African Rainbow Capital (ARC) Investments has done an about-turn on its plan to use R205 million of the R750 million it plans to raise through a rights issue to pay outstanding management fees for the 2019/20 year.
In an announcement on Friday, ARC Investments said it would “settle the fund management fee from internal cash resources”. This, it claims, is as a consequence of the board deciding to “cancel” the convoluted set-off agreement where the fee would be settled through subscription in the rights offer process. This would’ve avoided the flow of funds from ARC Investments to general partner UBI, which then pays through 95% of the fund management fee to (unlisted) African Rainbow Capital as an “investment services fee”.
In the circular for the rights offer, ARC Investments said the board had determined that the set-off agreement was “the most commercially advantageous manner to do so”.
Quite how this changed in a week is not clear.
Now that the set-off agreement has been cancelled, ARC Investments is at pains to state that: “The purpose of the rights offer will therefore solely be to raise additional capital for ARC Investments to invest in the ARC Fund for use in its existing portfolio companies and for future acquisition opportunities, and none of the rights offer proceeds will be utilised for purposes of settling any fund management fees.”
Trying to claim that there are two separate pools of capital within the business – one to invest and one to pay fund management fees – is, however, completely disingenuous.
ARC Investments has a single pool of capital with which to invest in portfolio companies (or the ARC Fund) and pay the fund management fee.
ARC Investments’ current market capitalisation is R2.82 billion, which means the rights offer equates to over a quarter of the company’s value.
In an interview with the Financial Mail’s Giulietta Talevi, ARC Investments co-CEO Johan van der Merwe contends that the rights issue equates to “only 7.5% of the company” given its published net asset value (NAV) of R10 billion.
The fund management fee of R205 million for the past year comprises 7% of market capitalisation.
In the pre-listing statement, ARC says part of the fund management fee is “in consideration for the General Partner’s obligation to maintain the ARC Fund’s B-BBEE credentials”.
It also says the fee is used to actually manage the fund. Van der Merwe states: “We’ve also got a team of about 20 people — we rent premises, we travel, we work — who have to be paid.
“That is what the fee is there for.”
Van der Merwe says this is a “standard fee and if you look at private equity — and this is almost a listed private equity vehicle — private equity usually charges 2% and 20% [on outperformance] … “.
“We charge 1.75% on a sliding scale and 16% on outperformance.”
At R205 million for the most recent financial year, this equates to an average of R17 million of costs a month, which he asserts ARC and UBI do not make “huge profits” on.
R453m in fees in three years
Since listing, 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 30 June 2019, and this R205 million).
Van der Merwe told the FM: “The fee is something that was there from day one.
“Maybe some people didn’t like it, but if they didn’t they shouldn’t have bought shares.”
The fund’s NAV, on an IFRS basis, is R9.983 billion as at June 30. When this exceeds R10 billion (and is below R15 billion), the fee will drop to 1.5% “on the average of the Opening Invested NAV and Closing Invested NAV of that Quarter”. Fees when NAV is above R15 billion are 1.25%.
Moneyweb last week questioned why the circular referenced the accrual of interest at “the prime rate plus 5%” if the fund management fee is not paid on the due date, while the pre-listing statement specified the rate as “the prime rate plus 2% per annum”.
In the announcement on Friday, ARC Investments says “a typographical error in paragraph 3.7.1 of the rights offer circular incorrectly states that in terms of the partnership agreement of the ARC Fund, the outstanding fund management fee, if not paid on due date, accrues interest at the prime rate plus 5%”.
“The correct percentage is the prime rate plus 2%, and there has thus been no change in this respect since the company’s pre-listing statement was issued on 28 August 2017.”
It says “all accrued interest on the outstanding fund management fee will be waived”.
“The error therefore has no impact on the rights offer.”