After my article entitled REITs: Why The Dividends Are A Mirage came out, I was asked "politely" to issue a retraction especially concerning American Reality Capital (ARCP) and the issue of dilution. In short, I made a case that the dividend paid out by REITs that simultaneously issue even larger amounts of equity are diluting at the same time as paying the dividend, making the economic effect of the dividend itself a wash (except for the REIT tax savings). As there's no guarantee of future returns with a REIT (or anything else for that matter), an equity raise for cash is always dilutive upon executed, and any "accretive" benefits will remain to be seen in the future. My thesis was met with a combination of laughter and angry, so I thought I owed it to readers in their search for alpha to make sure the record is correct and readers get as much information as possible, especially after bullish another article came out discussing ARCP's acquisition of ARCT III which stated, "the merger was accretive to shareholders."
Instead of finding evidence to retract my article, what I found from ARCP's 10K filed just last week on February 28 (same day as the merger), I found what is apparently near-verbatim of my own words warning investors, even printed in black bold from ARCP management stating quite clearly the exact opposite of what the two articles above claimed. The 10K warns investors in no uncertain terms that the merger is indeed dilutive and warns about the dilution that comes from raising money while paying dividends. Interestingly enough, a search for the word "accretive" in the 10K turns up only one time in 130+ pages, and it is preceded by the word "not" to form the phrase "not accretive."
Page 35, it can't get any clearer than this, and it's not a laughing matter (emphasis not even mine):
Your ownership position will be diluted by the Merger of us and ARCT III.
The Merger of us and ARCT III will dilute the ownership position of our stockholders. Following the issuance of shares of our common stock to ARCT III stockholders pursuant to the Merger Agreement, assuming 70% of the Merger consideration is paid in the form of shares of our common stock, our stockholders and the former ARCT III stockholders are expected to hold approximately 9% and 91%, respectively, of the combined company's common stock outstanding immediately after the Merger, based on the number of shares of common stock of each of us and ARCT III currently outstanding and various assumptions regarding share issuances by each of us and ARCT III prior to the effective time of the Merger (provided, however, such dilution could be greater than described herein depending on the number of shares of ARCT III common stock with respect to which ARCT III stockholders make stock elections). Consequently, our stockholders, as a general matter, will have less influence over our management and policies after the Merger than they exercise over our management and policies immediately prior to the Merger.
Page 19,(emphasis added):
If we fund dividends from the proceeds of offerings of securities, we will have less funds available for acquiring properties or other real estate-related investments. As a result, the return you realize on your investment may be reduced. Funding dividends from borrowings could restrict the amount we can borrow for investments, which may affect our profitability. Funding dividends with the sale of assets or the proceeds of offerings of securities may affect our ability to generate cash flows. Funding dividends from the sale of additional securities could dilute your interest in us if we sell shares of our common stock or securities convertible or exercisable into shares of our common stock to third party investors. Payment of dividends from the mentioned sources could restrict our ability to generate sufficient cash flow from operations, affect our profitability and/or affect the dividends payable to you upon a liquidity event, any or all of which may have an adverse effect on your investment.
I realize some will say that the funding of dividends come from the earnings and not from the capital raises, but if the capital raises are going on at the same time as the dividends are being paid (which is often the case), then the next effect is identical. It doesn't matter whether you use the credit card or the debit card or the checkbook. More money is being funded from the sale of additional securities than by earnings by a long shot. I understand ARCP has to pay out a dividend to retain its REIT status and save money on federal income taxes so the dilution is a good thing, but it's still a reality. Just as ARCP's 10K warns.
Overall, I think ARCP is a great REIT that has good odds of continuing to provide positive alpha for investors throughout 2013. I think it's important though for investors to get the full story and not be blinded by only one side. A well informed investor has a better chance of success than one who only seeks one side. ARCP in this reader's opinion will do well despite the dilution. Good luck to all.
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.