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By Craig Martin*
It is certainly going to be an interesting day for Steinhoff International Ltd (SHF) shareholders at the AGM to be held in Sandton at 10h00 this morning (2 December 2014). The purpose of the meeting is to transact the business set out in the notice of annual general meeting mailed to shareholders on 4 November 2014. However, since this notice has gone out, Steinhoff have announced (without any prior cautionary on SENS) the R64bn acquisition of Pepkor.
Shareholders will expect this significant acquisition to make its way onto the agenda and will expect management to be upfront about when negotiations started. There has been come outcry about the fact that Steinhoff’s acquisition was not preceded by a cautionary announcement on SENS. I invite shareholders to go back a number of years and you will find numerous deals and changes that Steinhoff undertook (including its recent change in shareholding at KAP and JD Group) without any cautionary statements. It has become the accepted norm for the way Steinhoff conduct business.
I have been critical of Steinhoff’s convenient accounting practises, such the removal of all reference to JD Group’s Consumer Finance (JDGCF) divisions losses from its annual financial statements. Incidentally, this “undisclosed international buyer” that needs to complete a due diligence before proceeding, still remains “undisclosed”? Granted, JD Group did renew their cautionary in this regard, but I remain sceptical about this transaction for the reasons I outlined before.
I have previously commented that I thought that all of Steinhoff’s growth from the prior set of results came from rand weakness. Their growth in earnings from the underlying businesses (except for property) was not attractive, in fact, in some areas; it showed signs of struggle. Secondly, the company has historically had a poor ROE, mainly due to managements haste in raising capital and the consequent share dilution.
So far, the 2015 financial year looks set to see at least a 57% dilution in Steinhoff’s shareholding from both the R350m rights issue and the purchase of Pepkor. Obviously they are buying earnings from Pepkor and so the HEPS of Steinhoff will only reduce by around 17% (based on June 2014 figures for Pepkor and Steinhoff). However, if the JDGCF sale to this “undisclosed” buyer does not go through, ironically, Steinhoff’s current dilution will look even better. I would expect that the comparative figures for 2014 will be restated, dropping those earnings by around R1,5bn. The restated comparative figures will now not look so bad – then if you add the excellent earnings from Pepkor, then all looks good for Steinhoff – or does it?
After the deal, Steinhoff’s ROE will have dropped to below 10% (considering that a 15% growth in ROE is a good benchmark). The NAV per share will have increased by less than ten percent, but at the short-term expense of HEPS. On the other hand, Brait SE (BAT) will look a lot better with its NAV rising by around 76% per share and its price to book dropping to less than Steinhoff’s.
Keep in mind that a big chunk of the NAV of Brait will be cash that could either be returned to shareholders, by means of a special dividend, or better still, used to find attractive investment opportunities.
Brait have already extracted a total gross return of nearly 500% (not including debt repayments) out of Pepkor from the time that they acquired their stake on 4 July 2011. Using the same metrics that used when acquiring Pepkor, they purchased it essentially on a multiple of 7.4 and sold it on a multiple of nearly double that. Nobody can deny that Brait did well from their investment in Pepkor.
In fact, if you consider the total growth in the value of Pepkor from just prior to delisting in 2003 to its current offer from Pepkor, the capital appreciation means more than 3,000% to Christo Wiese over this period (not including dividends). One could argue that the Wiese family have done well out of Pepkor as well.
Why then did Brait’s share price fall by around 18% from its highs after the announcement of the sale of Pepkor. Well, the table below shows that Brait’s NAV growth over the years was largely attributable to Pepkor. Further to that, Pepkor was very conservatively valued on an EV/EBITDA of around 8, whereas some of its peers are trading on multiples of 14 or 15x. Essentially, the market took it on itself to remove part of this peer discount (42% as at 31 Sep 2014) and weighted Pepkor slightly higher.
It was probably correct to do so, as the price that Brait will finally get for Pepkor is on a rating that is in line with its peer grouping. Nevertheless, retail tends to operate in cycles and while Pepkor has experience incredible growth over the past decade, it is unlikely to expect it to be a 30-bagger over the next decade.
It is a case of banking profits and banking on future profits. Brait will exit their investment in Pepkor having enjoyed a stellar return over the three-and-a-half years they were invested. Steinhoff will acquire a highly cash generative business that might just compensate for the poor cash flows and high credit levels that furniture retailer have experienced. In my humble view, Steinhoff might just have needed this deal more than the market or shareholders have acknowledged.
*Craig Martin is an entrepreneur with investments in information technology and financial services. He has experience as a discretionary Portfolio Manager, and has worked for ABN-Amro, Aurica Asset Management and Guardbank in the past. He currently invests for his own account and operates as an independent equity analyst.
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