It has been nearly three months since I exchanged my preferred shares in Rithm Capital (NYSE:RITM) for its common shares. Since then, the stock has gained almost 17% in terms of total return. Rithm Capital is in the process of implementing Rithm 2.0, which involves transitioning into a more diversified company with a managed private capital business. Recently, Rithm Capital announced its proposed acquisition of alternative asset manager Sculptor Capital Management (NYSE:SCU) for $639 million. This acquisition would enable Rithm Capital to expand into asset management, with $34 billion of assets under management across various investment strategies. However, the deal currently faces uncertainty due to a rival bid for Sculptor Capital Management.
The primary objective behind the acquisition of Sculptor Capital Management is for Rithm Capital to expand into private capital and generate recurring earnings by managing third-party capital. This move allows Rithm Capital to diversify its investment platform and move beyond its core mortgage servicing business. Sculptor Capital Management has faced challenges since its IPO in 2007, with its share price falling drastically.
In the second quarter of fiscal year 2023, Sculptor Capital Management reported a 37% decline in revenue compared to the previous year. The decline was primarily driven by a significant drop in incentive income. During the same quarter, Sculptor Capital Management also incurred a net loss and faced increased expenses, including higher interest expenses due to a rise in the Fed funds rate.
Furthermore, Rithm Capital may face limitations in realizing synergies from the acquisition, as the company does not have a comparable asset management platform. Sculptor Capital Management’s current cost base could remain intact even after the merger. The CEO of Sculptor Capital Management is expected to retain their position and receive a substantial compensation package. The current bidding war for Sculptor Capital Management indicates that the proposed deal may not close, potentially leading to a loss for Rithm Capital in acquiring a struggling asset manager.
While I remain optimistic about Rithm Capital’s future with Rithm 2.0, a bidding war for Sculptor Capital Management would not be favorable for the mREIT’s shareholders. Rithm Capital may receive a termination fee if its initial bid is not accepted, and some shareholders believe that this would be the best outcome. Sculptor Capital Management has been experiencing pressure on its assets under management, with fee-paying AUM declining compared to the previous year. The CEO’s total compensation is also a significant portion of the company’s revenue.
Fund Performance and Dividends
Rithm Capital would face challenges in improving earnings and AUM due to Sculptor Capital Management’s declining performance. However, it’s important to note that the broader macroeconomic environment and capital markets have impacted the decline. Despite the challenges, Sculptor Capital Management has attracted inflows into its investment funds and achieved better-than-average performance compared to its peers.
Given the uncertainty surrounding the acquisition of Sculptor Capital Management, Rithm Capital may decide against engaging in a bidding war. Rithm Capital has not yet detailed how it plans to leverage synergies from the acquisition, unlike other bidders with existing investment platforms. As of now, Rithm Capital’s quarterly cash dividend remains stable at $0.25 per share, supported by the company’s available earnings for distribution.
However, if the acquisition is finalized, Sculptor Capital Management’s negative operational cash flow could impact Rithm Capital’s ability to restore its quarterly dividend to pre-pandemic levels. Sculptor Capital Management’s operating cash burn has been significant, raising concerns about the recovery of the dividend. Considering the potential risks associated with the acquisition, my enthusiasm for Rithm Capital has diminished, and I may consider divesting my position if a bidding war ensues.