Constrained by its dual-share structure, the board of directors of Fortress Real Estate Investments has proposed a scheme to repurchase and cancel all FFB shares in exchange for shares in Nepi Rockcastle.
In terms of the scheme, all FFB shares in issue (net of treasury) will be exchanged for Nepi shares in a ratio of 0.060207 Nepi Rockcastle share per FFB share held.
This translates into about 56-million Nepi shares,reducing Fortress’ stake in Nepi Rockcastle from 23.5% to 17%, making it still the largest shareholder in the company. It will take two to four months to complete the transaction.
Nepi Rockcastle is the largest listed property company on the JSE, with a €7bn portfolio across nine Central and East European countries.
If approved, Fortress’s dual share structure will be simplified into a single class of ordinary shares.
The previous attempts to collapse the dual capital structure failed, resulting in Fortress losing its real estate investment trust (Reit) status in February and the company withholding dividends.
For the financial year, ended June distributable earnings reached R1.797bn, a 7.3% increase on the previous year. It recorded an 11.8% increase on normalised distributable earnings. During the 2024 financial year, distributable earnings are expected to increase to R1.93bn after tax.
To maintain Reit status, SA-listed property companies are required to pay a minimum of 75% of their taxable earnings available for distribution as a dividend annually by no later than four months after its year-end.
After the failed proposal to change the company’s memorandum of incorporation (MOI) to allow a dividend to be paid to all shareholders from the 2022 financial year’s profit, some Fortress shareholders have discussed with the company ways to simplify the dual share structure.
Fortress specialises in the logistics and retail property sectors in SA and owns premium logistics assets in Central and Eastern Europe. Its SA convenience and commuter-orientated retail portfolio comprises 46 shopping centres.
The company listed on the JSE in October 2009 with two classes of shares offering investors different risk and reward profiles, though they have equal voting rights.
Support letters
According to the board of directors, a single share structure has several benefits. It includes allowing for distribution of income at the discretion of the board without the restrictions of the MOI, implementation of dividend reinvestment programmes, greater flexibility regarding corporate actions, greater liquidity, and an appeal to a broader range of potential investors. In addition, management is able to focus more on the business rather than on the issues resulting from the dual-share structure.
Fortress has received non-binding letters of support from 40.7% of FFA shares and 51.9% of the FFB shares, including key shareholders such as Peregrine Capital, Coronation Fund Managers, Meago Asset Management and Allan Gray.
The company has established an independent board to appoint an independent expert to prepare a fair and reasonable opinion on the scheme.
Shareholders in favour of the proposed scheme said the dual capital structure, which has been a constraint for investors for years, will attract a wider shareholder base — especially those looking to access income opportunities in the sector.
Additionally, Fortress will present significant value relative to its comparative peers and is likely to rerate significantly.
“Meago is supportive of the deal as we believe it provides a substantial value unlock opportunity for the company. FFB shareholders receive an attractive ratio offer of Nepi shares, [while] Nepi itself is attractively priced,” Meago Asset Managers portfolio manager and director Anas Madhi said.
Leverage ratios
He said that due to the resolution of the capital structure the remaining shareholders will benefit from the strong performance of the company’s SA portfolio of mainly quality modern logistics and community retail assets. “These assets have shown resilience, good rental growth and generally demonstrated strong property metrics.”
Fortress management will have several levers to manage leverage ratios and reduce the significant discount to net asset value (NAV) that it trades at — the possibility of returning to Reit status at an appropriate time is also available, Madhi said.
The Public Investment Corporation (PIC) noted that Fortress is a significant player in the logistics property sector and has been expanding its retail portfolio footprint while reducing its exposure to the embattled office space.
“We support the amendment of its capital structure subject to shareholder approval, and resumption of dividend payments,” said the PIC.
Justin Cousins, executive director of Peregrine Capital, and one of the key shareholders in favour of the proposed scheme said the proposal was shareholder led and board endorsed.
“The board would not have put the proposal to shareholders unless they [shareholders] were able to demonstrate “adequate support” for the transaction, which we believe exceeds 60% of all Fortress shareholders (higher than the disclosed number per the FIA),” said Cousins.
Cousins noted that supporting shareholders include the biggest Fortress A-shareholders (Coronation) and biggest Fortress B-shareholders (Peregrine Capital) and a number of shareholders who were previously at war with each other.
He said though the PIC is not mentioned in the list of supporting shareholders, the transaction is rational for the organisation given its current shareholding proportions. Peregrine Capital believes the PIC is receptive to the deal.
“The list of supportive shareholders excludes passive shareholders, who we believe will vote in favour if the board recommends the transaction,” said Cousins.
Nesi Chetty, head of property at Stanlib, said the proposed scheme is optimal for Fortress, as a real estate investment company (Reic) status doesn’t allow for dividend payments or give the company flexibility to pursue corporate transactions or unlock value.
Costs minimised
“The swapping of cheap Nepi Rockcastle shares for illiquid FFB shares will allow those FFB unit holders to monetise some of their gains over the past year,” he said.
Chetty added that the costs to implement the proposed transaction will be minimised and mostly relate to tax payments. “A single-entry structure should allow the Fortress retail and logistics assets to attract a better rating going forward as well.”
Steyn Capital Management portfolio manager Andre Steyn said Fortress has great assets but a capital structure dilemma. “We strongly support this initiative to alleviate the drag from the dual share structure, which we believe will enable the management team to focus on managing the assets, rather than the shareholders,” said Steyn.
Madhi said the transaction is encouraging as it demonstrates that various stakeholders within the property sector, including fund managers, shareholders and management teams have the resolve to demonstrate to the market the value unlock opportunity that exists within the listed property sector.
“Listed property has performed poorly since 2021 owing to both local and global factors, but property fundamentals continue to improve.”
He said due to a broad expectation that interest rates locally and globally are close to peaking, the sector presents a compelling opportunity. The onus is now on SA listed property companies to demonstrate to the investment community that they have the ability to unlock value.
Significantly weaker
However, Naeem Tilly, portfolio manager and head of research at Sesfikile Capital, said the deal is “overwhelmingly” skewed in favour of B shareholders to the detriment of A shareholders.
“The company’s earnings after the deal are significantly weaker, even after adjusting for the tax reversal on re-Reiting [returning to a Reit status from a Reic], due to repurchasing nondividend-paying Fortress B shares using income-generating Nepi Rockcastle shares,” Tilly said.
He said based on management’s latest guidance, the overall earnings are just 3.3% below the Fortress A entitlement (or 2.1% above the entitlement excluding tax). Sesfikile estimates that Fortress A shareholders will be entitled to a dividend within two years.
“Given that last year’s proposed swap ratio, at three B shares per A share, was rejected, we struggle to understand why Fortress A shareholders would now vote for a less favourable deal when the company is in a stronger financially and operational position.”
Tilly said the effect on debt metrics is detrimental to the company, with loan-to-value and interest-cover ratios weakening in an environment of high interest rates and heightened economic uncertainty.
Should the transaction succeed, there is likely to be an overhang of Nepi Rockcastle shares in the market, placing further pressure on Fortress’s balance sheet and investors’ own holdings in Nepi, he said.
Additionally, all transactions costs and any timing delays relating to the proposed transaction are borne by the remaining Fortress A shareholders.
“Ultimately remaining shareholders may end up with a low-yielding, higher-leveraged company making it a less attractive value proposition,” Tilly said.
Cousins said though some shareholders are not supportive of the transaction, Peregrine Capital believes there is overwhelming support from a very wide base of shareholders and the transaction has an extremely high probability of success.
He said detractors [who are in the minority] point to the “low yield” for the remaining FFA shares, receiving an enormous NAV uplift on their shares. “We believe this provides a very strong underpin of future value — we remain large shareholders of the remaining Fortress A shares, and extremely optimistic about their future growth prospects.”
Cousins added that it had taken 10 months to reach consensus on this very difficult matter. “We are finally at the end of the road, and we believe that the company will now be set up incredibly well to generate strong and consistent shareholder returns.”
Update: October 9, 2023
This article has been updated with additional information from Justin Cousins, executive director at Peregrine Capital, one of the key shareholders in favour of the proposed scheme.
Would you like to comment on this article?
Sign up (it's quick and free) or sign in now.
Please read our Comment Policy before commenting.