TRADE OF THE MONTH

Go long on PSG and short on its biggest asset, Capitec

“Capitec has maintained its innovative stance. There is now a credit card as well as an entry into the small and mediumsized business banking sector

The near mythic status of Stellenbosch-based investment business PSG Group, since its founding in 1996, rivals that of US-based investor Warren Buffett. The group, now worth R41bn, has made millionaires (and billionaires) of its early followers.

But lately revered tones have given way to mutterings of widening discounts to PSG’s sum-of-the-parts (SOTP) asset valuation.

PSG’s ability to create enormous value by uncovering the blue chips of tomorrow meant PSG Group usually traded at a small premium or a small discount to its SOTP.

That sentiment changed in 2018 when the twin events of the Viceroy Research attack on PSG’s largest asset, Capitec Bank, as well as the placement of a vast line of PSG shares held by the scandalised Steinhoff company, shook market confidence.

Viceroy’s attack was damaging, as the Capitec investment (worth almost R40bn) makes up more than twothirds of PSG’s SOTP value, and equates to some 80% of PSG’s market capitalisation.

Capitec fell sharply on the Viceroy report, dragging the PSG share price and SOTP discount with it.

Capitec’s share price has recovered over the past year, but the PSG discount has remained wide.

The Steinhoff debacle did not help either. Steinhoff (its prime mover, Markus Jooste, and PSG founder Jannie Mouton were once pals) held a 25% stake in PSG, which needed to be offloaded when the furniture giant needed to cull debt urgently. About R7bn worth of PSG stock was offloaded by Steinhoff into the open market.

From showing low singledigit discounts to SOTP, PSG Group — at R208.21 — is now offering a 21.1% discount, and its stock (at the time of writing) was near a 52-week low.

In other words, some R10bn of value is simply not being considered by the market. What could be the justification for this widening discount?

PSG has valuable stakes in education stocks Curro and Stadio (both at recent lows); financial services business PSG Konsult; agricultural investment fund Zeder; and PSG Alpha, which holds a portfolio of special situations such as Energy Partners, FutureLearn and Evergreen Retirement.

Capitec, though, remains by far the biggest portfolio component. Since the Viceroy report, the Capitec share has recovered from a low of R810 in February 2018 to regain its peak in April 2019 at R1,433. Lately Capitec has declined 29% to the present R1,107.

The low-end mass market banking sector is no longer Capitec’s own. New entrants such as TymeBank and Bank Zero have been launched and the banks have launched new products to try to compete.

It must be said that Capitec has maintained its innovative stance, rolling out more transactional and fee-based services. There is now a credit card as well as an entry into the small and medium-sized business banking sector.

However, the issue remains that PSG is now nothing more than a cheap proxy to Capitec — if we extrapolate that the market is disregarding many of the other assets in its stable.

Ultimately this means PSG joins the ranks of many other investment holding companies that trade at a wide and widening discount — such as Remgro, Hosken Consolidated Investments and Sandown Capital. Has PSG lost the magic allure and become just another big monolithic value trap? There were always risks in PSG being so closely allied to one large asset. While Capitec may be a great business, does PSG really want to have all its eggs in one basket? There seems growing concern at the inherent risk of PSG becoming ever more intertwined with Capitec.

A way to change this is to unbundle Capitec to existing PSG shareholders. This may be an unpalatable choice for the family owner/managers of PSG for an asset built by the fabled founder, Mouton, who has retired. (Older readers may also remember PSG unbundling its Capitec stake in 2003, instantly regretting the decision, and then reacquiring the stake. — Editor)

But a precedent was recently set. Zeder Investments sold its 28% controlling stake in Pioneer Foods for R110 a share to unlock a 56% premium to market and release nearly R6.5bn of value back to Zeder shareholders (PSG being the biggest).

PSG, ex-Capitec, would be a R20bn corporate within a nimbler structure whereby the existing listed and unlisted assets would have more of a chance to shine and perform, no longer overshadowed by the giant Capitec holding. Perhaps some of the smaller assets within PSG Alpha and Zeder would add further lustre to the portfolio.

The discount would hopefully narrow as the market, sensing value unlock, would chase the inherent discount trapped within PSG.

Such a seismic move in unbundling such an entity is bound to draw resistance. A legacy has to be untangled. A mindset has to be changed. But only drastic action will preserve the PSG of old to become the PSG of the new generation.

For this reason, I see a perfect trade of long PSG and short Capitec. ●