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LONDON — Warren Buffett advises us to do our homework on companies we’d like to co-own. But only to invest when we see a temporary dislocation in their share prices. The recent listing of Steinhoff’s African interests (appropriately abbreviated to STAR) introduced the continental equivalent of mega-retailer Walmart to the investing market. RMB’s Arun Varughese was in the engine room ahead of the the JSE’s biggest ever new listing and shares the back story in this interview. You’ll be able to draw your own conclusions, but for me two obvious ones arise – STAR has unlocked a lot of value for Steinhoff shareholders, with its stock trading at 20% above the listing price. And secondly, this adds to the appeal of Steinhoff International itself after Markus Jooste‘s company’s shares were pummelled after tax-evasion-related allegations by a former joint venture partner. Creating the temporary dislocation Buffett reckons we need to pay attention to. We have Steinhoff in the Biznews SA Champions portfolio. After hearing the inside story from Arun, I’m happy it’s in the mix. – Alec Hogg
This special podcast is brought to you by RMB and it’s a warm welcome to Arun Varughese – a Corporate Finance Transactor with RMB who was intimately involved in what can be labelled as the listing of the year, STAR. It’s to do with the Steinhoff Africa interests. Maybe let’s just go back a little, how did you get involved in the first place?
We have worked quite closely with the Steinhoff Group over the years, so we were intimately involved when they bought Pepkor Africa from Christo Wiese and the Brait Group back in 2014. Since then we’ve been working closely with the company and looking at ways to unlock value for them.
So, do they come to you and say, we want to list our African assets on the JSE, separate them from international or do you go to them and say, ‘hey guys, we think that there’s value to be unlocked by doing X, Y, or Z?’
I think it’s a bit of both. We work closely with the company to explore various options and look at how they could unlock value and growth. We were advising them when they originally wanted to do the acquisition of Shoprite, which was late 2016 early 2017. From there we worked with the company and realised that the best way to unlock value was to do a separate listing, and that’s how it came about.
So, you’ve been involved with this project then, if you like the Steinhoff project for a few years. What were the particular challenges that you were presented with in doing the STAR listing?
As you can imagine, STAR, in its current form only came into realisation over the last couple of years when the core of the group (being Pepkor/Ackermans) was bought in 2014. From there Steinhoff put its other assets (JD, Bradlows, Hi-Fi Corporation, Tekkie Town and Timber City) in the group. This entity didn’t really exist three or even four years ago.
When you’re accumulating all these different assets you don’t really have a combined track record or a comparable set of financials. So from a regulatory perspective, they had to put the assets together create a pro-forma set of financials, and show a track record. There was also a lot of complexity around, for example the JD Group, which underwent a restructuring at the time, which meant that those results had to be restated. The IPO process itself, including the necessary diligence, documentation and marketing had to be pulled together within an extremely short timeframe, which made it a bit challenging.
Does the involvement of the executive team from Steinhoff make a difference? Is it a case of after the event you look back and you say, well, it looked pretty obvious but it needs vision and it needs quite a lot of drive from within the organisation itself, before they can even pass on the mandate?
Definitely. I think the executive team and staff have been instrumental in the group’s growth and direction. Markus Jooste and Ben la Grange were instrumental in looking forward to the future and asking how could they drive value and unlock growth for shareholders. I think what they realised was that there was a lot of value sitting in the African operations, which wasn’t really truly reflected in their overall share price. They felt that a separate listing of the African group would allow investors to focus solely on the African operations and allow it to re-rate upwards – thereby helping to get value at the top level for Steinhoff.
Arun, overall it sounds very complex, just the way you’ve unpacked it already. What were the most complicated issues that you had to deal with?
One of the most complicated issues was the fact that we were doing the listing in quite an uncertain climate. Retail, overall was not doing particularly well if you compare it to what the comparables were doing, e.g. Mr Price, etc. There was a lot of uncertainty in the market and the macro environment for Africa and SA was quite downbeat, to say the least. So, to really sell the Pepkor story, and Steinhoff Africa’s growth to its potential investors was challenging. The management team was fantastic on the road, going to investors and really showing the potential for business. This was evident by the share price growth after the fact. Investors really loved the story and have allowed us to do this complex listing – which turned out to be the largest listing that’s ever been done in SA.
You talk about investors – what was their reaction considering the South African context of a stagnating economy, political turbulence and the fact that Africa itself is not as attractive as it was a few years ago?
I think the story and what the real appeal of the business is, is the fact that it’s an extremely well-run business and it appeals to a consumer segment that’s largely defensive. So, Steinhoff Africa, through its discounted value segment and well-known brands, are more resilient to that kind of downturn and have shown strong growth, despite being in a weak economic environment. The business also has the largest footprint in Africa. It is a resilient consumer story with a real upside into the future.
The Shoprite component of the STAR operation must have brought complexities of its own?
We had to explain to investors the rationale why the Shoprite option made sense. If you were to view the consumers that STAR target and service, you would be inclined to think of a normal value mart, such as DIY, food and clothing. By adding a food and grocery segment to that, means that you can get a greater share of the consumer wallet that you’re targeting. So, there are really many benefits from adding a food and grocery part to your business. There are also many synergies, notably property and procurement, by putting Shoprite and STAR together in Africa. The management team really thought carefully about it, while we in turn had to extend this to investors. I do believe that they appreciate the fact that the combination can be a powerful story.
Part of the brilliance of Steinhoff growing the way that it has from a very small base, has been this vertical integration. You touched on that with procurement. Obviously, they own their own and they like to own their own properties, they like to do their own procurement, they like to do their own distribution and logistics. Is this a story that international investors like?
I think one of the real strengths of STAR is its procurement supply chain. They’re able to source at the lowest cost by having efficient logistics, so their end product to consumers is at a value and price point that makes sense for consumers. One of the real strengths of the group is that they can actually sell a product to an end consumer at the best prices.
So, you’ve got a big Africa footprint, you’ve got this highly efficient logistics chain and presumably, the scale that you’re talking about now, means they can get the best prices?
Yes, definitely. They have 4 800 stores in Africa with ZAR50bn revenue, so you can imagine the kind of synergies and discounts they can get from their suppliers, which they are then able to pass onto their end consumers. It really is a business of size and scale that can deliver quality products to consumers at the best prices. I think that the consumers have come back and taken to the business model, which is evident in the sales figures.
Arun, I’m just thinking from an international investor’s perspective, is there any other retailer in Africa that compares or how do you compare when you’re talking about a company like STAR, to perhaps someone in Scotland in Edinburgh, who hasn’t engaged with an African investment opportunity before? What other templates can you use?
They are a discount value business, almost like a Walmart in Africa. They have a real business of size and scale that procures products and targets the value customer. I think international investors will probably compare STAR to a business similar to Walmart, or other discount value retailers globally.
That’s interesting because Walmart, of course, did have an attempt when it bought Massmart but it maybe went for the wrong target at that point.
Definitely. I think Steinhoff, the management team, and the business have done phenomenally well with their footprint, their product range, and their ability to really understand customers.
If you consider that if you go into any small town in SA, even in the smallest provinces, you will find a Pep there and in that Pep, you can buy clothing, airtime, get finance and buy electricity. So they really are able to reach consumers in nearly every corner of Africa. They have done extremely well with their business model and the business is growing.
Won’t you also explain the way that it worked out for Steinhoff’s existing shareholders? You did raise money but it seemed to have come from outside of the people who owned the Steinhoff shares itself?
Yes. The money that was raised by STAR was returned to Steinhoff International. The group has been very aggressively expanding into Europe and America. The money that was raised will be used internally. Existing Steinhoff shareholders have effectively sold a portion of the African retail business to new investors, but still retain a majority ownership of those assets. We believe that Steinhoff shareholders received a fair value for the disposal and should benefit from further value unlock going forward.
So, it wasn’t a case of raising the money to retire debt?
I suppose they’ll look at that balance sheet and see what’s the best way to use it. They may use it to retire some debt and/or they may use it for some growth opportunities.
The amount of money is big numbers in an SA context, but how do you decide on how much or how does the group, yourselves, and Steinhoff or STAR executives decide on the amount of money that they would like to raise in a listing like this?
If you look at the JSE listings requirements, the JSE requires at least 20% free-float, so for an ZAR80-bn company, the number is roughly about ZAR16-bn. In order to meet the JSE’s minimum requirements to be a listed company, you would have to raise roughly, in this range of money.
In order to have a successful listing, you also have to consider the appropriate free float in the liquidity in the listed company, that will attract a broad range of local and international investors to participate.
That’s interesting. It’s quite simple really, when you look at it that way, but they’ve got debt so, they can always allocate the money towards debt or, as you say, use it for further expansion opportunities. When the Steinhoff guys look back at the way everything panned out, what’s their feedback been to you?
They were very happy with the overall book build which was multiple times oversubscribed. The pricing was in the mid-point of the initial price range. The demand was there and subsequent to the listing the share price has run from ZAR20.50 to almost ZAR24.00 now. I think overall, it’s been a real success for both the company, the new shareholders and existing shareholders.
When you say existing shareholders – they would have their stakes through the main Steinhoff operation, which is still by far the biggest shareholder in STAR?
Yes, definitely so. This separate listing has allowed them to achieve a separate listing valuation for the African operations and given a strong demand, you should be seeing that flow through to their share price eventually.
What’s the next step for Steinhoff? When you discuss the value adding opportunities clearly, they’ve added quite a lot of value to the group. We haven’t seen it in the share price though. In fact, the share price of Steinhoff has fallen, so where do you go next with this?
That must be an interesting question for management. We know that the management team are always actively looking for growth opportunities globally. I believe that the recent share price weakness is due to all the noise in the market regarding ongoing legal dispute in Europe. But overall, the management team are very focussed on deploying capital into new opportunities that they see growth in – such as America and Europe, and other developed markets, but also helping STAR in Africa grow. There are many opportunities and they’re always keeping their eyes out, such as their most recent acquisition.
As far as existing Steinhoff shareholders are concerned some of them might have thought they would have liked to have had an unbundling rather than a capital raising opportunity. That is the route that is sometimes taken. Why was that not decided?
Part of the rationale for this transaction was to separate the emerging market retail businesses and developed market retail businesses as there is a different investor base for each. The separate listing would allow the appropriate investors to value and invest directly into the African-focused retailer. An unbundling would not have achieved that.
The separate listing is that the separate listing also gives Steinhoff access to cash so that can be deployed elsewhere in the group. Secondly, it also allows you to retain control of a core asset in Africa. Steinhoff is not saying that it wants to dispose of its interests in STAR. Instead it wants to keep control and help the company grow further. An unbundling wouldn’t have achieved that.
It’s very good that you’ve unpacked that because it gets confusing, I guess, in some people’s’ minds, but if I understand you correctly, by doing it this way, the whole group, including Africa and the rest of the world, can benefit from this vertically integrated business model.
Whereas unbundling it wouldn’t be the case. It would be a completely separate company?
One-hundred percent. Unbundling will put the shares in the hands of the shareholders, while under a separate listing, Steinhoff will have more than 50% of STAR. This will allow it to consolidate the group, control the group, and at the same time it was able to raise capital through the IPO, so it did achieve all the objectives that they required.
Arun, was this listing the highlight of your career so far?
I think it definitely is one of the highlights of my career. It was really the biggest IPO in SA history. It was well received and it was a great deal for all the stakeholders. So, yes, I definitely think it’s one of the highlights.
Arun Varughese is a Corporate Finance Transactor with Rand Merchant Bank, and this special podcast was brought to you by RMB.
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