By Marco Barbieri
The recent unbundling by Remgro of its shares in RMB Holdings and the decision by PSG to return Capitec to shareholders captured news headlines and highlighted a well-entrenched trend.
The number of investment holding companies in the local market has significantly declined over the past few years as shareholders have seen increased benefit from collapsing these structures to realise value. Recent examples include the unbundling of MultiChoice (Naspers), Tsogo Hotels and Gaming (HCI), Grindrod shipping (Brimstone), Motus (Imperial) and Textainer (Trencor).
We expect more holding companies to follow suit in the coming years as management teams look to realise value for shareholders in an increasingly difficult macro environment, now aggravated by the impact of Covid-19.
A shift away from holding company structures
The traditional reasons for owning investment holding companies have been to:
- co-invest with capable management teams that demonstrated excellent track records and capital allocation abilities;
- gain access to better investment opportunities than those available to the average retail investor; and
- invest in a structure with better liquidity than that afforded by its underlying investments.
However, these companies have generally traded at a 5% to 20% discount to net asset value (NAV) in the local market, primarily reflecting the cost of capitalised management fees (fees management will earn over time), tax leakage (capital gains generated from trading positions) and portfolio construction or selection risk. In theory, unbundling of the underlying assets should unlock the discount for the benefit of shareholders.
Liquidation and de-listing of holding company structures is not only a South African phenomenon but is occurring globally with many investors citing the lack of flexibility, a preference for pure play investments, high concentration risk and the excessive management fees earned by company management teams as reasons for this.
A trend of widening discounts to NAV in South African holding companies
As the table below shows, with the exception of Naspers, several prominent South African large- and mid-cap investment holding firms have seen a significant increase in their discount to NAV over the past five years. The median discount of these companies has widened by almost 30% and now stands at 31% compared to their historical average of 12%.
|Company||Market Cap (ZARm)||Discount / (Premium) to NAV (%)|
|31-May-20||Jun 2015||May 2020||Average history|
|Naspers||1 196 330||30.3%||&28.9%||22.6%|
Source: Bloomberg, Avior, Northstar analysis
In addition to the general trend away from holding company structures, there are also stock-specific reasons at play in these discounts. These include:
- Poor asset allocation decisions (Grand Parade).
- High gearing levels (Brimstone, HCI).
- A shift in investor preference towards pure plays (Naspers/Prosus, PSG, RMB Holdings).
- A lack of unlisted opportunities in the market for these structures to benefit from (HCI, Remgro).
- High head office costs (Brimstone, Reinet, Grand Parade).
The current poor economic environment, further aggravated by the impact of COVID-19, has also created a perverse incentive for management teams, under severe pressure from shareholders, to unbundle assets to reduce holding company discounts as underlying asset growth and opportunities in the market have faltered.
While we think this trend will continue, we believe some assets are more likely to dissolve/de-list than others. The main impediments to this are:
- Management incentive structures for executive teams with no material shareholdings in the business. This includes incentive structures where executive teams control a large amount of voting rights without necessarily having a similar shareholding in the group.
- Black Economic Empowerment (BEE). A number of empowerment holding vehicles are unlikely to be able to dissolve or unbundle assets easily as a result of the BEE enhancement the structure provides for certain assets.
Why Northstar funds hold Naspers, Remgro, Reinet and PSG
Northstar has spent considerable time building our understanding of Remgro, PSG, Naspers and Reinet. In each case, these companies have a strong management team intent on reducing the investment holding discount and improving returns for shareholders. All four companies have a number of common characteristics that make the companies good investments at current levels. These include:
- Solid underlying businesses with a good blend of listed and attractive unlisted prospects.
- Management teams that have shown intent to address the investment holding discount.
- Highly liquid underlying assets, which increases scope for further unbundling.
- Strong networks, contacts and opportunity set which are not available to average investors (Rupert, Mouton and Tencent networks).
- Low debt and the ability to quickly deploy cash in attractive investments.
- Generally, alignment of management and shareholder interests. In the case of Remgro and Reinet, Rupert has significant voting and economic interest in both businesses, as has the Mouton family in the case of the PSG group with a 28% stake. Naspers has a particularly complex control structure with management controlling the voting, and while we generally do not favour dual share structures, we acknowledge Koos Bekker’s impressive track record over a long period of time.
Marco Barbieri is director of SA equities at Northstar Asset Management