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The next few weeks could be make or break for Fortress shareholders, who will be asked to cast their votes in yet another attempt to collapse the company’s divisive A and B share structure.
The two sets of investors have failed to agree on several previous proposals to change the company’s restrictive memorandum of incorporation (MOI) and do away with the dual capital structure.
Previous proposals didn’t garner enough support because each set of shareholders seemingly believed the share-swap ratio on offer unduly favoured the other.
The crippling impasse between A and B shareholders forced Fortress to withhold dividends, which ultimately prompted the JSE to strip the company of its real estate investment trust (Reit) status.
Last week, Fortress announced another proposal that could result in a single class of ordinary shares — and potentially see the company regain its Reit class.
The latest scheme entails a buyback of all B shares in exchange for shares in Nepi Rockcastle, the Eastern Europe shopping centre giant in which Fortress owns a 23.9% stake.
The latest scheme entails a buyback of all B shares in exchange for shares in Nepi Rockcastle, the Eastern Europe shopping centre giant in which Fortress owns a 23.9% stake
If approved, all Fortress B shares will be cancelled and Fortress’s stake in Nepi Rockcastle will decrease to 16.5%. Fortress will then be left with only one set of (former A) shareholders.
Does the latest proposal have a better chance of getting the go-ahead than previous attempts? It seems so, given that it’s the first time that Fortress has received nonbinding letters of support from about a dozen of their largest shareholders before voting.
What’s more, they’ve agreed to be named publicly, which could of course sway smaller shareholders that are on the fence to follow suit.
Supporting fund managers include the big guns such as Coronation, Stanlib, Peregrine, Momentum, Allan Gray and Meago. They all own A and B shares, except Coronation, which has only A shares — a sizeable 16.1% stake.
To date, shareholders who own about 40.7% of the A shares and 51.9% of the B shares have backed the transaction. But Fortress needs a minimum 75% approval from both A and B shareholders to seal the deal.
Anas Madhi, a director of Meago Asset Managers, refers to the latest proposal as a “substantial value-unlock opportunity”. He adds: “The capital structure has been an impediment for investors for several years now and needs to be dealt with decisively.’’
That’s notwithstanding the fact that Fortress B shares — the class of shares that formerly received a dividend only after A shareholders had been paid — are up 45% over the past year. Or that Fortress A shares, which relied heavily on dividends, are 39% stronger. It’s mostly due to the performance of Fortress’s underlying logistics and retail portfolio in South Africa and an exceptionally strong rebound in Nepi Rockcastle’s mall portfolio. Yet Fortress B shares still trade at a 62% discount to NAV, says Madhi.
He argues that the latest deal will make the company “a lot more attractive for the wider investor community, who understandably have been bewildered by the uncertainty around achieving distribution thresholds, which ultimately culminated in the loss of Reit status.’’
If the plan isn’t approved, one of the outcomes will be what he calls an unnecessary tax burden — to the detriment of all shareholders.
That’s because property companies that fall outside the Reit tax regime are saddled with sizeable tax “leakage”, as they are not entitled to deduct dividends from their taxable income, nor do they qualify for capital gains tax deductions on property sales.
Francois du Toit, equity research analyst at Anchor Stockbrokers, agrees. “We see significant downside for both A and B shareholders should the proposed scheme of arrangement fail,’’ he writes in a research note.
The proposal is an efficient way to unlock trapped value in Fortress’s underlying portfolio of logistics and community retail centres
— Francois du Toit
Du Toit says keeping the status quo comes with too many risks and uncertainties. He adds: “The proposal is an efficient way to unlock trapped value in Fortress’s underlying portfolio of logistics and community retail centres.”
Yet despite the backing of a number of sector heavyweights, the latest proposal is unlikely to be a shoo-in. Some shareholders, such as boutique asset manager Sesfikile Capital and Ninety One, still strongly oppose the deal.
Both believe that A shareholders will be short-changed at the proposed share-swap ratio of 0.060207 Nepi Rockcastle shares for each Fortress B share.
Sesfikile Capital director Evan Jankelowitz says while they are in favour of simplifying the share structure, it shouldn’t be done at all costs. “The deal is overwhelmingly skewed in favour of Fortress B to the detriment of Fortress A shareholders.’’
He says it doesn’t make sense for A shareholders to vote for a less favourable deal than the one that was rejected a year ago, “particularly given that Fortress is now in a stronger position financially and operationally”.
Jankelowitz refers to last year’s proposed swap ratio of three B shares for every A share, versus this latest proposal, which is effectively only two B shares for every A share.
He believes the proposal is short-sighted because Fortress’s earnings will be significantly weaker if it is approved — even after adjusting for the tax reversal on buying back the nondividend paying Fortress B shares, using income-generating Nepi Rockcastle shares.
The deal is also likely to create an overhang of Nepi Rockcastle shares in the market if a number of former B shareholders decide to sell some of their newly acquired Nepi Rockcastle shares. “That will place even more pressure on the Fortress balance sheet and erode value for Nepi Rockcastle shareholders,’’ he says.
Luqman Hamid, portfolio manager at Ninety One, has a similar view. “We believe the deal undervalues the A shareholders’ preferential claim to dividends at a time when the company is not far away from meeting the distributable earnings entitlement.’’
We believe the deal undervalues the A shareholders’ preferential claim to dividends at a time when the company is not far away from meeting the distributable earnings entitlement
— Luqman Hamid
Hamid says another concern is that Fortress is probably giving away one of its best assets (Nepi Rockcastle) to B shareholders, while taking its gearing to elevated levels in the process. He adds: “None of these outcomes appears to be favourable to A shareholders.’’
Meanwhile, Fortress’s management has yet to recommend the transaction to shareholders. Ryan Eichstadt, head of investor relations and corporate finance at Fortress, says the company won’t be in a position to do so until there has been an assessment by an independent board and expert as to whether the terms of the proposed transaction are fair and reasonable.
In the next few weeks, Fortress will issue a scheme circular to its shareholders, setting out the full terms and conditions of the proposed transaction.
Eichstadt says a further announcement will be released in due course, with the shareholder vote to follow two to three months later.
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