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Stanger Blasts Another ARC Merger

Robert A. Stanger and Co. issued a scathing horror-themed special report titled Friday the 13th critiquing the recently announced transaction between American Realty Capital Hospitality Trust and Brookfield Strategic Real Estate Partners II.

It is the third time in recent months that the investment bank has blasted an ARC/AR Global-orchestrated merger involving one of its externally advised real estate investment trusts. Previously, Stanger excoriated a number of ARC-sponsored REITs for filing proxy statements attempting to eliminate certain investor protections in their charters while the companies were in an ongoing strategic review process and undisclosed REIT roll-up. More recently, Stanger issued an equally pointed rebuke in regards to the still pending proposed merger between American Finance Trust and American Realty Capital – Retail Centers of America.

The ARC Hospitality deal, which was announced on January 13th, allows the AR Global-affiliated non-traded REIT to issue up to $400 million of convertible preferred units to Brookfield Strategic Real Estate Partners II – which could potentially result in a 41.3 percent ownership stake in ARC Hospitality.

ARC Hospitality Trust, which is changing its name to Hospitality Investors Trust, will initially issue to Brookfield approximately 9.15 million class C units that are convertible into common units at $14.75 per unit, for a total of $135 million.

The $14.75 conversion price represents a 31 percent discount to the most recent net asset value of $21.48 per share. Shares were originally sold for $25.00 each. According to Stanger, Brookfield can potentially purchase a preferred interest in $488 million of real estate net asset value for $400 million.

The preferred units have a 12.5 percent dividend, comprised of 7.5 percent in cash and 5 percent in the form of class C units, and will likely dilute FFO and reduce distribution coverage, Stanger noted. Shareholders receive an annual 6.8 percent distribution – which will be converted from cash to shares in the first quarter of 2017.

Perhaps most shocking, according to Stanger, is that AR Global, (ARC Hospitality Trust’s advisor), will receive a payment of $14 million in cash plus 804,285 shares for terminating the advisory agreement. AR Global will also be off the hook for $5.8 million of offering and organizational expenses owed to the REIT.

AR Global-affiliate Crestline Hotels & Resorts will serve as the property manager for 74 hotels for approximately 18 to 19 years for a fee equal to 3 percent of gross property receipts (a reduction from 4 percent currently).

Four years after the transactions close, the REIT can terminate the property management contract when the properties are sold for a fee equal to 2.5 times the prior 12 months property management fees.

Stanger estimates that based on the current valuation of the company, “per share net asset value stands to be reduced on a fully diluted basis from $21.48 to approximately $18.00 per share assuming the issuance and conversion at $14.75 of the $400 million of class C units, the payments to the advisor, the waivers of the advisor’s reimbursement obligations, and other estimated fees and expenses of the transaction. The dilution and fees equates to approximately $129 million on a $400 million capital infusion.”

“Why not sell the company and provide all the proceeds to investors rather than put current shareholders in a subordinated position with a potential dilution of approximately 16 percent to their existing per share net asset value?,” Stanger queried.

“All in all, the package appears to be a pretty nice payday for AR Global, particularly given the dismal performance to date of the company on behalf of shareholders – an aggregate loss on initial gross offering proceeds of approximately $260 million,” said Stanger.

The transaction has been approved by the board without a shareholder vote.

Click here to read Stanger’s special report, Friday the 13th