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Patrice Motsepe. Prior to listing, ARC was 100% owned by Motsepe’s Ubuntu-Botho Investments, which was founded in 2003 as a BEE partner of Sanlam. (Photo: Gallo Images / Sowetan / Thulani Mbele)
ARC seemed a bit taken aback by the rejection from investors, as the basis for calculating the fee has not changed since inception.
Nobody likes fees, especially pesky management fees that reduce investments. But SA has rarely seen the level of outrage it received at African Rainbow Capital (ARC) Investments’s announcement of a R750 million rights issue last month, a good chunk of which was aimed at settling outstanding fees owed to investors. managers of your investment fund.
While the black-powered investment group backed off spectacularly after the protest, it still highlighted the magnitude of the fees and the lack of value delivered to shareholders since it was listed three years ago. The fee will still be paid, with internal cash resources, while the proceeds from the rights issue will now be used to shore up capital, finance existing investments and any new opportunities that arise. Really, that’s just a juggling act.
A bit of history: ARC was created in 2015 and was listed with much fanfare two years later due to the top-tier pedigree of its leadership. In addition to the empowering credentials of billionaire founder Patrice Motsepe, the company is led by former Sanlam CEO Johan van Zyl and Johan van der Merwe, who previously led Sanlam Investment Management. Prior to listing, it was 100% owned by Motsepe’s Ubuntu-Botho Investments, which was founded in 2003 as a BEE partner of Sanlam.
It is listed at R8.50, a level based on the value of its investment portfolio as determined by its directors. Management fees of 1.75% per annum plus 16% performance share are calculated from that. ARC Investments’ medium and long-term objective is to increase its intrinsic net asset value (INAV) by at least 16% per year, net of fees. While it grew only 2.1% to R9.54 in the year to the end of June, ARC says it was indicative and in line with the market’s performance in the current economic environment.
Still, INAV grew as its share price continued to fall. During the same period, it fell by a third and has continued to decline ever since.
Almost exactly three years after its listing, ARC announced the issue of rights at R2.75 per share. While it came at the usual, albeit small, discount to the prevailing share price, it was 68% below the 2017 listing price. Meanwhile, the management fee is still calculated on its net asset value (NAV).
ARC seemed a bit taken aback by the rejection from investors, as the basis for calculating the fee has not changed since inception. That’s part of the reason why fund managers, including Cy Jacobs of 36ONE Asset Management and Keith McLachlan of Alpha Asset Management, did not invest in ARC up front. The other reason was the valuations of the underlying businesses, which Jacobs said were unrealistic.
McLachlan says that while he and many others pointed out how ridiculous the fee was, others chose to ignore it and still invested.
“Three years later, ARC’s share price is about a quarter of what it was trading, but its ManCo [management company] the commission has increased during this period as his NAV as assessed by the principal has increased, ”says McLachlan. “In this scenario, it is difficult to argue that value has been created for someone except the insiders and their ManCo “.
Therefore, if we assume that the market is correct in its valuation of ARC, then ManCo’s fees of 1.75% NAV are actually closer to about 6-7% of ARC’s market capitalization. And, in this case, ARC is an exceptionally expensive HoldCo.
Most other holding companies do not have external ManCos that charge fees based on a NAV determined by the director. For example, the board of directors and management of HCI and PSG own large amounts of their own vouchers and their cost structure is within the companies they manage. More disturbingly, says McLachlan, ARC’s ManCo fee is determined as a percentage of the NAV and directors are the ones who value this NAV the most. This means that they have an incentive to inflate the valuation as high as possible, as they will literally charge shareholders a percentage.
The fact that the market values ARC shares at only 25% of their net asset value created by the directors means that the market does not agree with the directors’ valuations, he says.
“So if we assume the market is correct in its valuation of ARC, then ManCo’s rates of 1.75% NAV are closer to around 6-7% of ARC’s market capitalization. And in this case, ARC is an exceptionally expensive HoldCo. “
The problem is that ARC has invested in three big startups – digital bank TymeBank, phosphate mining company Kropz, and data networking company Rain – and it’s hard to put a value on them, especially since investors haven’t had a vision. complete. . These early stage businesses represent approximately 43% of the portfolio value.
He valued his 20.7% stake in Rain at 3.1 billion rand at the end of June due to a fair value correction of 479 million rand, with the increase attributed in part to an increase in online activity during the Covid-19 lockdown. At nearly 28% of the fund’s value, Rain is her largest investment.
That would imply a value north of R14 billion for Rain, and Jacobs believes it is worth closer to half that. McLachlan agrees and says he would be deeply skeptical of this assessment in the current macro and sectoral context.
“Where is the sustainable profit or cash flow to say it is worth 14 billion rand?
“It’s been an accepted norm for these investment companies to charge fees on their NAV, but I think that’s unfair because it’s misaligned,” says Jacobs.
“Shareholders get value based on share price, not NAV.”
I don’t think Remgro or anyone else has ever entered into a rights issue with this kind of discount on NAV. It’s like hitting yourself when you are depressed.
While other investment companies, including PSG and Remgro, trade at discounts, none of the discounts are as large as ARC’s, as there is more confidence in the value of their assets. Remgro has outgrown its historic 12-18% discount, in large part due to the splitting of listed investments like FirstRand.
“I don’t think Remgro or anyone else has ever entered a rights issue with this kind of discount on NAV,” says Jacobs. “It’s like hitting you when you’re depressed.”
Jacobs thinks a fairer comparison is with Brimstone, another investment company with black power that also trades at a deep discount on its underlying assets that include companies such as reinsurance group Aon Re Africa, real estate fund Equites, the maker of House of Monatic clothing, the Oceana fishing group. and Sea Harvest, and a stake in the Life Healthcare private hospital group he’s busy exiting. He also owns a portion of the shares in the empowerment vehicles of MTN and MultiChoice. For many years, Brimstone’s management received commissions from the shareholders of Nedbank and Old Mutual for services rendered.
In addition to your normal operating costs, there is no additional charge for investors. The directors are aligned as they rely on dividends as the main source of income along with the potential appreciation of the share price, although lately that has been difficult to achieve in South Africa.
“That is a fair structure; at least their assets have done well and the maximum running costs they had in a year are maybe R10-20 million and they have a lot more assets than ARC, but they don’t charge on NAV, ”says Jacobs.
ARC is naturally disappointed in its share price performance since going public. Aside from the discount that investment holding companies typically trade, he believes the market is indicating that it does not place much value on its investments in the three start-ups as, with the exception of Rain, they do not generate positive cash. . flow.
“We believe this will change over the next 18 months as these companies expand their customer base, gain more operational traction, and generate significant revenue and therefore cash flow,” says ARC.
It maintains that the difference between the net asset value per share and the current share price does not translate into a reduced operating expense. In fact, management may have to work harder to close this discount, so it is quite possible that higher operating costs will result.
“Unlisted shares in ARC … who knows how much they are worth?” says Jacobs.
“If they were worth a lot, there would be large cash flows and dividends that would return to shareholders now or in the near future. Time will tell.” DM / BM
