The private equity-esque investment firm of billionaire Patrice Motsepe’s corporate empire, African Rainbow Capital (ARC) Investments, has come under severe fire recently.
The company, which owns stakes in (among others) Rain, TymeBank, the mining group Afrimat and Alexander Forbes, sent out a poorly conceived rights issue notice last month. It announced that it wanted to raise R750 million by issuing new shares, and selling them to existing shareholders – but added that 27% of the money will be used to pay fees to the managers of its investment fund.
Many shareholders – who have seen ARC Investments’ share price lose 60% of its value over the past five years – balked at paying these managers R205 million.
While ARC Investments subsequently changed tack, saying it would settle the R205m in management fees from internal resources, skepticism remained.
In the end, investors holding almost a fifth of ARC Investments did not want to take up the new shares. This means that Motsepe’s Ubuntu-Botho Investments will have to fork out R126 million to buy these shares.
“Maybe that was a mistake from our side,” says co-CEO Johan van der Merwe, when asked by Business Insider why the initial rights issue circular indicated that R205m of the capital would go towards paying outstanding management fees. Nevertheless, he maintains that the market misinterpreted ARC Investment’s true intentions.
“We never had to use the rights issue money to pay for the management fee – there was enough money in the fund,” he says. “The reason for the rights issue is to take opportunities in the market.”
That misunderstanding seems to be at least partly due to the rather convoluted group structure of Motsepe’s various investment entities:
The current structure and relationship of the various entities would’ve meant that the ARC Fund’s R205m management fee would’ve been paid to UBI General Partner, essentially the BEE management company owned by Ubuntu-Botho Investments (UBI), which is in turn Sanlam’s BEE partner.
UBI General Partner would’ve been required to pay 95% of the fee to the unlisted company African Rainbow Capital (via its parent UBI) as an investment services fee, which would then have simply returned the money to the ARC Fund to follow its rights under the new share issuance.
African Rainbow Capital was also fully underwriting the rights issue, which meant they would’ve had to return money to the fund anyway for that purpose. The decision was therefore made to simply fund the management fee from the proceeds of the rights issue instead of routing it through the various entities.
“It was just a mechanism to avoid the round tripping of money,” says Van Der Merwe. “We get more than the R200m in interest and dividends [from the underlying investee companies] per annum to fund the management fee so the R750m will be fully utilised to make acquisitions. I’d be surprised if we don’t spend it in the next 12 to 18 months.”
ARC Investments has already invested in 49 businesses broadly spread across two categories: financial services and diversified investments. The financial services category, in which the ARC Fund holds a 49.9% stake with Motsepe’s unlisted African Rainbow Capital holding the rest, can be further broken down into what Van der Merwe calls “building blocks”.
These building blocks include the asset management, insurance, specialist companies and banking sectors, which are accessed via stakes in Alexander Forbes, African Rainbow Life, A2X, TymeBank and others.
Under the diversified investments category ARC Investments gains exposure to the agriculture, property, telecommunications, business process outsourcing and mining sector thanks to investments in Rain, Acorn Agri and EOH amongst others.
When asked what sectors ARC Investments will be targeting with the proceeds of the R750m rights offer Van Der Merwe says: “We will look across the board but we don’t want to add more building blocks. We will only add to our existing building blocks.”
Market value conundrum
Another issue bedeviling ARC Investment’s standing among shareholders is that its current market value of R2.822bn is equal to just 28% of its intrinsic Net Asset Value (NAV) of R9.948bn as reported at end-June 2020. That means the company’s listed market value is trading at a staggering 72% discount to its intrinsic NAV, on which the management fee is based. Similarly, its NAV on a per share basis was R9.54 at end-June, 72% above its listed share price of R2.70 at the time of writing.
“People think we suck these values out of our thumbs and think we as management put any value on it,” says Van Der Merwe. “This is scrutinised; the auditors have to sign off on these values. They won’t sign off on a valuation unless they are happy with it.”
Nevertheless, Van der Merwe concedes this is one of the challenges for a listed entity that invests largely in unlisted, disruptive companies that aren’t legally required to make their financials public. Moreover, most regard that as a competitive advantage and are reluctant to disclose information that could benefit competitors. But this makes it difficult for investors to accurately value the underlying investments, which sometimes leads to skepticism about the reported NAV figures.
“How do you value something like Rain?” says shareholder activist Theo Botha. “Surely the management fee should be based on a different metric – maybe the share price?”
In addition, ARC Investments isn’t growing its intrinsic NAV at anywhere near its stated medium to long-term objective of 16% per annum, net of fees. For example, in its last fiscal year the ARC Fund increased its intrinsic NAV by just 2.1%. That’s partly due to South Africa’s weak economic fundamentals coupled with the impact of Covid-19 but the firm’s steep management fee is also a contributor.
“The fairly hefty fee is one of the reasons for the discount between their market value and NAV,” says Peter Armitage, CEO of Anchor Capital. “When you consider that the latest management fee amounts to about 7% of their market capitalisation it looks extremely onerous.”
Nevertheless, Armitage says Anchor will retain its current investment in ARC Investments as its underlying investments, particularly in disruptive technology-focussed businesses, remain attractive. While he says he’d like to see ARC Investments relook its fee structure he’s more concerned with efforts to grow NAV, something that can only be done by improving the financial performance of both existing and new assets.
“It’s a three to five-year play, so you have to allow time for these investments to pay dividends,” says Armitage.
Van Der Merwe says this is exactly what ARC Investments aims to do, adding that investors should bear in mind that of the handful of businesses ARC Investments has thus far exited, all have been sold at NAV or higher.
For example, ARC Investments sold its 20% stake in agribusiness BKB in December 2018 for R409.5m, more than R200m above the price it paid roughly two years prior.
“It’s our job to prove to the market that we don’t suck these values out of our thumb,” he says. “We’re going to start paying dividends and show that there’s real value in this business.”