African Rainbow Capital Investments will spend R205 million, or 27%, of the R750 million it intends raising through a rights issue to pay outstanding fund management fees to (effectively) its parent.
The company announced the rights offer last week and said the additional capital would be invested “in the ARC Fund for use in its existing portfolio companies as well as for future acquisition opportunities”.
It also said some of the proceeds would be used to settle “the outstanding Fund Management Fee”. It provided no further details until the publication of the circular on Monday.
In the circular, it was revealed that the Mauritian-based JSE-listed investment holding company had accrued fund management fees totalling R205.66 million over the last financial year (from July 2019). These payments are due to general partner UBI on a quarterly basis. UBI then pays through 95% of the fund management fee to (unlisted) African Rainbow Capital as an investment services fee. African Rainbow Capital is majority owner (51.1%) of ARC Investments, which in turn owns the majority of the ARC Fund. This houses all the group’s investments, save those in the financial services sector which are co-owned by ultimate parent African Rainbow Capital and ARC Investments (via the ARC Fund).
ARC Investments notes in the circular that if the fund management fee is “not paid on due date, it accrues interest at the prime rate plus 5%”. The R205.66 million payable excludes any interest as the “general partner has agreed to waive all accrued interest on the outstanding fund management fee provided that it is settled at the time of the rights offer”.
What is curious is that the pre-listing statement specifies that any late payments of these fees “shall bear interest at the Prime Rate plus 2% per annum”. This suggests the agreement has subsequently been changed with any arrears now attracting a substantially higher interest rate.
Convoluted settlement plan
To avoid the flow of funds between the parties to settle the various obligations, they have agreed a convoluted manner of ensuring settlement through subscription in the rights offer process.
It says the ARC Investments board has determined this is “the most commercially advantageous manner to do so”.
The rights offer is being fully underwritten by parent ARC.
Fund management fee
In the pre-listing statement, ARC Investments disclosed that the fund management fee payable to the general partner (UBI) is calculated as follows:
i. “Where the Opening Invested NAV [net asset value] is below R10 billion, 1.75% per annum on the average of the Opening Invested NAV and Closing Invested NAV of that Quarter;
ii. Where the Opening Invested NAV is between R10 billion and R15 billion, the higher of the amount determined in terms of (i) and 1.5% on the average of the Opening Invested NAV and Closing Invested NAV of that Quarter;
iii. Where the Opening Invested NAV is above R15 billion, 1.25% on the average of the Opening Invested NAV and Closing Invested NAV of that Quarter, will be drawn down from the ARC Fund. The Invested NAV will be adjusted for investments and realisations during the quarter”.
It says the fee is “in consideration for the General Partner’s obligation to maintain the ARC Fund’s B-BBEE credentials and management responsibility for the ARC Fund in terms of the Partnership Agreement”.
Fees to date
Since listing in 2017, including the sum to be settled following the rights offer, ARC Investments will have paid a total of R453 million in fees to UBI (R94 million in the first 10 months, R153 million in the year to June 30, 2019, and the R205 million from the rights offer; figures rounded).
There is a separate “Performance Participation” structure that uses convertible C shares to further incentivise UBI for annual growth in NAV.
At a market capitalisation of R2.86 billion on Tuesday, the rights offer equates to over a quarter (26%) of the company’s value. Astonishingly, the management fee for the past year comprises 7% of market capitalisation.
The shares are down by two thirds since listing in 2017.
Investors have made it clear they do not value the business at anywhere close to the amounts published by the directors. As at end June, ARC Investments reported intrinsic portfolio value of R11.139 billion.
That means the shares are currently trading at a discount of 74% (or around 70% to the published net asset value per share). While it is common for investment holding companies to trade at a discount to the sum-of-the-parts, these levels are extreme.
It remains to be seen how many minority shareholders, including the Public Investment Corporation with 13.4% of ARC Investments, will take up their rights next week.
Listen to Ryk van Niekerk’s July 30 interview with ARC’s Johan van Zyl: