Value in in­vest­ment hold­ing com­pa­nies

Financial Mail - Investors Monthly - - Front Page -

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

Pic­ture: THINKSTOCK

Pic­ture: THINKSTOCK

Farai Mapfinya … Lower val­u­a­tions on un­der­ly­ing hold­ings than the mar­ket’s.

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