Trials And Tribulations For Vereit

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About: VEREIT Inc. (VER)
by: Beyond Saving
Summary

VER remains a turbulent stock.

The Block trial is underway and should be wrapping up soon.

There are several possible downside catalysts in the near future, and the share price is more likely to be influenced by news than by the numbers.

In my last article on Vereit (NYSE:VER), I focused on the legal risks. I argued that throughout 2017 that news stories generated by the legal issues would have more of an impact on VER share price than fundamentals.

Since that time, the share price floated above $9 before crashing down to the $7.50's and is now back above $8. In addition to the legal issues plaguing the stock, it has taken a hit along with the entire NNN REIT sector that has more to do with sentiment than fundamentals.

Fundamentally A-OK

Fundamentally, VER is moving along, following the plan previously laid out by management. The first quarter results were in-line with guidance as VER remained a net seller of properties and reduced debt.

Additionally, VER received some good news as Moody's and S&P each raised their credit ratings on Vereit to Baa3 and BBB- respectively.

The dividend is currently yielding over 6.5% and the AFFO payout ratio remains a comfortable 73%. With their liquidity over $2.5 billion, VER holds a strong balance sheet which should provide dividend security even if the payout ratio compresses.

Management has confirmed in the conference call that VER would go from being a net seller to a net buyer the second half of the year.

All the fundamentals are pointing positive for VER to start growing by the end of the year. Remove the litigation aspect and I agree with Brad Thomas's assessment that VER would be a strong buy.

Unfortunately, wishing reality away does not really work, the litigation exists and is likely to bubble back up to the surface in the coming months.

Block Trial

Brian Block has been on trial since June 13th. The Government's key witnesses are Ryan Steel and Lisa McAlister both cut deals in exchange for testifying against Block.

Last week, Steel testified that while shareholders accounted for 96% of operating partnership units, the add-backs for calculating AFFO were based on 100% of units. This resulted in an artificially inflated AFFO.

According to InvestmentNews.com McAlister further alleged that Nick Schorsch, then CEO of ARCP, was involved. She claims on a conference call discussing a $0.03 shortfall in AFFO Schorsch said (to Block), "It's in your deferred financing costs. There it is. You know what you need to do"

The prosecution's story is that Schorsch encouraged Block to create fraudulent numbers, which he did with the assistance of Steel and McAlister. Naturally, Steel and McAlister describe themselves as reluctant participants acting out of fear for their jobs and misplaced loyalty.

The defense on the other hand appears to be focusing on the reality that there are no laws, rules or regulations regarding the calculation of AFFO. AFFO is a completely voluntary number that is supplied as supplemental information. Many companies calculate it in slightly different ways, and it is always surrounded by warnings. While it might not be the most compelling argument on the morality of Block's actions, it might be compelling as a legal argument.

As the trial enters its final stages, we can expect a verdict in the near future. While Block's fate has little to do with the health of VER directly, it is reasonable to expect that a conviction is going to have a short term negative impact on share price. It is not a coincidence that the day of his arrest share price dropped 8%.

It is quite likely that the market is going to attempt to read the tea leaves regarding the civil lawsuits against VER using the verdict of the Block trial. A conviction would likely be a strong downside catalyst for the share price.

Civil Lawsuits

VER currently has 35 civil lawsuits pending against it, the most recent one brought by Reliance Standard Life Insurance Company in New York Southern District Court.

The law suits that are likely the most important for investors to follow are the lawsuit brought by TIAA in New York which is seeking class action certification and the Vanguard lawsuit in Arizona.

Since January, these cases have been in a holding pattern due to the federal government requesting a stay on discovery activities involving witnesses in the Block trial. When the trial concludes, discovery activity will resume in the civil cases. For VER, this means an uptick in legal expenses and more headlines as these cases progress.

VER should be eager to settle these cases just to close the issue and put focus back on their results. However, legal issues have a way of dragging out for an extended time. Before a settlement is reached in any of the cases, we can expect considerable legal maneuvering on both sides. Those maneuvers are going to be reported and it is unreasonable to expect that they are all going to look positive for VER.

What About Schorsch?

Whatever fraud happened, it is likely that Schorsch had knowledge of it. In the Block case, McAlister offered testimony that he ordered it. If Block is convicted, will the government see that as a green light to attempt to go after Schorsch? Some news stories have suggested that Block might be a "stepping stone" to Schorsch.

While many might see such a scenario as justice, it would be a worst case scenario for VER since it would guarantee that the legal issues hang around for years.

Conclusion

By the numbers, VER is showing every sign of being a successful turn around story. The balance sheet is stabilized and the company is in position to start accretive acquisitions in the near future. In 2018 and going into 2019 the company should start showing real growth.

However, the lawsuits remain a drag on share price and in the very near future there are going to be potential catalysts for further downside. A conviction of Block, certification of the class action, federal action against Schorsch and/or trial dates being set for the civil cases are all potential catalysts.

Regardless of the criminal verdict, the end of the trial will allow discovery to resume in the civil trials. Renewed news stories and developments in the civil trials are also likely to put downward pressure on share price.

For now, I am sitting on the sidelines and will wait for some more clarity on the legal issues. There is no reason to take an unnecessary risk when there are several possible downside catalysts. The only real catalyst for upside would be reasonable settlements of the civil cases and even in the best case scenario that is several months down the road.

If the share price drops closer to $7, I might start looking for an entry point, but even then it will be with extreme caution.

The bottom line is that the unknowns of these lawsuits is going to prevent the share price from reflecting the fundamentals. There is little to gain from jumping in too early.

Sources: Company SEC Filings, justia.com, law360.com, investmentnews.com, Moody's, S&P

Disclosure: I/we 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.