Fortress (FFB) – Given away your golden goose

Post 1H24, Fortress bought back the old FFB shares with a swap for Nepi Rockcastle (NRP) shares. From a company perspective, Fortress gave up its golden goose to repurchase its cheapest source of capital. When we remove NRP’s performance, what we find is that the direct property assets operated by Fortress have a return on assets less than cost of debt, destroying significant value. The return generated from Fortress’ directly owned property has declined steadily over the past three years and is almost immaterial – we calculate ROE on those assets to be 1.5% in 1H24 (3.5% for FY23). The growth in NAV and distributable earnings, in our view, are driven by NRP.

We believe the distributable income is not representative of a sustainable cash flow, and with the ROA below the cost of debt, Fortress would need to raise additional cash. Fortress has elected to offer a scrip alternative to the remaining shareholders at a discount to the current price, which is at a significant discount to NAV. This is in an effort to raise cash as the LTV is now high due to giving away NRP shares with an opportunity cost of the dividend yield (10%) at the time, which has put additional strain on future cash flows.

In our view, a sizeable portion of operating costs has been capitalised to investment property and impairments are mixed into fair value adjustments, improving DIPs, however this puts strain on cash. From June to December, vacancies increased across almost the entire portfolio of directly owned property. Property operating costs have increased significantly ahead of inflation (14%), and interest costs have risen 20% half-on-half. Fortress is selling off assets at yields greater than those on new developments. More importantly, new development yields are below the cost of debt and, given the leverage, this destroys shareholder value.

Fortress does still own a significant portion of NRP shares, which are currently performing well.