With sentiment and emotion explaining much of what is currently going on, investors should take a good look at the quality of the underlying assets. (Patrick Cairns – 6 February 2020)
Some of the JSE’s most successful companies are not those selling goods and services. They are holding companies that generate a return by investing in other businesses that they expect to deliver growth.
Perhaps the most well-known example is Remgro, which has created real long-term value for shareholders by investing in a range of assets from banking to infrastructure. PSG Group is another that has grown a successful portfolios of assets, including in private education and financial services. Naspers is also largely seen as a holding company, since its value is derived from its underlying investments, primarily in Tencent.
Recently, however, many of these companies seem to have lost some of their attraction. This can be seen in how they are trading at large discounts to the value of their underlying assets.
Investment holding company discounts are getting wild. ARC Invest at 60%
— Piet Viljoen (@pietviljoen) January 31, 2020
As the table below shows, some of the smaller holding companies on the JSE are being valued at less than half of what you would get if you added up the reported value of all of their investments. Even larger stocks like Reinet and PSG are trading at significant discounts to their net asset values (NAVs).
Seeing a discount on a holding company is not unusual. In fact, for a number of reasons, it should be expected.
Firstly, the discount is there to take into account the cost of managing the business.
“A holding company can always tell you exactly what its assets are, but there are some contractual liabilities on which no value is ever put,” explains Piet Viljoen, chief investment officer at RECM.
“If there is a contractual management fee, that is a liability that you need to include in your estimation of fair value.”
How significant this liability is also takes into consideration the quality of the management team. If the market sees management as exceptional, the discount may disappear completely and investors may even be willing to pay a premium in expectation of future value being delivered.
This was the case with Brait towards the end of 2015. After the acquisition and subsequent sale of a large stake in Pepkor that realised enormous value for shareholders, Brait shares were trading at a 15% premium to its net asset value. This is because investors were expecting management to produce more of the same.
Another important consideration is that even though a holding company’s assets may be given a market value, shareholders would never actually receive all of that if they were sold. This is because any sale would both attract capital gains tax and incur other transaction costs.
It’s also worth considering that, for most holding companies, the underlying investments are not all equally attractive. This has an impact on how the market values the holding company as a whole.
“Investors like to diversify for themselves, but they are now relying on a management team to diversify for them,” explains Kokkie Kooyman, portfolio manager at Denker Capital. “And that management team might have diversified into assets investors don’t like.”
Hannes van den Berg, a portfolio manager at Investec Asset Management, expresses a similar sentiment.
“As a fund manager investing in listed equities, I often feel you could do better to pick one or two of the underlying businesses and invest in them, rather than buying the holding company,” he says. “With RMI Holdings, for example, you can decide whether to buy Discovery or Momentum Metropolitan. Of course Outsurance is unlisted, so if you invest in RMI you have to believe that it will outperform the other two.”
It may also be the case that there is one asset within a holding company that overshadows the rest. Investors may be prepared to pay more just to get access to that.