Description

I am recommending a long in Rithm Capital (RITM). Rithm is a REIT operating as a holding company with diverse businesses including a large mortgage origination-servicing platform (NewRez), an asset manager, a mortgage REIT, and a collection of other investments and operating assets. We believe Rithm will break up into 2-3 separate public companies over the next few years, which will transform RITM into a pure-play asset manager. In the process of breaking up the company, the “RemainCo” asset manager will establish new management agreements with the spun-off entities, which should drive higher management fees to the asset manager, and, ultimately, a rerating of the stock as low value earnings are transformed into higher value fee-related earnings (converting current earnings valued at single-digit multiples to fee-related earnings valued at 15x-25x). The transformation could drive Rithm to rerate closer to $15-$20 per share, which, when combined with the $1.00 annual dividend (9.1% yield), could generate a 60%+ total return over the next couple of years.

To orient those new to Rithm, below is a brief overview of the company’s segments:

Rithm’s CEO, Michael Nierenberg, an astute investor in his own right, is focused on transforming Rithm from a mortgage-REIT-proxy with constrained upside (~1.0x book value, low multiple of earnings), to a capital light asset manager with attractive growth prospects, and the potential to trade at much higher multiples (the “Alts” currently trade above 20x fee-related earnings). The Sculptor platform gives Michael and Rithm the scale and fundraising team necessary to raise capital around new strategies, while continuing to raise large Sculptor flagship real estate and credit funds.

In the process of splitting up Rithm, management will have the opportunity to establish new management agreements with the spun-off NewRez and mortgage REIT entities. To illustrate, Rithm’s “Investment Portfolio” segment is a mix of agency mortgage loans, mortgage servicing rights (MSRs), consumer loans, and single-family rental properties, which collectively comprise $17.4B in assets and $3.0B in equity. Assuming the mortgage-related assets are spun-off into a stand-alone REIT and other assets are sold into fee-generating entities, Rithm Asset Management could add $87M in incremental management fees, assuming a blended 0.50% management fee on $17.4B in assets (a ~20% uplift to Rithm’s existing base of ~$400m in management fees). Similarly, when NewRez spins-off as a stand-alone entity, Rithm could charge a 1.50% management fee on NewRez’s equity to manage its sizeable portfolio of residential mortgage loans (mirroring aspects of the structure between industry peer PennyMac Financial Services and PennyMac Mortgage Trust). On NewRez’s $3.5B of equity, a 1.50% management fee would generate an additional $50M in management fees for Rithm Asset Management. Following the spin-offs, the Rithm REIT and NewRez entities would trade at RITM’s current multiples—near 1x book value—but the Rithm asset manager would gain ~$140M in very high incremental margin asset management revenue that the market could value at a much higher, 17.5x, multiple.

The table below reflects the revaluation potential of breaking up the company:

Notes: Assumes corporate costs stay with the “Rithm Asset Management RemainCo” for simplicity. EAD add-backs include one-time expenses, non-cash gains & losses, and deferred tax benefits. See below for bridge to 2024 pro forma Asset Management FRE of $235m.

The Rithm asset management business is well positioned to grow over the coming years regardless of Rithm’s future corporate structure. Scultptor’s flagship real estate and credit funds have performed well and should attract new capital as they raise new funds over the next 12-18 months. We assume Sculptor’s funds will raise $5B of AUM over the next couple of years, adding ~$50M in management fees at a 1.0% fee rate. We also believe Rithm has a large opportunity to cut costs at Sculptor, which operated with inordinately high compensation levels relative to its peers. At the same time, Rithm intends to establish its own family of funds by raising third-party capital to invest in its core strategies. Specifically, Rithm could raise funds for the following strategies:

• MSR investing: a few fund managers have MSR-focused funds that employ Rithm’s MSR investment strategy with third-party capital. The Blackstone affiliated Bayview has a ~$7B MSR Opportunity fund; Rithm manages a much larger MSR portfolio and has a longer investing track record in the sector.
• Transitional home and commercial building loans: Rithm owns Genesis Capital, a transitional lender purchased from Goldman’s merchant bank at an attractive valuation in 2022. Genesis makes first lien mortgage loans to builders who buy homes to fix and sell. Banks have dramatically pulled back from the transitional loan market in the current environment and Rithm is seeing highly compelling opportunities.
• SFR, MFH, and “Rent-to-own” lending: Rithm’s owned SFR portfolio, Adoor, has generated a ~14% IRR since inception and Rithm intends to increase its presence in the space as an investor using third-party capital.
• Bank disintermediation: Michael Nierenberg has a good track record of buying assets from distressed banks. The Rithm team is actively pursuing opportunities to capitalize on potential asset shedding by banks as they are forced to comply with Basel III capital requirements and more stringent Fed oversight following the 2023 regional banking crisis.

We see a path to Rithm building a $600M+ management fee asset management business (from ~$400m today) earning over $230M of fee-related earnings (excluding any benefit from incentive and performance fees):

There are other fundamental reasons why Rithm’s stock could perform well. First, NewRez’s mortgage origination business is severely underearning in the current rate and housing environment. The Origination segment’s net income has swung from net earnings of $100M-$419M in 2019-2021, to losses throughout 2023 as mortgage origination volumes dropped -70% over the 2021-2023 period. In response to the decline in origination volume, management cut costs and significantly improved the efficiency of the origination operation. If mortgage origination volumes return to 2019 levels, Rithm’s origination revenue could improve significantly, which would drive earnings above the $100M earned in 2019 given the company’s newly slimmed down cost structure. Furthermore, the servicing segment should continue to generate strong earnings if interest rates stay above ZIRP levels. A 3%-4% rate environment (4.25%-5.5% mortgage rates) would drive very strong earnings upside at NewRez.

The unbundling of Rithm requires some imagination and belief in management’s ability to execute on the plan. We are confident that Michael Nierenberg is up to the task based on his successful track record as an investor and operator, and the high proportion of his compensation tied to performance-based stock awards (70% of his total comp is in stock, most of which is performance-based). Rithm has already taken steps to spin-off or IPO NewRez, and management is explicit in its goal to transition the business to an asset light, asset management model so the simplification process is underway. The transition will take time, but the upside potential is substantial ($17 p.s., +74% upside), and, in the meantime, we will collect a ~9% annual dividend with potential for a positive earnings inflection if the rate environment normalizes.

Financial Overview

Catalyst

• NewRez spin-off.
• Creation / spin-off of separate Rithm REIT.
• Sale of assets into funds managed by Rithm.
• Additional asset management agreements like the recently announced Ajax agreement.
• Fundraising at Sculptor and Rithm’s new funds.
• Rates moderate, driving higher origination and investment portfolio earnings.