In January 2016 shares of New Residential Investment Corp (NYSE:NRZ) were in a tailspin falling below $10 and investors were looking for action from management. In response, a $200 million share buyback was announced to take advantage of the undervalued share price by snapping up cheap shares. Since the buyback announcement shares have bounced over 60% from their January low which would make the buyback a well-timed success.
However, to my disappointment (and I suspect the disappointment of many other investors), New Residential did not execute the buyback and therefore missed a major opportunity to help its shareholders.
When $200 million equals $0
Like many investors I was supportive of management's decision to launch the buyback in January in the midst of a share price downturn that flew in the face of an otherwise strong company. But at the same time I noted that the buyback would actually need to be executed to build value for shareholders.
It is important to note that the New Residential buyback, like almost all buybacks, was not a commitment but instead just an authorization. Because of this, management could choose whether to buy $200 million of shares of $0 of shares.
As it turns out management chose the latter as 230 million shares remain outstanding and the most recent 10-Q states, "No share repurchases have been made as of the date of the issuance of these condensed consolidated financial statements."
Why no repurchases?
Stock buybacks are often criticized as a quick way for management to boost the value of their stock options while providing little long-term value. The debate over the value of buybacks has no end in sight but it's worth asking why New Residential's management would choose not to execute its buyback authorization.
One possibility stems from the way management is compensated. Unlike most companies where management profits from a higher share price through stock option appreciation, New Residential is managed by Fortress Investment Group (NYSE:FIG) which receives much of its compensation based on assets under management. This means that even if share repurchases are a good value spending capital to repurchase shares would reduce assets under management and therefore cut Fortress' compensation.
In fact, this was one of the reasons I was skeptical that New Residential would launch a buyback even when shares were cheap. But despite New Residential's lack of buybacks, another Fortress permanent capital vehicle, New Senior Investment Group (NYSE:SNR), did repurchase some shares showing Fortress is not completely opposed to buybacks. It should be noted that even if the other possibilities discussed below are cleared up, the incentive structure could still prevent management from repurchasing shares even in the event of another undervaluation scenario.
A deal announced on August 9 could provide a reason for management's buyback avoidance. In a transaction of roughly $500 million New Residential is on track to purchase $35 billion UPB of mortgage servicing rights alongside a set of assets including another $37 billion UPB of mortgage servicing rights.
New Residential has been trying to prove that it can continue acquiring new MSRs and this latest package further expands the company's operations. Not surprisingly, market reaction was bullish with shares rising another 4% after seeing significant gains over the past few months.
But the question of the buyback has to do with why no shares were purchased when they traded near $10 in January and none purchased since even as they remained in value territory for an extended period of time.
Possibly management was aware of this potential deal far in advance and wanted to keep the capital on hand. Management may also have been retaining extra capital in order to be able to pursue deals such as this one on-demand. But if management's primary goal was retaining capital for expansion it seems odd to announce a share buyback. Management may have wanted to give itself the freedom to repurchase shares should they become highly undervalued but then investors have to wonder why management would not see shares undervalued at $10 given that state of the company.
There is also the possibility that management was trying to time the market with its buyback and lost. As shares were plunging in January management may have believed that even quality shares can get cheaper and therefore waited for even lower prices to get more value for its buyback.
If this was the reason investors should not expect buybacks to happen anytime soon given that the current share price is now well above the January lows that did not get management to act.
A lesson in buybacks
The New Residential buyback authorization demonstrates why investors need to keep an eye on how buybacks play out rather than simply assuming they are being completed. Even as shares traded at deep value levels at the time of authorization management declined to execute the buyback and missed a chance to snap up shares on the cheap. It is also an important reminder to pay attention to management incentive structures which may or may not have influenced the decision to not execute the New Residential buyback.
In my view, management is unlikely to begin repurchasing shares in any significant amount in the near-future given the current compensation structure, the recent deal announced, and the higher valuation where shares currently trade.
Despite my disappointment that no shares were repurchased under the buyback authorization, I remain bullish on New Residential for its dividend, valuation, and interest rate exposure. However, the handling of the buyback authorization is a reminder to keep an eye on the operations and capital return strategy execution at even the best-performing companies.
Disclosure: I am/we are long NRZ.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The author does not guarantee the performance of any investments and potential investors should always do their own due diligence before making any investment decisions. Although the author believes that the information presented here is correct to the best of his knowledge, no warranties are made and potential investors should always conduct their own independent research before making any investment decisions. Investing carries risk of loss and is not suitable for all individuals.