JOHANNESBURG — Unless you’re a shareholder in NEPI Rockcastle, it’s probably a good time to grab your popcorn and watch what is turning out to be a very interesting battle with Viceroy. Both sides have offered rebuttals to each other in what is increasingly turning out to be an ugly fight. Viceroy accuses NEPI Rockcastle of essentially having over-inflated its profits and of allegedly ‘improving’ their dividend figures at the expense of future disbursements. NEPI Rockcastle, meanwhile, has accused Viceroy of disseminating false and misleading information and of failing to understand its business. NEPI now wants regulators to investigate. Posted below are recent comments from both Viceroy and NEPI. – Gareth van Zyl
Post issued by Viceroy Research on 6 December 2018:
NEPI Rockcastle – Mucking out the stable
On November 28th, 2018 Viceroy Research released a report regarding NEPI Rockcastle (JSE: NRP) detailing what we believed to be overinflated profits in the company’s Romanian operations. NEPI issued a response to our research and hosted a call for concerned investors.
Unusually NEPI provided some clarity in terms of their accounting treatments. We maintain our belief that NEPI is fundamentally overvalued with reservations regarding the sustainability of distributable income, the tax treatment in foreign jurisdictions and the status of the overall company. This we will update on.
NEPI Rockcastle have not sought to deliver any scope of investigation in response to a request by investors in August 2018, and claim it is the prerogative of investors to identify the exact issues they want investigated. It seems clear what issues 10 of South Africa’s largest financial firms sought clarity on: potential trading of associated companies, suspicious capital raising activity and property transactions.
Per our original report, we were of the opinion that transfer pricing is not an adequate explanation as to why statutory losses are incurred in Romania. This is due to transfer pricing legislation in Romania and the EU. On further investigation, these hard currency, unsecured, intra-group loans are disclosed in NEPI’s Dutch subsidiary at rate of 8%-12%, compared to the Romanian mortgage rate of 4.5-5% and safe harbour limit of 4%. This is in stark contrast to the CFO’s description, in which she did not provide the figures, but guided the rate was between 4% to 8%.
Having obtained the filings of Dutch subsidiary, NE Property Cooperatief UA, we find it untenable how a local CFO or Financial Controller locally can advocate a “fair” and arm’s length transfer pricing interest rate on unsecured loans of 8%, formerly 12%. Essentially, the equity holders at the local level are being punished for an excessive and non-arm’s length priced loan. We make this assumption based on local Euro borrowing costs within Romania with an LTV of circa 28% as disclosed by NEPI.
NEPI uses the entirety of its funds earmarked for deferred tax payments to inflate its distributable earnings figure. In effect, the company is likely improving their dividend figures at the expense of future disbursements.
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New anti-abuse legislation will materially hamper NEPI’s transfer pricing model going forward in Romania, Netherlands, and across the EU. Given the extent of transfer pricing, this will impact NEPI’s distributable earnings.
Taking a step back, it is delayed outgoings, not earnings, that substantiate ~20% of distributable earnings. The Romania tax channeling is in fact one of many adjustments that allow this unsustainable dividend practice. Other items that deserve scrutiny include the dividend contribution of stocks, the antecedent dividend add back and the sale of financial investments.
At a property yield of 6.77%; after accounting for cash costs, interest costs, taxes, and the stock trading at a premium to NAV, we fail to see how NEPI can justify a 7.5% dividend unless holders choose to take their dividend as scrip, which is dilutive and makes future dividends even harder to justify. Accordingly, we maintain our view that the stock is fundamentally overvalued.
Of concern is that large money managers, including retirement money managers PIC, have continuously chosen to take dividends as scrip.
SENS trading data shows entities associated with the Resilient stable associate Roque Hafner traded large amounts of NEPI shares at least for the period between May 2016 and May 2018. Hafner was implicated in the media as being involved in the Resilient insider trading scandal and several Hafner entities used to trade Resilient shares also traded NEPI shares.
We reiterate our belief that NEPI Rockcastle’s shares carry a high investment risk and are fundamentally overvalued, which will become increasingly unattractive over time given what we believe are unsustainable distribution practices.
Statement issued by NEPI Rockcastle on 6 December 2018:
NEPI ROCKCASTLE REQUESTS INVESTIGATION BY REGULATORS FOLLOWING VICEROY REPORT
The Company requests investigation by regulators following Viceroy Report
Following the publication of a report on NEPI Rockcastle by Viceroy Research (the “Viceroy Report”), and further to our various announcements in response thereto, the Company has made a written submission to each of the JSE Limited, the Financial Sector Conduct Authority in South Africa, the Dutch Authority for the Financial Markets and Euronext Amsterdam requesting inter alia an investigation into trading in NEPI Rockcastle shares in the days leading up to and immediately following the publication of the Viceroy Report.
Having discredited with full transparency all accusations and allegations made, NEPI Rockcastle believes that the only purpose of the said report was to knowingly disseminate false and/or misleading information regarding the Company.
As such, the Company has requested the above-mentioned authorities to investigate any market manipulation offences that may have occurred in terms of the Financial Markets Act 2012 (in South Africa) and the Dutch Financial Supervision Act (in the Netherlands).
Further report issued by Viceroy Research
NEPI Rockcastle notes Viceroy’s latest report, released 6 December 2018. Despite the Company’s public commitment to discuss any concerns regarding its activities directly, Viceroy has published a new report without contacting the Company for comment or to confirm the accuracy of the information contained therein.
Viceroy’s latest report continues to spread inaccurate information, which the Company considers to be a further instance of market manipulation. Some of the erroneous information included in today’s report has already been addressed in the Company’s previous announcements or during the global investor call held on 29 November 2018, including (i) matters relating to the transparency into corporate governance, (ii) that intra-group finance expenses are not fully deducted for tax purposes, and (iii) that new tax legislation implementing the Anti-Tax Avoidance Directive rules has already been introduced in Romania from 1 January 2018 and has been applied by the Company since its introduction.
NEPI Rockcastle again requests Viceroy to disclose how it generates its income and if it has knowledge of any parties that stood to profit from the publication of their reports.
A more detailed response to each of the allegations made in Viceroy’s latest report is set out below:
- As previously announced, the Company is aware that the Financial Services Conduct Authority in South Africa (“FSCA”) is currently investigating possible prohibited trading practices in respect of NEPI Rockcastle shares traded on the JSE. Importantly, this is not an investigation into the business affairs of the Company. NEPI Rockcastle has and will continue to co-operate fully with the FSCA investigation. The Company confirms that it is not responsible for the trading activity of third parties, including shareholders.
- The Company’s Transfer Pricing files and related documentation, including intra-group loan agreements and interest rates used, are prepared and reviewed by transfer pricing experts. NEPI Rockcastle is comfortable that the interest rates used for intra-group funding purposes are in compliance with local tax legislation and transfer pricing regulations, and withstand the scrutiny of tax authorities.
- Viceroy continues to ignore that finance expenses deducted for tax purposes are different (and much lower) than finance expenses recognised for accounting purposes, and that the extent of tax deduction is defined by local tax legislation. The recent amendments to Romanian tax legislation regarding the deductibility of finance expenses were implemented through the Government Emergency Ordinance no. 79/2017, amending law no. 227/2015 on the Fiscal Code, and became effective as of 1 January 2018. NEPI Rockcastle’s subsidiaries in Romania have been applying this legislation since its introduction.
- It is apparent from its latest report that Viceroy does not understand NEPI Rockcastle’s business (and especially its accounting and tax processes and procedures) sufficiently to be able to draw conclusions as to what impacts the operations of the group. The report also ignores the fact that dividends declared in 2018 (corresponding to the distribution for the second half of 2017 and the first half of 2018) were fully paid in cash, without any scrip dividend being offered to shareholders.
- The deferred tax included in the consolidated financial statements as at 31 December 2017 was determined in accordance with IFRS, and audited by the group’s external auditors. The distributable earnings are a measure of the underlying operating performance of an investment property company, excluding fair value gains, investment property disposals, deferred tax, and items that are not considered to be part of its core activity. The Company is preparing the calculation of its distributable earnings based on EPRA and the Best Practice Recommendations of the South African REIT Association, which note that deferred taxes on unrealised capital gains on assets should be excluded.
- The Company’s dividend yield is a function of its share price, which is outside of the Company’s control; management’s main role is to drive the operational performance of the Company.
- The changes to the Company’s board of directors have been extensively discussed in the Company’s reports and presentations, and did not result from any investigation by the FSCA or other regulator.
The Company maintains that Viceroy’s allegations are based on incorrect and incomplete information, and it does not appear that they have consulted any accounting or tax experts. The Company considers that it has now addressed all allegations in detail and stakeholders that have concerns about the Company’s activities are invited to contact management directly. As previously mentioned, the Company is working on preparing a Q&A section which will be available on its website.
The Company is willing to entertain detailed discussions with its stakeholders only if done in a direct and transparent manner. Stakeholders that have concerns about the Company’s activity are invited to contact management directly at [email protected].
Shareholders are reminded that S&P and Fitch have recently confirmed NEPI Rockcastle’s ratings remain unchanged following the publication of the Viceroy Report, due to its lack of conclusive evidence and unsubstantiated allegations.
The Company expressly reserves its rights against Viceroy and any related party or contributor to the latest report.
