The world is changing fast and to keep up you need local knowledge with global context.
In episode three of Inside Investing, we consider the investment case for two stocks South Africans love. The world’s biggest gold miner, Barrick, and inimitable Berkshire Hathaway of Omaha. There are also thoughts from Famous Brands’ former chief executive Kevin Hedderwick on whether it’s time to jump back into this fallen angel. We get to work out whether it’s too late to get aboard the EasyEquities train with founder Charles Savage and catch up on progress of an ambitious agenda, with Mark Barnes of the Kisby Fund. – Alec Hogg
On the rational radio webinar this week, our CEO in focus was Charles Savage, the chief executive of the Purple Group. That’s a listed entity which owns the mushrooming online stockbroker, EasyEquities. The full interview is on BizNews radio. But here’s a taste for you on a stock whose share price has trebled in just over a year and the client base continues to double. Now, having hit 275,000.
There are very few exponential companies on the JSE, and that’s where all the action is happening if you dig down into the US markets. But one potential exponential company – certainly they have been growing in this way – is in focus today. Charles Savage is the chief executive and founder of EasyEquities.
Charles Savage: The storyline of EasyEquities – whilst it’s been around for almost six years now – hasn’t been well understood and also to a large extent think that the average South African investor isn’t necessarily a growth investor. I think if this was listed in other places like the US or Australia, then it might have got more support earlier. But I think as the numbers have unpacked and as we told our story every six months through our financials, it’s become more and more obvious for people to follow.
As those numbers have surfaced as being exponential, the share price has responded. And that momentum shift really happened into our results in February, where the prospects of profitability suddenly became tangible to potential shareholders. Whereas before, the losses were significant in the context of the size of the group. If you go back and look at the losses of the last two years in the context of the size of the market cap of the group, they were sort of 10% of the market cap.
I guess there might have been a lot of nervous sentiment around the fact that we had these large losses against a very small market capitalisation. But when it became very clear that we were gonna be profitable – and that was signaled in our February results – I think the market confidence responded positively.
I think people are now seeing a very different future for the group. I would say the final element of it is that the Capitec deal, which we announced post results, I think gave everyone confidence that the runway for future growth is also very well secured, given the fact that we are going to be entering inside the Capitec banking app and have access to those customers – all of those online mobile customers for free, essentially.
The secret in providing a low cost offering is in order to be sustainable, you have to have the lowest cost of acquisition for your customers. That is the key number that everyone needs to track and measure. In EasyEquities, our cost of acquisition, our target when we started the business was R250 a customer. To contextualise that against the industry, the average cost of acquisition for a financial services firm in South Africa is around R2,500 a customer. So we backed ourselves into quite a bold cost of acquisition, quite a low cost of acquisition.
In this financial year, our cost of acquisition was R49 a customer. Now, given that cost of acquisition, the ability for us to generate a great return from our customers in a very short period of time is substantially increased. The problem a competitor will have is that, yes, you can come in and you can try a zero cost brokerage. But if you don’t get your cost of acquisition right, then you won’t create a sustainable business model. Now, the secret in our business model is how do we create this low cost of acquisition? It’s all in the fact that 60% of our customers come from other customers. It’s all a referral business. We’ve created a brand that South Africa’s fallen in love with in a very short period of time and that can’t be replicated by either money or technology.
A lot of people have said to me, ‘Charles, if I gave you 200 million, could you recreate that business?’ The truth is, I wouldn’t even try. Because there’s some magic in what we’re doing that is demonstrably evidenced in this love that our customers have for the brand and the business, that has created this huge wave of referral business, which keeps us growing faster and faster each year. It is like a snowball rolling downhill.
But I think that locks out the competitive threat to a large extent. It’s not to say that doesn’t exist. I’m not trying to be arrogant to say that we’re not going to get competitors. But it does significantly widen the moat for anybody else who needs to enter the market because it isn’t just about technology and it isn’t just about the cost. We charge a fair price for our services, not free. Everything we do is about ensuring that the barriers to entry for first time investors is fairly proportioned, whether you’re a R1-million investor or a R1 investor.
So lower cost or the lowest cost is not a defendable differentiator. Some of the business models that are deploying that are going to go under. Many more are going to go under then are going to succeed, in my view. So for us, we’re focusing on ensuring accessibility and fairness of the price or the cost of investing is managed. Then, most importantly, that our customers love us and keep referring us to their friends and family. Because the more they do that, the faster we grow.
For a decade and a half, Famous Brands was one of the JSE’s top performing shares. But after a disastrous acquisition in the UK in 2016, the share price has been spiraling downwards. It’s down now by two thirds from the recent peak. With Covid-19 hammering the food service sector, investors seem to be steering a wide berth.
But things might be changing. I asked former Famous Brands chief executive Kevin Hedderwick whether his successor, Darren Hele, has what it takes to get the business back to its former glory. When I look at Famous Brands’ market cap today, it’s back where it was in 2011. So you’re buying business from nine years ago. If he is any good or if he’s another Kevin Hedderwick, then surely this would be something that investors should be looking at very closely.
Kevin Hedderwick: By his own admission, he will say he’s not a Kevin Hedderwick and no two of us are alike. But he’s a very astute young man, not so young anymore – we’re getting older. He’s got a big engine, I’ve never met a man with an appetite for work like Darren. He inherited the business, which was at the peak of its performance at the time. A lot of things have gone against him.
None of the stuff that’s happened in Famous Brands of late could be laid at the door of Darren. I can honestly say that the business couldn’t have wished for a greater successor to myself. He knows the business intimately. He’s a wonderful man. Just give him time. It goes back to the basic stuff. Get the housekeeping right and the balance sheet will be right.
Is Famous Brands still doing that?
Kevin Hedderwick: Of late, I’ve tried to stay out of Famous Brands. I’m not even a shareholder anymore. I’ve relinquished all my she only in the business, because for too long I was emotionally attached to that business. Nothing can prepare you for leaving a business like Famous Brands, after you’ve been there 18 years and it’s consumed your life.
So I can’t tell you what the current state of the business is because I don’t go in there. When I do go in there, I perhaps don’t look at it through the same set of eyes that I used to when I was the CEO. But again I think there’s still a lot of people at Famous Brands that were there in my time and if they’re still doing what we taught them to do or what we expected them to do, I see no reason why it shouldn’t be.
Covid has got to be a huge challenge for them?
Kevin Hedderwick: Covid – for the restaurant industry in South Africa – has been tragic. They’ve probably been the hardest hit by a country mile. It’s going to take a long time to recover from it, but it’s trickling back. I understand that in the quick service spaces, it’s up to 80/90% of what it was. In the sort of casual dining environment, it’s probably up to 50/60% now. The guys serving alcohol were very hard hit, at one stage doing just 25/30% of their turnovers.
So the landlords have been very generous in helping. And so, of course, was the employment fund with TERS. But those two holidays are coming to an end now. Landlords won’t always say they’re going to subsidise rent and UIF is going to dry up. So there are still a few moments of truth down the line for a lot of the restaurant space.
Was it over traded?
Kevin Hedderwick: Oh, yes. it’s over traded. The funny thing is that it just doesn’t stop. Once a restaurant or a restaurant. There’s a site, there’s a restaurant, doesn’t work and closes. Some other guy reopens it again.
Kevin Hedderwick: I think there’s this myth about the fact that the restaurant business is like a magical place to work and it’s a great place to make money. It’s not. It’s an unforgiving business and it’s relentless. People don’t understand how tough it is to succeed in the restaurant space. It is just hard work.
Long hours and hard work. Not so long ago, it was quite an attractive, sexy investment. Today, not really. Today, the returns are not what they used to be. Not too long ago, any guy that owned five Wimpy’s had the ability to be a multi-millionaire. It doesn’t exist anymore.
That was part of an extended interview with Kevin, who’s the feature of episode eight of the Alec Hogg Show. Now for that story about Barrick and Berkshire. Larry Pitkowski, the co-managing partner at Good Haven Capital Management in New York, joins our partners at Bloomberg to make the case for two offshore stocks that South Africans just love. Estcourt born and bred geologist Mark Bristow’s Barrick Gold and Warren Buffett’s Berkshire Hathaway. He was talking to Sarah Ponczek and Mike Regan.
Sarah Ponczek: I noticed that Barrick Gold is one of your top holdings. Lately, although we have seen this unbelievable run – at least in the price of spot gold over the past couple of months – is your holding of Barrick Gold at all tied to an outlook on growth and outlook on inflation, or is there a different reason that you’re actually interested?
Larry Pitkowski: Barrick Gold. It’s a very interesting story. We made it a big holding when John Thorne, the current executive chairman of the board, came in and really started to clean up what had been a prior mess under old management – where they made an acquisition of a copper company with no due diligence and over leveraged themselves.
I’m primarily a business analyst. I’m a securities analyst. I’m a business analyst. I’m a stock picker Aad I’m a risk manager. Lastly are macroeconomic thoughts. So Barrick has been an important holding for us for a couple of years. I never minded having the optionality of the exposure to gold, which is an alternative currency for all intensive purposes as part of the thesis. As long as the majority of the thesis, which was the business, the valuation we paid, the management team, was really the predominant reason to be in it.
Now, when Barrick merged with Randgold and Mark Bristow took over, the story got even better a couple of years ago, because Randgold was the best managed gold miner, I think, in the world and had unbelievable statistics for creating shareholder value.
So as I was looking at the portfolio somewhat recently, what you’ve seen since the pandemic as far as money printing increases in debt – and that goes in the US and around the world, it does lead one to be even happier to have some exposure and material exposure to an alternative currency. The thing to keep in mind about these types of things is that after the 2008 financial crisis, the number of people who were thoughtful and really had a strong view that we were about to enter a period of hyperinflation and that the stuff done during the great financial crisis to create certain bail outs was going to create a weaker dollar and runaway inflation – all kinds of problems.
There were strong views about that. Instead, over the next nine years, we had deflation and a stronger dollar. So you’ve got to be very careful because these are very difficult things. But from where I sit today, Barrick, we have an enormous unrealised gain in it. The thesis and how they’re running the company keeps getting better.
It’s hard not to look at what’s happening as far as printing of money, deficits, stimulus and negative real interest rates. The Federal Reserve is very clear that they want to keep rates low for a long, long time and feel that it’s nice to have something in the portfolio that has some potential exposure positively to all those things, but wrapped around what appears to be a well-run company.
It’s not an easy business to be in. There’s not an enormous number of companies in that business that have created a lot of long-term value. But Mark Bristow has done it at Randgold and we’re forever grateful for John Thorne for having come in and really righted this ship. So, that’s how we think about that position and how it became where it is today.
Mike Regan: I always think back to that famous open letter to the Fed that 30 or 40 investors and fund managers signed warning of Zimbabwe-like inflation from quantitative easing. I guess the lesson there, Larry, is never sign your name or a letter like that predicting dire outcomes.
Larry Pitkowski: The lesson is that trying to put together a portfolio using macroeconomic predictions is really, really hard. There’s a couple of people in the world that have done it well, such as Soros and Druckenmiller. But I think a lot of investors should really try to steer clear of having that be the thing that is the driving force in how you’re picking stocks for your portfolio because it’s very very hard and very few people get that kind of stuff right.
Again, the interesting thing also about Barrick is that a lot of people have become interested in this sector and it’s interesting. And of course with gold at U$1900, the cash flow is a lot more than when gold is at U$1300. But when we made it a bigger holding a couple of years ago, nobody was calling me up saying, ‘Oh, that’s really interesting, you made that a bigger holding.’ I was getting more comments along the line of ‘What the heck are you thinking?’ and ‘What are doing?’ and things I wouldn’t repeat on your very high-class podcast.
Mike Regan: Larry, you make a great point. I think a lot of investors struggle to wear that micro and macro cap at the same time. Sarah and I appreciate being able to talk about individual names like this. I don’t know how many guests we have that say they’re not allowed to talk about individual stocks. So it’s refreshing for us. I want to talk about the biggest holding, at least as of the end of last month, Berkshire Hathaway. Maybe a few listeners have heard of that company, Larry. Kind of an obscure one. But are you a Buffetologist, I assume?
I guess that the big question I have is, eventually we’re gonna get this passing of the reins from Buffett to his successor. Is that a buying opportunity or a selling opportunity, do you think?
Larry Pitkowski: I’ve owned Berkshire on and off in different sizes for many decades. The interesting thing – which I wrote about in a large shareholder letter – is that I find that many people who are supposed to be professional investors have very strange ways of thinking about Berkshire.
There’s some form of worship without really doing any real deep, analytical work and thinking about it as a business. And some just have a never ending joy in finding anything that Berkshire does wrong. Those who say, ‘Oh, I told you they’re not so good.’ Neither of those two extremes are logical ways to think if you’re trying to make logical decisions with money.
From my perspective, when I looked at them – by the way, in March/April of 2020, during the height of the market collapse, I basically doubled our exposure to Berkshire. So, what was I thinking? I was thinking,well, we have an economy that is shut down to a great extent. Here’s a company that has U$140 billion of cash. Here’s a company that has a long history of great shareholder returns. Their main business is property and casualty insurance in a couple of different sectors.
My feeling was that property and casualty insurance, the market for pricing in terms is improving and they wouldn’t be able to deal with the Covid-19 claims. There’s some noise around some of that. I thought the stock price was selling at a very attractive price, really kind of approached book value. The optionality for them to put money to work in different rescue financing transactions existed, though they may or may not do it.
I think it’s unfortunately a certainty that at some point Mr Buffett and Mr. Munger won’t be calling the shots anymore – I think – and I have some knowledge that the bench at Berkshire is more talented and deeper than I think people really give it credit for. I think Berkshire – while 20 odd years ago was really a holding company with a securities portfolio – is much more than that today.
The magic of Berkshire is the generation of insurance flowed at no cost, which then can be invested and helped to drive book value growth. A couple of very large businesses – the railroad business, the utility business, the insurance business and an investment portfolio – that one has to make a judgment of. So when you put that all in the mix, I thought these were really dirt cheap prices. So we bought an enormous amount.
I think that it is playing out reasonably well. The negative on Berkshire – which is material – is just size. It’s hard to move the needle. It’s U$500-billion market cap. They do something very clever and they make U$1-billion. It doesn’t really move the needle that much. But, if you buy back more stock or at some point you distribute more money, that’s a solvable problem. So, one of the keys I found over the years is to try and be rational and not get caught up in too much emotional drama on how you think about any holding.
So, on Berkshire I may change my mind one day, but I thought it was a very good thing to increase our exposure to dramatically in the spring. As it turns out, a lot of the criticism lately of Berkshire had been, ‘Oh, it’s a lot of old economy assets.’ Meanwhile, something like 40% of the portfolio is Apple.
Another criticism is that they’ve been too inactive. Shortly after all that criticism, they made a U$10-billion deal from some natural gas distribution assets from Dominion and they’ve done plenty of other things over the last month or so.
And there was a board member, Meryl Witmer – a well-respected investor who bought U$2-million worth of stock in the open market for herself and her family in the spring.
Mike Regan: I kept thinking back to the financial crisis when they made those really well-timed investments with the preferred shares and some of the banks that were struggling back then. I was kind of expecting something like that this time. I wonder if it tells you anything. Buffett calls it his elephant hunting gun, all that cash. Like you said, he’s fired a few shots from it, but still kind of holding fire with all that cash through all of this.
Does that tell you anything about perhaps how just uncertain and risky this environment is, where Buffett doesn’t seem to be comfortable really writing a giant check for some distressed asset right now?
Larry Pitkowski: I think in the March and April timeframe, one of the things that got in the way of Berkshire potentially doing some rescue finance, was the Fed coming in so fast – and in such an extreme way – into the credit markets, which I think allowed a lot of borrowers that were viable and interesting, but on somewhat shaky ground to access the fixed income markets or the equity markets.
You saw the number of underwritings done across the investment banking spectrum. I think, if not for that massive Fed intervention, some of those companies would have been knocking on Berkshire’s door. Thursday morning, Berkshire announced a deal with Scripps, which was preferred with some warrants and very attractive terms – kind of a smaller size, but a very typical Berkshire deal.
Recently, they did buy a slug of the five or six major Japanese trading houses. But they were less active at that period and again, I think there were a couple of reasons. Mr Buffett and deputies may have very well looked at a shut down economy and said, ‘Well,let’s tread gingerly a little bit.’ But I think the Fed intervention and the ability of companies to access traditional financing so quickly was very different from the global financial crisis. That process took months. That Fed intervention gave Berkshire an opportunity to put some capital to work.
Kisby Fund is a partner of BizNews and we’ve been following the progress very closely over the last few months. Mark Barnes, who’s the chief executive of the Kisby Fund, joins us now. Ambitious targets that were set right from the outset. I suppose now, this has been the tough work that we’ve seen over the past few weeks.
Mark Barnes: It’s an extraordinary mixture of a very tough environment to raise money and a very necessary environment to raise money. Those two are often close cousins. So we have found an extraordinary interest, which is now at last translating into some action. We have the due diligence room up and running. We have people who have signed the NDAs and we have people who are going through our work programmes and working through our investment memorandum.
We’ve got real things happening on the ground. I think that we might say that our first closing would be around the end of November. I think we would say that between R750-million and R1,25-billion might be an appropriate starting point. All of the structural and preferred structures of the investors have been aligned and signed off by our lawyers. We’re good to go, but people are in a state of ‘Can we just see what happens tomorrow?’ with Covid, the economy, the government and all of the variables that surround it. The interest rates, for example.
So you are focussing on investors, people putting money into the fund. There’s no real problem in being able to distribute it?
Mark Barnes: I don’t exaggerate this, but I get at least a call a day. A bunch of those calls are valid businesses who are saying we’ve been looking for the right funding equation. We’ve got funding in the wrong mix. We’ve got sustainable funding, but not growth funding. So, no. We’re not going to have a problem on the demand side. We’re going to have to be selective rather than eager.
The biggest hurdle we’ve had, to be frank, is getting current established capital to look beyond its very well-worn mandates of investing in listed shares, bonds – maybe property – and going into what we think will be a new asset class that needs to be properly hunted down, properly cleansed and properly presented in the dining room. You need to get some first mover enthusiasm around it. Getting through those mandates has been our biggest challenge ever.
If ever there was a time, surely it’s now?
Mark Barnes: It is surely now, and the definition of SME is changing as we speak. It’s getting bigger and bigger as we speak. We’re not looking to the so-called informal settlement sort of economies. We’re looking to businesses that can be 10 times their size if they have the right capital partners. There’s an abundance of them. Some of them are in the situation brought about by Covid. But actually, the majority of the target companies you look at are just well-run businesses who haven’t had the right capital construct.
So what is stopping the institutions from creating or supporting this new asset class?
Mark Barnes: Well, comfort zones and peer group comparison. I somewhat tongue in cheek have said to more than one institution, ‘Why didn’t you just give me 10% of what you lost in the listed equity markets? Or better still, give me 10% of what you lost in your offshore eagerness and expansion.
People need to be taken out of their comfort zones. Established capital beyond Kisby and the SME fund – established capital needs to move out of where it is circulating amongst its very few members, and it needs to venture into this forest of extraordinary growth. We will not find growth in the fully priced, established capital markets. We will find it in real business that’s happening and functioning, financing itself almost on a month to month basis.
Mark, you’ve played on the other side of the fence, as it were, in senior positions within big corporates and institutions. How are you changing minds? There’s that lovely saying that you don’t poke people’s eyes out with a stick. You open their eyes. How are you doing that? Or what strategy are you employing to do that?
Mark Barnes: Well, I think there’s a groundswell of obviousness, if I might call it that. I think as we look around us and we see pockets of economic behaviour. Go stand at the crossroads of Alexandria and you’ll see billions of rand changing hands in businesses that are valid and real – but they are not part of the formal economy. They are not bankable in the classic sense.
So, when we look around us – we are talking about a population with world record inequality and unemployment – yet, people are surviving. So there is business happening. I sit on the board of a major industrial company, the classic corporate market – the measured market – is failing in all measures.
The informal market. People have come home and started to build their houses. There are people who have a face in the future of this economy and it is starting to spread beyond the center of Sandton. I think that’s becoming clear to all of us. What do we need to do is find that in an investable form.
We spent the last month and a half getting the boxes ticked – not getting the message across. The message is clear. People see the growth and they want to asset. But have we got adequate reporting structures? Are these registered taxpayers? Are they compliant in their monthly returns? All of those good things. Our partners have got eight years of experience doing We can offer that observation, and technology is going to be the difference. Technology now allows you to oversee business behaviour while you sleep, by monitoring accounts.
So end November? That’s the time when, if you like, the money is going to start hitting your bank accounts or Kisby’s bank account and then start getting distributed. Is it too long, though, given the difficulties that many SMEs have been going through post-Covid – not just during the lockdown, but thereafter?
Mark Barnes: It is too long. It’s been too long already. But all that does, in our view, is change the mix of capital. That means we’re going to need more equity than we thought in the beginning. The company is going to be able to bear less debt. But if you’re a company that’s selling your purchasing orders forward at 2% a month, your annualized cost of that is 40% for funding.
We’re offering you at a half of that was a blended cost that comes out at much less than half of that. That business that has survived, that’s made it happen, can make it happen for real in the years coming forward. I think Covid is never going away, but it’s going to become an annual, perhaps vaccinated disease. It’s not going to result in shutdowns of economies, but managing sick people rather than managing fear. So I think we’ll come back.
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