Vodacom deal raises questions about PIC’s investment processes

DOES the Public Investment Corporation (PIC) — the stateowned fund manager — have an investment decisionmaking process that meets professional best standards? Does it conduct thorough due diligence, estimate key return and risk factors, fine-tune correlations between its assets to ensure it delivers the most efficient returns to its beneficiaries?

I ask because the PIC seems to be doing deals that do not reflect a credible decision process. According to recent reports, the government is about to sell its R26.6bn stake in Vodacom to the PIC to generate funds to help pay for Eskom. The PIC already owns 3.2% of Vodacom and the government’s stake will increase it to more than 17%. It already holds 17% of MTN, so its exposure to telecoms is going to be heavily skewed.

The size of the PIC means that it has large exposures everywhere, at an average of around 10% of every JSE company. Managing large exposure risk has to be done carefully. Of course, all this comes down to price. The risk problem can be compensated by a discount to market prices in the transaction, giving the PIC room to hedge the exposure or effectively self-insure.

Politically, a PIC transaction is fairly neat, allowing the government to make out like it is not flogging assets to private hands. Given the conflict of interests, as the PIC’s political overseer is also the vendor of the stake, I should expect that the process is being driven by independent nonexecutive directors who have developed a clear tactical investment strategy to justify and manage the risks. I doubt it, though. The worst PIC deal I’ve seen in the public domain — and there are many deals in the PIC’s private equity portfolios that never get any public scrutiny — was its $270m investment a year ago in Camac Energy, recently renamed Erin Energy. A look at the latest financials for the firm, which is in the business of exploring for oil, raises concern that the PIC will not be seeing that money again.

At the end of March, Erin had about $8m of cash left out of the PIC’s injection, and current liabilities of $191m. That suggests a severe liquidity crunch. In the quarter to end-March it lost $33m. It is far behind its initial goals for production from some Nigerian wells, and recently signed a deal with Glencore which effectively presells the Nigerian output when it comes on line, presumably to give it some much needed liquidity. The cash-burn rate is going to swamp that pretty fast, though. I have no doubt that the company is going to be coming cap in hand to the PIC, which holds 30%, to add good money to bad.

For reasons I can’t comprehend, the share price of the firm has rallied sharply this year on thin trade, giving it a market cap of $1.5bn on a book value of about $304m. That makes the PIC’s investment look good on paper, but the price discovery mechanism seems whacked.

The PIC does proclaim to worry about concentration risk, as it should. That was the ostensible motivation for a deal last year that saw the sale of a stake in property company Growthpoint to empowerment firm Southern Palace. From what I understand of the terms of that deal, the PIC effectively provided a hedge on the downside risk of the R4.5bn stake, allowing Southern Palace to raise funding from commercial banks. The banks happily financed it, knowing that the PIC was on the hook for the risk. The share price rallied strongly to February giving Southern Palace a good paper profit but has since drifted back down to about breakeven.

What did the PIC get out of it? Ostensibly, it was worried about the concentration risk it had in its large exposure to Growthpoint. The disposal reduced its interest from 19% to 11%. It may argue that benefit justified taking the downside risk and handing the upside to an empowerment firm. But if an empowerment deal was the objective, it is not clear why the firms did not get Growthpoint to play some role as the beneficiary of the enhanced empowerment status. Keeping the downside, while letting go of the upside, just looks like bad investment strategy. And if concentration risk really is a problem, how can it do the Vodacom deal?

Much of the PIC’s assets are managed in order to fund the retirement benefits of public servants. It is a defined benefit scheme, so any underperformance has to be funded by the government as the employer. In other words, a poor investment performance by the PIC directly translates into an increased burden on the taxpayer. But there are some defined contribution elements to the schemes: annual benefit increases and some other adjustments are driven directly by investment performance.

So taxpayers and retirees are directly affected when the PIC’s investments underperform. It is therefore in everyone’s interest that the PIC run itself to the best professional standards and that all investment decisions are properly scrutinised.

The size of the PIC means that it has large exposures everywhere, at an average of around 10% of every JSE company