Almost exactly four years ago, on the 4th July 2011, Brait changed its investment model and raised R5.9 billion from shareholders, as it transitioned from a private equity manager into an investment holding company.
It used the proceeds to acquire 34% of Pepkor and 49.9% of Premier Foods.
This change in strategy has delivered handsome rewards for the investment team and shareholders. Reported NAV per share has grown from R16.50 on 1 April 2011 to R77.12 at 31 March 2015, reflecting a four year CAGR of 47%.
In the same period the share price rose from R18.61 to R83.50. The company also entered the MSCI Emerging Markets Index in August last year and the JSE’s Top 40 Index in June this year.
The sale of Pepkor for R30 billion in March this year draws to a close Brait’s first chapter since changing its business model, writes company chairman, Jabu Moleketi in the latest annual report. At the same time the proposed acquisitions of majority stakes in Virgin Active and UK retailer New Look signal the start of second chapter, he says.
The question many shareholders will be asking is: will the second chapter be as profitable as the first?
For Brait executive director John Gnodde, speaking to Moneyweb from London, the answer is a definitive yes. “Chapter one has been good. But from a Brait perspective we are excited about chapter two. What created the potential was investing in businesses with good growth and high cash conversion potential. We bought our assets well in chapter 1 and believe we have bought even better assets now.”
Brait bought Pepkor for R4bn and sold it for R30bn, effectively a 20x enterprise multiple (enterprise value/ebitda). To put that in perspective, other SA retailers trade on 12x enterprise multiple, which investors believe is rich relative to the market.
“Brait sold Pepkor on a rich valuation and used the proceeds to buy good businesses with better than average growth profiles for half the valuation,” says Lonwabo Maqubela, head of research at Perpetua Investment Managers. “This was, I believe, an example of good capital allocation.”
Further through these transactions Brait has diversified its net asset value (NAV) both geographically and by business line. Pepkor accounted for 60% of Brait’s valuation. Now the NAV comprises Steinhoff at 20%, New Look 35%, Virgin Active 25%, Premier Food 10%, and the others at 10%.
Brait acquired 90% of New Look for £1.9bn (£780m + about £1bn debt) at an EV/EBITDA multiple of 9x – a significant discount to SA retailers.
New Look EBITDA grew at 13.8% between 2012 and 2015 and is better than all the South African retailers with the exception of Mr Price (18%) and Pepkor (ebitda growth of 20% pa over the past five years). Bear in mind that EBITDA growth is also driven by inflation and relative inflation levels in SA have been significantly higher than in the UK.
New Look has a number of additional features in its favour, says Maqubela. Among these is the fact that retail growth in the UK is firming after a few years of low growth.
New Look is also well positioned in the higher growth, value segment of the UK’s apparel and accessories market. Brait believes the retailer has strong growth prospects, in particular in China where it has opened 31 stores in the past 14 months.
“New Look generates attractive gross margins relative to the South African peer group. The implication here is that a small change in sales will have a levered effect on earnings, Maqubela says.
In April Brait announced it would pay £682m to acquire an 80% stake of Virgin Active, which also translates into an enterprise multiple of 9.3x. The gym group’s EBITDA growth has averaged 11% p/year over the past three years, with growth in Q1 2015 of 16%. “This is a high fixed cost business, with good retention rates, predictable EBITDA and cash flow generation given its subscription based model,” he says.
“It’s true that New Look and Virgin have a slower growth profile than Pepkor, but these are businesses that have brand strength. Also investors can accept a lower return from these assets as they are based in regions that have a lower cost of capital,” he says.
Both businesses carry some debt. In the case of Virgin it’s about £360m. In the case of New Look it is £1.2 billion. “Brait is adept at refinancing debt at cheaper levels and this will be one of the first steps they will take,” says Neelash Hansjee, banking sector analyst at Old Mutual Equities. “Strong cash flow characteristics of the companies means they can pay down the debt to create value.”
Gnodde confirms that New Look’s debt was refinanced 2 weeks ago and the interest rate reduced from 9.42% to 6.25% which results in an interest saving to New Look of £32m/year.
Much of Brait’s portfolio is focused on the mass market or value sector, which is growing faster than other sectors. “Don’t forget existing assets like Premier Foods which is an exciting story,” says Hanjee.
Along with peers like Rainbow Foods and Pioneer, Premier – in which Brait now has an 86% stake – is shifting from basics to higher value foods and has diversified its portfolio. In the last year the company has invested R2.2 billion on eight acquisitions (at an average multiple of 7x) including Star Bakeries , Lil-lets Group and most recently, 68% of CIM, the leading food producer in Mozambique.
Premier’s revenue for the nine months ending 31 March 2015 increased 31% on the comparative period. Group EBITDA margin improved to 9.1%, generating an increase in EBITDA of 70% for the period.
“It is early days as Premier transforms, but these are good numbers,” Hansjee says.
Steinhoff is the other asset that investors are watching closely. Brait has indicated it will sell this stake, which it has valued at R15.2 billion in time. “Many believe that the plan to list Steinhoff in Europe will drive the price higher. This is probably feeding through to the Brait value,” says Reuben Beelders portfolio manager at Gryphon Asset Management.
While it would seem that investors are not questioning the quality of Brait’s assets, there are questions around its current valuation.
The chart below shows Brait’s price to book value, which is management’s valuation of underlying assets. It shows that the current share price is rich, relative to history.
The share was trading at R116.95 on Monday June 28th, a significant premium to the R77.12 NAV that Brait calculated as of March 31st 2015.
“Investment holding companies of this nature have seldom traded at a premium. If one considers the classic example in the SA market, Remgro, it generally trades around a 15% discount,” says Beelders.
Some investors believe that Brait trades at a premium to its NAV, because management is too conservative in arriving at this NAV, he says.
This may be true, as the sale of Pepkor demonstrated (it was valued by Brait at 8.5x ebitda and sold to Steinhoff on 20x ebitda). However one could argue that a fair portion of the valuation is now made up of New Look and Virgin, which are valued at market value (as these just traded).
The market is clearly willing to pay over the odds for Brait.
“This could be for one of three reasons,” says Maqubela. “Investors are willing to pay a premium for management’s deal making abilities. Or they believe Brait management under-paid for these acquisitions. Or the market is betting that management will extract more value from these businesses.”
Whatever your views on the valuation, the second chapter will undoubtedly be interesting.