African Rainbow discount to NAV stubbornly wide
Though some investors have started looking closely at African Rainbow Capital Investments (ARCI) as a possible value stock, its share price has been a truly dismal performer since listing in 2016, losing 75% during that period while net asset value (NAV) has hardly moved.
Discount to NAV has widened significantly. As a rough rule of thumb, discount to NAV should typically be in the range of 20%-30%. But even before the share price collapse in equity markets triggered by the coronavirus, ARCI’s discount was already far wider. In December 2019, the intrinsic NAV was 952c per share, compared with the current share price of 260c, making that a 73% discount to NAV.
A few reasons have been advanced for this situation, most revolving around the management’s own valuation of its varied unlisted investments. Other concerns include the lack of a group dividend and somewhat anaemic cash flows from underlying investments. Some observers have even suggested that asset sales may be needed to release cash, a view that is not disputed by management.
The largest contributor to ARCI’s NAV is Rain, a telecom company that aims to be a fullservice network mobile operator and is focused on data. With a fair value estimate of R2.7bn, the group’s 20.7% holding in Rain accounts for 27.4% of ARCI’s value. No other single investment comes anywhere close to Rain’s contribution to NAV.
It is thus vitally important to interrogate whether the management’s valuation is reasonable, especially at a time when telecom companies globally are taking strain, both operationally and from a valuation perspective. Being unlisted, there are no publicly available financial statements.
Such a valuation implies a total valuation of about R13bn for Rain. This compares with Vodacom’s R215bn, MTN’s R67bn, Telkom’s R8.8bn and Blue Label Telecoms’s R1.4bn. Interestingly, Rain’s valuation of R2.7bn is almost identical to ARCI’s total current market capitalisation.
Management uses a discounted cash flow method to value Rain. It is extremely important to determine those future cash flows with a reasonable degree of certainty, and this is where investors start disagreeing with management.
Rain is effectively a start-up operation, though it derives a degree of annuity income from providing Vodacom with a variety of services. Other income comes in the form of 4G data sales, 5G subscriptions and reseller income. It operates 300 5G sites and plans to roll out many more in metropolitan areas. On the traditional 4G data front, a side effect of the coronavirus outbreak is that many more people are taking up Rain’s unlimited data service for R250 per month, due to working from home. Though this phenomenon is likely to persist only as long as the pandemic, it may well help to encourage the work from home habit in the longer term.
Few people would disagree that Rain’s prospects are strong, but there is a price for everything, and the market appears to be saying that the current valuation seems excessive.
The other large contributor to NAV is Tyme Bank, in which ARCI has a 33% stake. Tyme has 1.5-million customers and believes it will reach breakeven at a figure of 3-million customers. Recently it sealed an agreement with the Zion City Church (ZCC) whereby its members would receive preferential deals on signing up as Tyme Bank clients. Considering that the ZCC has 12-million followers in SA, this deal should help the bank surpass break-even by June 2021.
IT IS VITALLY IMPORTANT TO INTERROGATE WHETHER THE MANAGEMENT’S VALUATION IS REASONABLE
It would indeed be strange if investors perceived ARCI as a stock that should be paying handsome dividends, at least at this stage in its life cycle. Once all its underlying investments are profitable and paying dividends themselves, only then would it be reasonable to ask for a group dividend. Now only very few of those companies, such as Bluespec and Alexander Forbes, pay dividends.
The market isn’t prepared to concur with the ARCI management’s valuation of Rain. Until Rain’s financials become more transparent and there are signs that it really does have the type of outstanding growth prospects that are implicit in the management’s rating, the market is likely to maintain this jaundiced view of ARCI.