Value in investment holding companies
In a market that’s looking pricey, investors can still access quality companies at a discount, with someone else managing the investment process. Stephen Gunnion takes a look at the value to be found in investment holding companies
The JSE is expensive; there’s no question about it. Trading on an average price:earnings (PE) ratio of about 19, it’s well above its long-term average of around 14. A lot of that has been driven by industrial shares, particularly those with large offshore operations, including Aspen, Mediclinic, Richemont, SABMiller and Naspers. The latter, in fact, is one of the biggest contributors to the high multiple, trading on more than 100 times its current earnings.
But Naspers shouldn’t be valued on its PE ratio at all. Many fund managers see it as an investment holding company because of its investments in new media across the globe. Instead, they would rather group it with the likes of Brimstone, PSG, African Equity Empowerment Investments (formerly Sekunjalo) and Reinet. In a market that is looking pricey, some of these investment holding companies still offer value for investors.
Ignore their PE ratios, though, as this is a meaningless valuation for investment holding companies, says Cannon Asset Managers’ Victor von Reiche. These companies should be valued according to their sum-of-the-parts (SOTP) value and their discount to net asset value (NAV), he says.
“The underlying holdings are marked to market, so any change in value is reflected in the NAV of the holding company,” he says. “A lot of investors look at these companies and think that just because they are on a PE of 5 they are cheap, but that’s immaterial. The value of the underling holdings relative to the share price is important.”
JM Busha Asset Managers uses its own internal valuations for the listed assets of these investment holding companies. It places HCI as the cheapest, trading at a 25% discount to its fair value, while AEEI is the most expensive, at a 29% premium.
“HCI, Brimstone, Remgro, Niveus and Pallinghurst are the only counters that are trading at a discount to our fair value. Of those, on a risk adjusted basis, we would prefer Remgro, Brimstone and Niveus, in that order,” says JM Busha head of equities Farai Mapfinya. “Sekunjalo (African Equity Empowerment Investments) … has rallied quite aggressively in the last few weeks and swung from a discount to a huge premium to our fair value.”
We can hold onto our winners as we don't have prudential limits forcing us to sell our best stock and I think the active nature in our investment strategy plays a significant role
Other investment holding companies trading at material premiums to JM Busha’s fair value measure include RMI, Reinet and PSG, while Zeder and Grand Parade trade at close to fair value. Naspers trades at around 7.6% above fair value, says Mapfinya.
Von Reiche agrees that Naspers should be valued as an investment holding company rather than according to its PE multiple.
“It holds a minority stake in Tencent, so the earnings are equity accounted and are not consolidated in its income statement. You have to look at the value of Tencent and what Naspers’ 34% stake is worth to get its value,” he says. “What you are left with is the value of the other parts, including Mail.ru, which is a listed company, then its television, e-commerce and e-classified assets.”
Investors wanting access to Naspers’ other assets (or rump) can short Tencent for that exposure, he says.
“We have never held Naspers because we are a long-only manager and have been nervous about the Tencent valuation,” says Von Reiche.
While some of Cannon’s valuations differ slightly from JM Busha’s, they both value Remgro at around a 15% discount to its NAV, in line with the 13% historical discount. More than half of Remgro’s NAV comes from its holdings in Mediclinic, RMB Holdings and FirstRand. Mediclinic’s share price was boosted earlier this year with the decoupling of the Swiss franc from the euro.
“It has a quality portfolio and has outperformed its underlying assets, but I wouldn’t say it’s cheap,” says Von Reiche. “I would actually want a bigger discount relative to its historical discount because the underlying parts have moved up so much.”
Brimstone trades at a 15% discount to its NAV, which presents reasonable value, he says. “We like it because we are struggling to find value in the market,” he says. “Resources are under pressure, financials have run up and industrials have been expensive for a while, so with an investment holding company like Brimstone you are getting a quality portfolio of assets at a bit of a discount.”
Brimstone also recently paid out a special dividend on top of its ordinary dividend, continuing its trend of returning excess capital to shareholders. The company’s empowerment credentials are a bonus because they allow it to strike deals at a discount to their market price, such as its recent empowerment deal with Grindrod.
“[Brimstone has] made great capital allocation decisions over time,” says Von Reiche.
Its 2005 empowerment deal with Nedbank recently matured. The deal was financed through debt and when the options matured it gave an internal rate of return of over 70%.
“That was a fantastic deal for shareholders as it added a lot of value,” he says. “We like the other underlying components too. Currently Life Healthcare is the biggest part of its NAV and it’s moving into India. Oceana is set to benefit from the lower oil price as it will have a material positive impact on operations, and the weak rand will also translate into higher earnings as a lot of the hake it sells is into the European market.”
With Brimstone’s option in Old Mutual — also struck through an empowerment deal — set to mature, another special dividend could be on the cards, he says.
Right now Reinet, another investment holding company emanating from the Rupert family, is too geared to British American Tobacco, though it may be a prospect in the future.
“It is moving into offshore financial and property assets in the US, using the strong cash flow it gets from British American Tobacco, which is a great dividend payer and very defensive,” he says. “Another problem is the high management fees that it charges. But 10 years from now, the portfolio will likely look very different.”
While there’s an argument to be made for investing in an industrial conglomerate such as Bidvest, which manages and operates its underlying assets, Von Reiche says there are few options available on the JSE. Also, companies like PSG with majority stakes in many of their investments and significant holdings in others will take an active role in managing how these companies are run. That requires focus though, as well as a manageable portfolio to which management can add value.
Zeder, an investment holding company controlled by PSG, for example, has been consolidating its portfolio, selling down its holdings in noncore assets and increasing its stake in Pioneer Foods to play a more active role.
“You don’t want a portfolio with 100 underlying assets at 1% each; you want sizeable investments,” he says.
Though PSG and Zeder have solid assets, Von Reiche says their discounts to NAV of around 10% aren’t attractive enough.
JM Busha’s Mapfinya puts PSG at a 28% premium to fair value because of the lower valuations he places on underlying holdings than the market does, such as its Capitec stake. PSG’s own SOTP valuation
puts it at a 3% premium to its market capitalisation on the JSE.
Valuation aside, PSG says it’s the selection process that it uses in identifying investments that has led to its success. In fact, PSG has delivered annual total returns of more than 51% since the company’s inception in 1995, compared with just below 16% for the JSE’s all share index. Zeder has returned 26% a year for investors.
“Our selection process has evolved over time, partly driven by the sheer size of the portfolio,” says PSG CEO Piet Mouton. “We are very stringent, given that our focus has shifted to companies with the potential to make a difference to the overall SOTP, so new investments need substantial growth potential.”
Mouton believes that if the performance of investment holding companies were to be compared with that of the fund management industry, companies like PSG would emerge as the winners. Some of the advantages these companies have are permanent capital, with the ability to tap the market for more when required; no prudential limits; the ability to hold listed and unlisted investments; and a long time horizon. Unit trusts, on the other hand, are guided by prudential limits that restrict the size of investments in a single company; they have shorter time horizons; and they can’t actively manage the companies they invest in.
“We can hold on to our winners as we don’t have prudential limits forcing us to sell our best stock and I think the active nature of our investment strategy plays a significant role,” says Mouton.
Within its investment portfolio, Mouton says PSG values its private equity investments either at carry value or on a conservative PE multiple of between 10 and 12 times earnings.
‘The valuations as a whole are not a significant part of our SOTP so it doesn’t make a big difference either way; so we have taken the conservative route.”
You don’t want a portfolio with 100 underlying assets at 1% each; you want sizeable investments
Farai Mapfinya … Lower valuations on underlying holdings than the market’s.