It has been fascinating to watch the development of the public broad-based black economic empowerment (BBBEE) share space over the last 17 years. A number of schemes have come to market over time, and they’ve delivered returns in excess of the overall stock market.
There wasn’t much action when this market first opened up, as schemes had initial empowerment periods in which the trading of shares was not possible. This was then followed by a period where a number of shares became available for trade on over-the-counter marketplaces and on the JSE BEE Board.
The most disappointing outcome of the public BBBEE share offers has been investors’ response to maturing deals. Investors appear to have been frustrated by long empowerment periods when making sell decisions in particular. Empowerment periods typically run for periods of 10 years, although there are deals with over 20-year terms.
Typically, there will be some sort of liquidity event at the end of the empowerment period where investors either receive shares in the underlying empowering company or cash in the form of a dividend. There can also be an extension of the empowerment period.
Sasol experienced the wrath of many investors in 2018 when the empowerment period for its Inzalo scheme approached maturity. It seemed to them that they would earn almost no return, and that the period was going to be extended for another 10 years. A Facebook group by the name of ‘Sasol Inzalo robbed us’ was formed and grew quite quickly. I joined out of morbid curiosity because I did not believe that would be the case.
In the end, the Sasol Inzalo deal delivered a superior return to that experienced by ordinary Sasol shareholders and investors in the JSE Top 40. What saddened me was the number of shareholders who missed out on these returns because they allowed their emotions to dictate their investment decision-making.
The key to making money out of BBBEE share offers: the liquidity discount
One of the resounding complaints around public BBBEE share offers is the lack of liquidity. The shares are restricted to black South African investors as defined in the BBBEE Act, which tends to translate to low levels of trade. These investors were largely historically disenfranchised and therefore inexperienced when it came to equity investing. In the last few years I’ve seen even ‘educated’ investors express deep frustration at the liquidity discounts seen in many of these shares. I’ve corresponded with a number of them who could not understand why their shares traded at a much lower price than their worth.
However, for me, the main attraction of BBBEE shares is the liquidity discount. With it, I am able to buy a lot more shares. A liquidity discount often means a higher-than- market-dividend yield, which can compound to a fantastic return outcome over time. But the real return kicker happens when there is a liquidity event, which results in the liquidity discount disappearing. The best way to illustrate this is by way of example.
At the end of February 2013, Thembeka Capital (now known as Dipeo Capital) had an intrinsic value of R112 per share. It was trading at around R65 – a discount of 42%. Making up the intrinsic value were underlying investments such as PSG Group, Capitec, Curro and a host of quality unlisted assets. I wrote back then that a more appropriate discount would be around 30%. By the end of August 2013, the intrinsic value had increased to R120 per share.
If the discount narrowed to 30%, investors would have experienced capital growth of around 29%. However, there was an unexpected liquidity event 18 months later when investors were offered 1.7 PSG shares for every Thembeka Capital share owned. PSG was trading at around R99 per share, meaning that Thembeka shares were worth R168 each – a return of 158% on the R65.
Had the share been trading at its intrinsic value that return would have been a relatively muted 50%. The discount effectively trebled the return to shareholders who were prepared to hold a discounted asset in their portfolio.
Liquidity events come in various forms, as we’ve seen in the past:
- In 2018 Vodacom announced that its YeboYethu deal would pay a special dividend and a portion of the value of the deal would be committed to a new deal. That announcement resulted in the share price increasing by more than 60% in a week.
- In 2018 Naspers announced that it would unbundle MultiChoice Group (MCG) and give Phuthuma Nathi (PN) shareholders a larger stake in MultiChoice South Africa as part of that unbundling. PN shareholders would also be able to swop some of their PN shares for listed MCG shares. The share price increased over 75% in the week that followed.
- Recently Sasol announced that it had appointed a market maker for the SOLBE1 share, which had been experiencing low levels of liquidity. The result is that SOLBE1 was trading at a discount of over 50% to its intrinsic value, when that discount should really have been in the 25 to 30% range. This announcement has resulted in more than a 50% increase in the value of SOLBE1 shares as liquidity has made a return to the share.
- In 2017 Naspers announced the unbundling of the printing business from Media24. This resulted in a special dividend to Welkom Yizani shareholders, which amounted to over 100% of the value of the shares just before the announcement.
In all five cases, the liquidity event resulted in large returns to shareholders in a very short space of time. This characteristic makes it difficult for investors to try to time an investment, and a buy-and-hold strategy becomes the best one to apply. The question then becomes how do investors know which shares to buy?
What’s looking attractive at the moment?
My usual refrain when asked which of these shares an investor should consider is to buy as many as one can afford. The principle of diversification is as relevant in this instance as it is in any other investment setting.
The two shares I have been buying into lately are SOLBE1 and YeboYethu. SOLBE1 has been trading at around R200 per share with an intrinsic value oscillating around R400, resulting in a discount of 50%. A more suitable discount for an investment in a share like this would be around 30%. The discount put SOLBE1 on a forward dividend yield of around 7%, which is attractive. That could easily grow to over 10% in three years.
I was happy with that return profile in the absence of any liquidity event. Unfortunately there was a surprise discount event with the appointment of a market maker for the share. This resulted in the share price running up to R298 a share at the time of writing, a discount of around 31% and an expected forward yield of around 7.2%. The investment thesis is still attractive, but the easy money has been made (assuming that the SOL share price does not rerate upwards any time soon).
The investment thesis for YeboYethu, on the other hand, is more interesting as a geared investment (there is fresh debt in the scheme). That debt is worth around 86% of the value of its investment in Vodacom Limited (with VOD trading at R116 a share). This makes YeboYethu a volatile share to invest in at the moment. It is trading at a discount of around 45% to its intrinsic value, but given the gearing, value can emerge in the share quite quickly.
YeboYethu reminds me of both PN and Sasol Inzalo. The similarity to PN stems from the cash generation ability of the underlying investment – Vodacom Limited. This helps YeboYethu to service its debt in the early years and then to be a high dividend payer after that. PN generated over 920% in dividend returns between 2007 and 2018 with the bulk of those returns coming through after 2014. The similarity to Inzalo stems from the high gearing, which can result in a volatile share price. My entry points into YeboYethu are therefore based on the discount, but here I want a higher discount than for SOLBE1. As we saw with Inzalo, the discount can disappear with a falling share price in the underlying share.
Similar to value investing
Investing in BBBEE share schemes is a lot like value investing where investors tend to focus on factors like discount to net asset value (NAV) and dividend yields. Deep value funds – like those managed by the likes of RECM chairman Piet Viljoen, Cannon Asset Managers CEO Adrian Saville and Investec Value Fund manager John Biccard – have delivered relatively good returns over time, but have tended to be lumpy. Investors in BBBEE share schemes can expect a similar return profile over time. However, calculating the NAV is often easier as there is a reference price for the underlying asset, and the empowerment period is also often the catalyst for a liquidity event.
As always, it is advisable for investors to keep some cash in the kitty. There are other potential opportunities opening up in future, with the MTN Zakhele Futhi deal coming out of its initial lock-in period and Barloworld’s property-backed Khula Sizwe coming to market in the first half of 2019.
The public BBBEE share landscape continues to evolve and continues to offer investors the prospect of higher-than-market returns and dividends. But investors need to learn to embrace that one thing that makes them most uncomfortable about these shares, the liquidity discount.
Craig Gradidge is an investment and retirement planning specialist at Gradidge-Mahura Investments.
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