Is Zeder serious about an unlock?
The JSE has numerous investment holding companies and shareholders who live in eternal hope of the Great Value Unlock™ that is usually promised as part of the investment thesis. On occasion, this works magnificently.
There are also operating companies that happen to hold interesting portfolio investments alongside other operations, like Caxton and its stake in Mpact. Caxton wouldn’t traditionally be considered an investment holding company, but the market narrative has shifted as the stake in Mpact has grown.
Pure investment holding companies generally don’t control their underlying portfolio companies, though there are exceptions. Traditional names in this space include PSG, Remgro and African Rainbow Capital.
At the other end of the spectrum, you find groups that are serial acquirers and operators of businesses: Bidvest, Transaction Capital, Invicta and Barloworld all spring to mind.
The traditional investment holding companies have a different set of accounting rules. Instead of consolidating or equity accounting the underlying portfolio companies, which would result in a balance sheet full of operational line items, these companies are required to measure their investments at fair value. Any changes in fair value are recognised in profit or loss, as the primary business of the group is to make investments. Because the balance sheet is theoretically recognised at fair value, you would expect the NAV per share to be a fair approximation of what the company is worth.
Why, then, do investment holding companies trade at significant discounts to NAV?
Before we delve into the answer, it’s worth noting that this wasn’t always the case. A few years ago, investors were happy to pay a premium to NAV to get some of the action. The idea was to give capital to the investment heroes of SA, giving them a mandate to work their magic and generate amazing returns. This mostly ended in tears, which is why sentiment has soured towards these structures.
Despite this, we now see a similar trend of premium-to-NAV share prices in industrial property funds, as the market has become obsessed with logistics properties. Sirius is trading far above NAV, which I’ve said for months is a recipe for disappointment. Despite this, the share has kept running; momentum is a powerful thing.
The argument behind the premium in Sirius is that the underlying properties are not being accounted for at a valuation that considers the true potential. In other companies, the market frequently argues that directors may be valuing unlisted companies too aggressively, which could help explain a traded discount to NAV.
The point is that because the underlying assets are usually unlisted, the market’s view on their value is reflected in the share price, with the directors’ view reflected in the NAV.
The discounts exist despite directors usually taking a conservative approach. Given the chance, wouldn’t you choose to be the director who underpromises and overdelivers? This should technically drive a lower discount to NAV, as the asset values within the NAV are more conservative.
A clear driver of discounts is the cost of the management team. In Naspers/ Prosus, the huge cost of the executives is one of the reasons for the significant
discount to NAV. We can use a less ridiculous but still painful example, like Zeder, where the two lead executives earned a combined R14m in each of 2020 and 2021. Total administration costs came in at R27m, which shows how expensive listed structures can be.
To take these costs into account, investors would typically estimate the present value of the costs into perpetuity. This would use the cost of capital and the growth rate of the costs in the formula, which can give a shockingly high number. For example, on a cost of capital of 10% and a growth rate of 5% for these expenses, the present value of a recurring cost of R27m is equal to a liability of R540m. Depending on the structure, costs can easily explain 10%20% of the discount.
Then we have the deferred tax issue, which is the elephant in the room with Zeder. The company is touting a valueunlock strategy, highlighting that approaches have been received for portfolio assets. This implies that investments will be sold off piecemeal, which would most likely attract capital gains tax (CGT). In contrast, unbundlings usually have tax relief in SA, so the tax issue is less important in holding companies with listed investments that can be unbundled.
In companies with unlisted portfolio companies, an allowance for CGT (known as deferred tax) is critical.
Zeder doesn’t recognise deferred tax, a decision which I understand would only be appropriate when there isn’t a plan to sell assets. But Zeder is telling the market that a value unlock is imminent, so where’s the deferred tax?
In companies with unlisted portfolio companies, an allowance for capital gains tax (known as deferred tax) is critical