Advisors is reasonable in relation to the nature and quality of services performed and the investment performance of the Company and that such compensation is within the limits set forth in our Charter. Upon termination of the Advisory Agreement, we may be required to pay to CR III Advisors a performance fee similar to the performance fee described above if CR III Advisors would have been entitled to a subordinated participation in net sale proceeds had the portfolio been liquidated (based on an independent appraised value of the portfolio) on the date of termination.

Christopher H. Cole, our chief executive officer, president and chairman of our board of directors, indirectly owns 100% of the ownership and voting interests of CR III Advisors. D. Kirk McAllaster, Jr., our executive vice president, chief financial officer and treasurer, is the executive vice president and chief financial officer (REITs and real estate funds) of CR III Advisors. Marc T. Nemer, one of our directors, is the chief executive officer and president of CR III Advisors.

Mr. Cole, indirectly, owns 100% of the ownership and voting interests of CCPT II Advisors and he has little to gain if he accepts the offer; however, he reaps a fortune managing the day to day operations of the company. Essentially, for the year ended December 31, 2011, Cole received:

$20.3 million for management services
$47.7 million for acquisition fees
$2.2 million for expense reimbursements
$14.9 million for "…a financing coordination fee…"
And it doesn't end there (please see above)

On March 20, 2013, Chimicles & Tikellis LLP initiated a shareholder class action and derivative action against "Cole Holdings Corporation, et al." According to the firm's website:

The litigation was brought by investor Dr. Richard Strub on behalf of Cole Credit Property Trust III, Inc. ("CCPT III") and a class of CCPT III shareholders against CCPT III's board of directors, including CCPT III's founder Christopher Cole, Cole REIT Advisors III, Cole Holdings Corporation and other affiliated Cole Holdings entities.

Plaintiff's direct and derivative claims arise out of a Merger Agreement that defendants approved by which CCPT III, a non-listed externally advised real estate investment trust ("REIT"), will become self-advised by acquiring affiliated entity Cole Holdings Corporation which, through its wholly owned entities, provides property management and advisory services to CCPT III. This type of acquisition is commonly referred to as an "Internalization," and is widely recognized within the REIT industry as against best practices. Plaintiff alleges that the Internalization represents a sweetheart deal designed and implemented by the defendants, each of which owe fiduciary duties to CCPT III and its shareholders, to give the defendants an unjustified $150 million payday and exit strategy prior to the contemplated listing of CCPT III on a national exchange.

Plaintiff also alleges that the Internalization and Merger Agreement are being thrust upon Shareholders without their approval. Defendants are not seeking shareholder approval before consummating the Internalization Merger, which is expected to close any day now. Plaintiff has also alleged that Defendants' hasty rejections of American Realty Capital Properties' offers to acquire all of the outstanding shares of CCPT III, particularly in light of the proposed self-dealing Internalization Merger, were in violation of their fiduciary duties to CCPT III and its shareholders.

On March 27, 2013, Plaintiff filed papers seeking a Temporary Restraining Order that would prevent Defendants from closing on the Internalization Merger until the Court rules on whether Defendants are required to get CCPT III shareholders' approval of the Internalization Merger before it can proceed. The papers filed in support of the TRO can be viewed here: the TRO Motion, the Memorandum in Support, and the Proposed Order.

Whatever the outcome, it would certainly appear that ARCP's offer is worthy of further consideration. According to Nicholas Schorsch, American Realty's Chairman and CEO, ARCP's "offer is superior to that involving Cole Holdings. He noted that Cole Credit Properties' shareholders would not be required to pay to Cole Holdings $120 million in fees and that American Realty [it] has a track record as a public company." He also stated that "[o]ur bid is fully banked" and "It's fully financed. We have the stock available. It's approved by our board. It's subject really only to a merger agreement and shareholder approval. It creates a real powerhouse in the REIT industry." [Quotes Link] Perhaps it would be appropriate for CCPT III to put the offer to a shareholder vote.

For those who have an financial interest in the outcome of this ongoing situation, you may wish to contact Chimicles & Tikellis LLP directly:

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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