On November 28th, 2018 Viceroy Research released a report regarding NEPI Rockcastle (JSE: NRP) detailing what we believed to be over-inflated profits in the company’s Romanian operations. NEPI issued a response to our research and hosted a call for concerned investors.
NEPI Response 2018.12.06 – Download Link
NEPI Dutch Filings – Download Link
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 harbor limit of 4%. This is a 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.
- 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.
November 28, 2018 – Viceroy published its report on NEPI Rockcastle on November 28, 2018. NEPI Rockcastle have subsequently issued a preliminary response to our report.
Viceroy Response 28 Nov 2018 – Download Link
We note that our data was sourced directly from NEPI’s filings, government records, and court records. Where we have conducted calculations, our analysis and workings have been show in full. Investors have the ability to determine the veracity of our analysis and conduct their own due diligence.
We are not of the opinion that NEPI has consistently proven transparency towards shareholders, the latest example of which is the outright refusal to engage an independent party to investigate potential trading of associated companies, suspicious capital raising activity and property transactions, at the request of 10 of South Africa’s largest financial institutions (including Government fund managers).
In stark contrast to any “reasons” NEPI provides for accounting discrepancies, investors should also note with extreme caution that the Company failed to provide details of outgoings, arrears, management matters, negotiations, rent reviews, to its valuers, Cushman & Wakefield. This was not an issue for all its other geographies.
Further to this, analysis of NEPI’s Romanian portfolio accounts show the company has, on average, 80 days of accounts receivable. This is indicative of substantial rent arrears, and fails the company’s claim of a 99.9% collection rate. These issues are independent of where earnings have been recognized, if this should indeed be NEPI’s response, and would not account for discrepancies in taxes paid in foreign jurisdictions.
We look forward to NEPI’s comprehensive response to our report.
Irreconcilable international earnings, enriching management through M&A, hoodwinking investors through misleading analysis via rejection of independent investigation.
Report – Download Link
Letter to Auditor – Download Link
Romanian Subsidiary Filings – Download Link
NEPI Rockcastle (JSE:NRP) is a JSE-listed entity holding one of the largest real-estate investment portfolios in Eastern Europe. Viceroy’s investigations have uncovered numerous inconsistencies within NEPI Rockcastle’s financial reporting and major links to an established financial fraud:
- Local filings for NEPI’s Romanian subsidiaries suggest company figures are massively overstated for at least the past 3 years. Romania is NEPI’s largest geographical income segment in which consolidated 2017 group accounts show net profit before tax of EUR 284.87m (2016: EUR 221.90m). Local income statements show these companies operate at losses of over >EUR 40m (2016: >EUR 50m) for the same period.
- Viceroy believe corporate or tax-effective structure or transfer pricing does not adequately explain the substantial differences in Romanian earnings generation as NEPI’s reported income tax expenses in Romania also do not match local filings. Given the criminal implications of misrepresenting tax numbers to the Romanian tax office, we assume NEPI chose to instead mislead its shareholders.
- NEPI’s recent acquisition of Rockcastle was immediately followed by a massive write-down of subsidiary loans reflecting uncollectable debt from SPVs. When taken together with the purchase premium for the business of almost 80%, it is clear that the only winners in the Rockcastle acquisition were Resilient Stable insiders.
- NEPI’s former chairman Corneliu-Dan Pascariu was involved in Romanian real-estate venture CEEIF, funded by the Peregrine Financial fraud perpetrated by Russell Wasendorf Sr. NEPI purchased Romanian assets from CEEIF before the Peregrine Financial fraud came to light. Court filings establish that CEEIF and several subsidiary development & holding companies were utilized by Wasendorf Sr. to embezzle cash.
- Despite having financial recourse for beneficial ownership of ~11% of CEEIF’s purported book value of >EUR 60m, Peregrine’s Receiver, Michael M. Eidelman, had no interest in pursuing these recoveries. Eidelman’s investigations alleged CEEIF was insolvent, did not discount asset values to CEEIF’s pro-rata minor stakes, hid assets and liabilities from its balance sheet, and had no audited financial statements. Given Pascariu’s involvement as a major shareholder and financier through Unicredit, at which he was chairman at the time, it would have to have been extremely neglectful to not detect this activity.
- NEPI shareholders issued a written request on 8 August 2018 for an independent investigation into potential trading of associated companies, suspicious capital raising activity and property transactions. NEPI rejected demands for an independent investigation, instead establishing a subcommittee of its own members to investigate themselves, and their predecessors.
- Even without considering the above points, NEPI is fundamentally overpriced when compared with peers.
Based on our analysis, we see a significant downside to NEPI’s share price driven by an unwarranted overvaluation and the likelihood of substantially lower-than-reported earnings. Were NEPI to trade in-line with peers we believe shareholders would face an 25% downside, however, given the suspected extent of financial misrepresentation, we believe the company’s shares are worth substantially less.
We believe stakeholders should reinforce their demands for an independent forensic investigation into the company’s operations and veracity of its financial consolidation and tax compliance. Until such time, Viceroy believe NEPI carries a high investment risk.
For more research into the Resilient Stable, readers should refer to the leaked internal memo by 36One Asset Management which we believe was published around the end of 2017. A Scibd link to this report is below. Viceroy have no business relationship with 36One Asset Management and have never discussed NEPI Rockcastle with them.