MUST READ! The EXPLOSIVE report on Resilient insider deals. Here on BizNews

EDINBURGH — Shares in the Resilient group of Real Estate Investment Trusts (REITs) have been battered following allegations of complex insider deals to massage the financials and manipulate stock prices. Resilient has fobbed off allegations of dodgy dealing behind the scenes, suggesting that short-sellers are being opportunistic. But analysts aren't buying the spin. The problems started for Resilient, Fortress, NEPI Rockcastle and Greenbay when investment house 36ONE and Arqaam Capital started digging around into why Resilient companies appear to be overvalued. Forensic precision uncovered an astonishing series of transactions among a group of connected people. From a distance, it is looking a lot like the Resilient group has been scamming investors, though Resilient insists nothing untoward has gone on within its bosom. Investors in South African property funds are vulnerable right now, with a big weighting of Resilient across portfolios. You can read the 36ONE report here on BizNews (scroll down). The 36ONE analysis is the third controversial report to hammer South African stocks in recent months. Viceroy Research has released two reports - one on Steinhoff and one on Capitec - indicating creative accounting. Steinhoff is under investigation in Germany for financial irregularities while Capitec has denied allegations it has been hiding losses. - Jackie Cameron

By Loni Prinsloo and Thembisile Dzonzi

(Bloomberg) - A group of intertwined South African real estate investment trusts is finding that while their close ties and dealings with each other have business benefits, when it comes to suffering, they also suffer together. Fortress REIT Ltd. and Resilient REIT Ltd. extended losses on Monday to cement their positions as the worst-performing REITs this year among 199 global funds tracked by Bloomberg. Stable mates NEPI Rockcastle Plc and Greenbay Properties Ltd. are hovering in the same territory, with losses of 36 percent to 45 percent between the four of them. More investors are betting the stocks will drop as short interest in Johannesburg-based Resilient and Bucharest, Romania-based NEPI climb to a record, according to IHS MarkIt data. The funds came under scrutiny in an internal research note by 36ONE Asset Management Pty Ltd. and analysts at Arqaam Capital Ltd., who questioned the valuation of the companies as well as inter-related transactions of as much as R122 billion ($10 billion). Resilient said in a statement on Monday that 36ONE’s research is “more informed by its large short position than by objective analysis.” The hedge-fund manager declined to comment because the report is an internal document. The share slump continued even as the companies issued regulatory announcements saying investors have nothing to fear over the cross-holdings they have in each other or the inter-related transactions. Resilient, which played a founding role in NEPI Rockcastle, Fortress REIT and Greenbay, said its investments in the other companies have always been a “clear and important component” of its business and that it’s preparing a document to address matters raised in the 36ONE report as well as those in the Arqaam note.
Read also: Meet Viceroy’s Fraser Perring, after exposing Steinhoff, has more SA stocks in his sights
It is “not quite fair” to single out only short sellers as some long-only money managers and analysts are raising the same concerns, Michele Santangelo, a money manager at Independent Securities, said by phone from Johannesburg. “More and more people are citing the same sort of issues with regards to the Resilient stable and I think its making a lot of investors nervous.” Resilient shares rose 1 percent to 101.01 rand in early Johannesburg trade Tuesday, snapping two days of losses. Fortress fell 2.1 percent, extending a three-day decline to 14 percent. Rockcastle fell 0.6 percent and Greenbay rose 3.7 percent.
Executive summary: Resilient, Fortress, NepiRockcastle and Greenbay

This report summarises the results of our investigations into a group of property companies (Resilient, Fortress, NepiRockcastle and Greenbay) listed on the JSE. It has been well-documented in research reports by independent research houses that the shares trade at higher price-to-book ratios and lower dividend yields than most property companies operating in the same geographies as these companies. As a result, investors have sometimes described these companies as “overvalued” in the past.

In our opinion, the findings in this report shows that simply considering the companies as being overvalued is a euphemistic view of the situation. We believe that our findings show that the premium valuation of each of the group companies did not arise from normal market activity, but from deliberate (and frequently concealed) actions by some of the influential owners and key management of the group.

People walk near the reception at the Johannesburg Stock Exchange (JSE) in Sandton, Johannesburg, South Africa. REUTERS/Siphiwe Sibeko

The first part of our analysis shows how a complex and convoluted group-structure with cross-shareholdings make it difficult for investors to determine the true size of the premium valuation (price-to-book ratio) of the group companies. We provide our calculation of the true premium valuation and show that it requires a large number of assumptions and that it is much higher than that calculated from using the net asset values provided by the group companies in their financial results.

We then show that a significant portion of distributable income for the various group companies consist of antecedent dividends, accrued dividends and interest received on loans to employees and BEE trusts. This report also presents arguments on why we believe the BEE trusts should have been consolidated into the group in accordance with the principles and application guidance contained in IFRS 10 and not reflected merely as a financial asset (a loan to the BEE trust) and interest thereon.

This is a significant finding, as consolidating the BEE trusts would lead to a significant loss of distributable income and net asset value, specifically for Resilient and Fortress. In addition, this implies that the financial statements do not comply with International Financial Reporting Standards (IFRS) which constitutes a transgression of both the Companies Act, 2008, and the JSE listing requirements.

The final part of our report shows that an unusually high proportion of monthly trading volumes in group companies can be ascribed to transactions by the group companies and their BEE trusts. In addition, our investigations show that transactions by parties related to group companies and directors were unusually prescient as to the timing thereof. We believe that the degree of success is far too unusual to be ascribed to mere luck, but that only knowledge of inside information could generate these returns.

Finally, we also find a number of transactions between group entities which serve no clear economic purpose (considering their nature and frequency) and conclude that these transactions in our opinion had only one purpose: to artificially inflate the share prices of the group companies and increase volumes traded.

This research raises the questions: what was the purpose of these transactions and activities? What benefit accrued to the instigators of these transactions?

We believe the answer lies in a number of factors characterising property investment companies, which we discuss (see report):

As described by George Soros: “The true attraction of mortgage trusts [property investment companies] lies in their ability to generate capital gains for their shareholders by selling additional shares at a premium over book value. If a trust with a book value of $10 and a 12% return on equity doubles its equity by selling additional shares at $20, the book value jumps to $13.33 and per share earnings go from $1.20 to $1.60.

Investors are willing to pay a premium because of the high yield and the expectation of per-share earnings growth. The higher the premium, the easier it is for the trust to fulfill this expectation. The process is a self-reinforcing one. Once it gets under way, the trust can show a steady growth in per-share earnings despite the fact that it distributes practically all its earnings as dividends. Investors who participate in the process early enough can enjoy the compound benefits of a high return on equity, a rising book value, and a rising premium over book value.” (Source:, accessed on 26 January 2018.)

We believe the influential owners and key management of the group realised this fact early on and instituted several deliberate actions to drive the share price of group companies above their net asset values. This includes the transactions by related parties which appear to be based on inside information and the “book-over” trades between group entities which serve no clear economic purpose.

The underlying growth rates were boosted/maintained by the group structure. As smaller companies can grow faster using these techniques, it suited management to create smaller associate companies (first Fortress, then Nepi and Rockcastle prior to their merger and finally Greenbay). As the smaller associate companies generate higher growth rates, this boosts the growth rates in the holding companies higher in the group.

In addition, inclusion in security indices can boost share prices further for several reasons. Firstly, with the emergence of index-tracking funds, inclusion in security indices create forced buyers of the stock. Secondly, some institutional investors will only invest in companies above a certain market capitalisation or with significant average volume traded per day. Finally, some institutional investors benchmark their performance against indices and cannot afford to ignore securities with large weightings in these indices. By artificially increasing the share price and volume traded in these securities, the group of companies effectively created a new group of buyers to whom they could sell their own shares at a profit.

Turning to the BEE transactions, we believe the lack of consolidation of these structures is due to two reasons. Firstly, it created another set of related parties through which group share prices and volumes could be manipulated. Secondly, the group needed to avoid consolidation of these trusts at all costs. The reason is that consolidation would represent a drag on growth rates within the group, representing a headwind for the cycle to continue. By charging interest rates higher 3 than the group’s funding cost on every higher loan balances, the group could find another source of income growth (provided that the trusts were not consolidated).

Finally, we note that the interests of employees and executives are highly tied to an ever-increasing share price. Unusually, employees do not receive share options, but loans carrying interest at the cost of borrowings for the group to invest in shares.

Given the low dividend yield on the shares, the only way in which employees can ever repay these loans would be by selling shares at prices higher than those at which they bought them. This creates an incentive for employees to support key individuals in perpetuating the actions detailed above to continue to support the cycle.

In summary, we therefore believe that the exceptionally high valuation of the companies in the group arose from insider-directed and insider-related transactions in group companies’ shares to deliberately inflate share prices and volumes traded. Once this was achieved, third party investors quickly became enticed by the attractive dividend growth rates on offer and became vested in the continuation of the cycle themselves.