Tag: Our Thinking

Perpetua Quarter 3 2017 Commentary Report

By Perpetua Investment Managers

Perpetua Turns Five

October 2017 marks the fifth anniversary since Perpetua commenced managing money for clients. Perpetua currently employs 23 staff members, 11 in the investment team, and manages in excess of R10 billion in client funds. Logan Govender provides a business update.

Also in this edition, Mahesh Cooper reminds readers of how we invest along the Perpetua True Value Continuum, Lonwabo Maqubela explains why we find Brait attractive and Mark Butler shares his positive view on the South African financial system.

It has been another strong quarter for the South African equity market and with Naspers as the biggest driver of those returns, our underweight position in the stock has been the biggest detractor of the performance in our portfolios. Patrick Ntshalintshali outlines our views on the largest stock in the South African equity market index and why we continue to believe that consensus opinion is overly optimistic in respect of this share.

We have been building our global capability and Phomolo Rabana’s article on Pandora outlines one of the many attractive opportunities we are finding for clients in offshore markets.

 

Read the full report here

Perpetua Quarter 2 2017 Commentary Report

By Perpetua Investment Managers

Assets under management at R9,5 billion as at 30 June 2017 and significant new appointments
As Perpetua closes in on its fifth year of operation, the firm has evolved methodically from a start-up investment firm in 2012, to a fully-fledged business with R9,5 billion in assets under management and a staff complement of 22.

Perpetua has seen significant growth in assets under management in 2017. The growth in AUM has been the result on new client mandates, additional flows from existing clients and market movements. Some of the flows has been the result of us graduating out of the incubation programmes of the clients that had assets invested with us close to inception. Perpetua has graduated into the mainstream managers for two such clients. This graduation was a vote of confidence, particularly in Perpetua’s continued investment in human capital, business infrastructure and its brand. Perpetua has identified our multi-asset class, global and alternative investment offerings as growth areas in the business and we needed to continue our investment in additional resources in these areas.

Read the full report here

Perpetua Quarter 1 2017 Commentary Report

By Perpetua Investment Managers

In our commentary this quarter, Bongiwe Beja, client services manager provides the usual performance and market review as well as summary of our proxy voting for the quarter (also always available on our website).

From an investment commentary, portfolio manager Patrick Ntshalintshali opens with our thoughts about the credit downgrade and the impact this has on our portfolios and portfolio positioning– given this is topical.

From a fundamentally-focused standpoint, portfolio manager, Lonwabo Maqubela together with analyst, Mahomed Ibrahim have done some interesting research into earnings of South African companies over the long and medium term.  This is an important component of the expected returns for equities.

This quarter, sectorally, we have focused on the life insurance sector – where we are finding quite compelling value.  Lonwabo, Mahomed and analyst, Glen Heinrich have provided our readers with our perspective on how we at Perpetua value insurance companies and why we see mispricing in selected counters.

Analyst, Phomolo Rabana attended the Consumer Analysts Group of Europe (CAGE) conference in London during the quarter.  At this event he listened to several global consumer companies and his article shares some of the key themes emanating from the event.

The telecommunications industry remains one of the most dynamic in our country and global landscape.  Analyst, Bjorn Samuels takes a deeper dive at some of the key local trends we need to be aware of as investors and consumers.

Finally, our closing piece is about one of the newer investments into our portfolio over the past year (while certainly not a new company), namely Woolworths.  Analyst, Kanyisa Ntontela has put together a summary of elements of our investment case and why we have now chosen to invest in the share.

We hope this commentary gives you a varied and interesting viewpoint about some of Perpetua’s thinking.

Read the full report here

Investment implications of the 2017 South African budget speech

By Perpetua Investment Managers

On 22 February 2017, South Africa’s Minister of Finance delivered the country’s annual budget speech.  As has become more a feature in more recent times, given the current challenging political and economic climate, the content of the speech was greatly awaited by all citizens in the country, irrespective of one’s perspective.

While several market participants would have summarised the key elements of the budget speech, for the purposes of this commentary, we focus on a few selected aspects of the budget speech in terms of key investment implications in so far as they impact relevant industries; companies; or asset classes in which our clients could be invested.

The areas we therefore cover:

1. Key elements of the budget
2. Proposed sugar beverage tax
3. Infrastructure spending and Stated owned companies
4. Implications for the bond market

Read the full article here

MTN: Looking beyond the near term

By Mahomed Ibrahim, Analyst, Perpetua Investment Managers

MTN is facing challenges on many fronts resulting in a murky near term outlook. This has been weighing on its share price which has fallen by almost 60% since peaking in 2014. The share was last at these levels more than 6 years ago.

Read the full article here

2016: The tale of two halves

By Patrick Ntshalintshali, Portfolio Manager and Phomolo Rabana, Analyst, Perpetua Investment Managers

We share in this commentary what we have learnt from the recent trading updates by the SA retailers

Introduction

Since the start of 2015, we had been cautioning our clients about the imminent tough headwinds in the South African private consumption and retailing environments. We identified the following potential fundamental negative impacts:

• A tough macro-economic backdrop in general, which had started in prior years (low GDP growth, rising inflation, interest rates hikes, poor employment, stricter credit, etc.)
• Rising competition in the industry, more specifically the entry and expansion of new international retailers (H&M, Cotton On, Zara etc.) in the apparel space stamping their presence in this market.
• Difficult high revenue and earnings base for retailers and slower store expansion trend.
• Stricter credit granting by banks and introduction of tighter Credit Affordability tests by National Credit Regulator in September 2015.
• Sharp import price increases post weaker local currency in 2015.
• Low consumer confidence.

Read the full article here

Commodities – now what?

By Glen Heinrich, Analyst, Perpetua Investment Managers

2016 finally marked the turning point for many commodities (and the companies that produce them).  After multi-year price declines based on overcapacity on the supply side and/or a reduction in demand expectations, many commodities launched a spectacular recovery in 2016, with Iron Ore up 86%, Thermal Coal up 68% and Brent Crude up 46% year to date.

Not all industrial metals have reacted in the same way with Copper up 18% year to date and the precious metals (Gold and Platinum) up 5% and 2% respectively.

Read the full article here

Perspective on the size debate in the South African market

Author: Lonwabo Maqubela, Portfolio Manager

Mid & small caps have outperformed the Top 40 over the past 20 years.

Figure 1: SA Size Index Performance

Even during periods of market corrections, they have actually performed better than large caps. This is case specifically in the 2008/9 drawdown as the large mining shares had big declines. In previous downturns small caps declined by more than the market. Due to the high growth rate, coupled with low ratings that they were trading on, small caps and mid-caps also delivered higher dividend yields, adding to the above-mentioned returns.

Table 1: Annualised returns 1996-2016

	Small	Mid	Top 40
Annualised price returns	11.6%	13.1%	10.8%
Dividend yield	3.8%	3.2%	2.7%
Total return	15.8%	16.7%	13.8%

Small and Mid-Cap Performance

As with all index related returns, investors have to look deeper in order to understand what drove the index returns.

With respect to the small cap index, we have identified the following shares as the exceptional performers that graduated to either the mid-cap or large cap indices.

Table 2: Small cap stock specific performance

What we would like to highlight is that stock selection is important as the outperformers have tended to do so by a large margin.

There are factors that affect investors’ ability to realise the returns (e.g. primarily size and liquidity). As you will note from Table 2 above, the market capitalisation at entry or 2003 for many of these was very marginal.   An ameliorating factor is that that many of the small caps tend to be capital hungry as they are in growth phase/acquisition phase. As a result, they tend to give shareholders opportunities to acquire more through rights issues. Further the real winners do end up becoming large companies, and therefore become more accessible, albeit with the drawback of having missed the initial returns.

Below is the performance of some mid-cap shares over since 2003. Again the divergence in performance is notable.

Table 3: Mid-Cap performance since 2003

At the core of the issue is whether smaller managers would have been able to access these opportunities. We are of the view that in order to own a meaningful position, it has to be at least 3% of fund in order to impact fund returns. Below we estimate the AUM level and how many shares a manager can own at 3% of fund.  In the South African context (all else equal) the levels that manager position sizes is typically restricted is around R50bn level and again at around the R100bn mark.

Figure 2: Number of shares a manager can own to 3% based on AUM level

For this exercise we have restricted the most that a fund can own of a company at 20%, whilst still maintaining that stock position at 3% of fund.

Another way of reflecting the message is to answer the question how many companies can a manager trade to 3% of fund within 20 trading days?

Note: There are many factors that affect daily traded volumes so historical trading activity is not always fully reflective.

Again the universe is reduced around R40/R50bn AuM level and at the R100bn level.

In conclusion

Rather than the exactness of the opportunity set given a manager’s size, what we would like to conclude with are the following thoughts:

• Small and Mid-Caps are eclectic combination of businesses and hence return outcomes. Stock picking is very important.
• In the current South African context, once an equity manager is greater than R50bn and again R100bn, the opportunity set declines meaningfully as evidenced by data above.
• We are not prophesying poor returns from large managers. Rather we would like to leave with the message that they will generate their returns from the large shares. Smaller managers have the opportunity to then also generate returns from small and mid-caps.
• From a long term perspective, there are times when managers should be invested in small and mid-caps. It’s not obvious that this should always be the case. For example, the timing to be invested in mid-caps and small caps was good in 2003 as they were also trading on low ratings and depressed earnings.
• Investors need to have good judgement to know when it makes sense for them to use their ability to be different to the benchmark. We do think that the current market environment is conducive for small and mid-caps: large cap shares are trading on high ratings. The rest of the market is trading on low multiples and low earnings.

Click here to download article

 

The shifting balance of power in the advertising industry

By: Mark Butler, Portfolio Manager, Perpetua Investment Managers

The balance of power is shifting in the advertising industry to the digital platform owners.  Advertisers’ have long wanted to influence our behaviour. From the “serpent” in the Garden of Eden to an online retailer enticing a prospective customer to act. Historically advertising has been done on radio, in various print formats: billboards on the side of the motorway, magazine or newspaper, sponsorship of a sports team or concert, in the cinema or on television. Advertisers want their adverts to have a high impact and, ideally to track that impact on their customers. In the digital world, they have followed customers online. Initially it was on a desktop but the advent of mobile devices has further enabled them to segment the market. Search remains the largest category, display as a category is declining being replaced by social media and online video.

The global television advertising market at US$180bn[i] is the largest advertising segment in the world, a thirty second slot on television during the Super Bowl will set back the advertiser US$5 million. It is difficult to measure the impact of these adverts and the additional revenue from advertising during the Superbowl final. The digital advertising market is growing at a faster pace than the television advertising market. and it is estimated that it will surpass the size of the television market within two years. The size of the digital advertising market during 2015 was US$149bn.[ii] The country with the highest digital advertising spend is the United States (US$80bn) followed by China (US$32bn). The dominant players, outside of China, are Google and Facebook controlling close to 70% of the digital advertising market.  Google is the larger of the two, which is not surprising because it is the Western World’s preeminant search engine and their ownership of YouTube. Facebooks’ brands include Facebook, Instagram and WhatsApp. Verizon’s, a US fixed and mobile telephone company (think Telkom in South Africa), acquisition of Yahoo is an attempt to build a third player using Yahoo’s customer base and AOL’s (which Verizon owns) technology.

One of the reasons for the success of Google and Facebook is the ability of these platforms to reach out to specific market segments and the ability to track the conversion ratio. In the last year the second largest UK online retailer, Shop Direct, used a cinemagraph video to build awareness of their Black Friday sale. An ad campaign was built around people who had not only clicked on the video but had watched the majority of it. This is known as a warm lead and these are potential customers who are geniunely interested in the advertisers value proposition. In the week prior to Black Friday, Shop Direct retargeted a series of “one day only” sales to a select audience of people who had watched the video. On Black Friday, Shop Direct’s campaign paid off with 4.2m visits to their website and 339% increase and their single largest day of sales ever.

Companies which use Facebook’s carousel ads have reported as much as a 20% increase in conversion rates.  Facebook has recently updated the configuration of their app-install adverts because people download apps and then often don’t use them. According to eMarketer only 6% of people still use an app one month after downloading it, so you want to make sure that your target audience includes those in the six percent.  Advertising on Facebook is not only for corporations with large advertising budgets or capabilities, they also target the small business. An example is a new swimming school. They could target a specific catchment area and focus on parents with toddlers e.g. those who purchase nappies. Without the data which platforms such as Google and Facebook are able to gather from their users’ shopping / browsing / location patterns it would be impossible to offer such targeted advertising and be able to provide reliable conversion data for their clients. All of this improves their value proposition and their attractiveness to advertisers.

In my opinion, it will be difficult for Verizon to reach the scale to be able to compete meaningfully with Google and Facebook which have a significant advantage and deeper pockets. The rate of change in technology is rapid and at times it may not be clear as to who the winner will be. Cast your mind back to 1998 when Yahoo wanted users to spend more time on their own platform and did not acquire a start-up which would send a user to the most relevant site using a soon to be patented PageRank system. The owners Larry Page and Sergei Brin, the company is now called Alphabet but is more commonly known as Google. In my opinion, the clear winners are Google (Alphabet) and Facebook as they benefit from the network effect and users shift away from traditional media to digital mobile devices. When last did you check your mobile device? Depending on your age, you may even be reading this on a mobile device. How the balance of power has shifted!

[i] Source: Bloomberg – Magna

[ii] Source: Bloomberg – Magna

 

Click here to download article

 

The Myburgh report regarding African Bank’s demise: key learnings in a governance context

By Phomolo Rabana, Analyst, Perpetua Investment Managers

A wise man once told me: it’s a funny thing that happens in the corporate world sometimes; the qualities attributed to a person’s success and rise, are the same qualities that are attributed to their failure on the way down. When things are going well, he’s ambitious, he’s thinks ‘out the box’, he’s smart, he’s got good judgement. But when fortunes change, he’s arrogant, he’s not realistic, he’s too ahead of time, he’s naïve. 

I guess how you get things is not always how you keep them.

The Myburg report’s findings about African Bank CEO, Leon Kirkinis

The Myburgh report was released earlier this month on the 12^th of May.  It’s an intriguing read, and provides insight into the demise of African Bank (ABIL). From our perspective, it makes us wonder what can be learnt from this event. After all, there was a time when ABIL traded close to R30/share (Figure 1); had a market capitalisation of over R32bn; was well favoured; and its CEO at the time, Leon Kirkinis was revered by market for all he had accomplished. At the time, his was a good story to tell; founder turned CEO, running a highly profitable operation, and offering investors both good growth prospects and an attractive dividend yield.

Furthermore, he had many qualities a good CEO should have; he had ‘skin in the game’ (he was a large ABIL shareholder); and was very knowledgeable about the business – one he essentially built. According to the Myburgh report, some of the words used to describe him by his colleagues were, ‘amicable’, ‘too nice a person’, ‘very hands on’, ‘very optimistic’, ‘extremely charismatic’, and ‘had the ability to rally the troops’.

However, upon reflection of the events that led to ABIL’s unravelling in 2013 and Mr Kirkinis’ resignation in May 2014, the Myburgh report uses the word ‘hubris’ to describe Mr Kirkinis’ personality – although he was in a position of power, he appears to have lost touch with reality and overestimated his own competence and capabilities: Mr Kirkinis believed “he was right; everyone else was wrong.”  The report further states even post the demise, Mr Kirkinis was “unrepentant and unapologetic” and indicated that ABIL had been wrongly placed under curatorship – and if it hadn’t it would have had a rosy future in 2015 and beyond.

How you look at it is pretty much how you’ll see it – Rasheed Ogunlaru

In any case, while it is all very well to talk of ‘turning points’, one can surely only recognise such moments in retrospect. Naturally, when one looks back to such instances today, they may indeed take the appearance of being crucial, precious moments in one’s life; but of course, at the time, this was not the impression one had – Kazuo Ishiguro

What about ABIL’s board and other executive directors?

We’ll leave it to the courts to ultimately attribute blame in the overall demise of African Bank. However, there were some findings from the Myburgh report that are worth highlighting as they underscore the importance of having strong and competent boards.

Often it is the allure of the title of board director that draws people to serving on company boards. However, all potential directors and shareholders must be specifically aware that the title comes with an equally weighty fiduciary responsibility, and significant reputational risk, should things go wrong on your watch.

• Overwhelmingly influenced by the CEO

Of the four executive directors who served on the ABIL and bank boards over this crisis period (Mr Kirkinis, Mr Sokutu, Mr Fourie, and Mr Nalliah) the Myburgh report found that Mr Kirkinis (Group CEO until 6 August 2014), had an overwhelming influence over the board and the entire operations of the bank. So much so, the report reveals that it appears he unilaterally concluded the significant R9,8bn acquisition of furniture retailer Ellerines in 2007 without a due diligence or complete board approval.

• A gap in appropriate competence

Mr Sokutu, the Chief Risk Officer of the bank over the past 10 years, was not qualified to hold his position. He did not have a good understanding of the underlying processes and principles of risk management within the bank, and also had a severe drinking problem as the report details. While another executive director, Mr Fourie by his own admission had no technical banking skills, and was not in a position nor was he qualified at all to contribute meaningfully to resolving the operational challenges the bank faced.

• Inability to withstand perceived or actual conflicts of interest

ABIL (the group including Ellerines) and the bank boards were identical in composition and held meetings at the same time.  The issue arose when the bank started providing significant financial assistance to Ellerines from September 2012 (initially in the amount of R450m). At the time the financial assistance commenced (be it in the form of guarantees or loans), the board of ABIL and the board of the bank were effectively conflicted – as what might have been in the interests of ABIL (the group that owned Ellerines) might not necessarily be in the interests of the bank.  Interestingly when all directors were canvassed at the time about whether they perceived there to be a conflict – all bar one non-executive director disputed there was a conflict or perceived conflict. When Ellerines was eventually placed under business rescue in August 2014, it owed the bank R1,4bn and both sets of directors of both entities were one and the same.

• Lack of internal credibility and influence

The only executive director who at times disagreed with Mr Kirkinis, was Mr Nalliah, the bank’s financial director since May 2009. However, as he was still earning his stripes in the organisation, he appeared not to have much sway, and was overruled by Mr Kirkinis. However, Mr Nalliah correctly disagreed with Mr Kirkinis on the bank’s provisioning and credit policies, and its treatment of accounts in duplum (arrears).

ABIL’s board should have been more proactive in attending to this issue considering that the Group’s auditors, Deloitte, highlighted that ABIL’s treatment of accounts in duplum (arrears) was not in compliance with accounting requirements. Furthermore, Deloitte believed that management’s impairment practices, although acceptable, leaned towards the less prudent side. Given that ABIL operated in the riskier segment of the lending market – unsecured lending, its accounting practices ought to have been more prudent, not aggressive.

My model for business is The Beatles. They were four guys who kept each other’s kind of negative tendencies in check. They balanced each other and the total was greater than the sum of the parts. That’s how I see business: great things in business are never done by one person, they’re done by a team of people – Steve Jobs

Perpetua research metrics place high importance on governance in financial companies

Governance is extremely important, more so we believe for financial companies. This is why at Perpetua Investment Managers, as part of our proprietary ESG analysis we conduct on all companies that we write fundamental research group reports on – we place a greater weighting on the importance of governance factors in respect of financial companies and banks. This would be in contrast to mining companies for example where we would place a greater weighting on environmental and social factors.

This ESG analysis and our concerns over governance at ABIL played a significant role in our ultimate decision not to expose client funds to ABIL two years ago. This was despite the fact that on many investment metrics the share screened as attractive. There were a few factors we struggled to overcome in the investment decision, namely:

1. Oversaturated levels of debt – we were concerned about the long-term sustainability of a business model that charged clients exorbitant interest rates.
2. Use of funds – ABIL’s client base used those borrowed funds primarily to finance consumption, or the repayment of other debt, as opposed to fund investment or asset purchase.
3. The binary nature of the investment outcome – this was our judgement of the state of play as we were doubtful about management’s credibility and objectivity as they repeatedly maintained that they were comfortable that the business was sufficiently capitalised (which effectively turned out to be not the case).

Considering the above factors in the framework of our assessment of the governance (G) and social (S) aspects facing the business, we ultimately decided not to invest on behalf of our clients.

In conclusion

The Myburgh report does provide some key learnings, particularly around the importance of board strength, that all investors and market participants, and even company management, can learn from. For investors it highlights specific red-flags to look out for when analysing a potential investment opportunity.

There are no guarantees in life or investing, and we like all investors will make mistakes along the way. However we want to learn from all experiences and use them to become even better, more skilled fundamental investors. It is for this reason that at Perpetua we developed our proprietary risk rating and ESG analysis system that we conduct when writing fundamental research group reports. We believe it will help us to better mitigate against potential company and industry specific risk by limiting our exposure to riskier companies in riskier industries, without being overly conservative on potential investments that may be attractively priced, notwithstanding the risks.

Click here to download article

 

Platforms

Author: Mahomed Ibrahim, Analyst, Perpetua Investment Managers

 “Platforms” have become a buzzword lately with new companies like Uber, AirBnB and Snapchat springing up at a frantic pace around the world.

So what exactly is a platform?

A platform simply facilitates transactions between two or more groups of users. In this way it increases efficiency by matching users who would otherwise have had difficulty finding each other. It also improves productivity via more efficient use of assets. This makes them highly disruptive to industries.

Physical and virtual platforms

Historically, platforms were mostly physical. Examples include the London Stock Exchange which is more than 300 years old (connects investors, traders, brokers and companies), the telephone network and even shopping malls.

More recently, these have been virtual, driven by rapid advances in the internet, microprocessors, software, mobile broadband penetration and the cloud.

How do they create value?

It is tempting to dismiss these new virtual platforms as part of a new tech bubble as many sell products and services for less than cost and do not charge users. This makes them unprofitable giving them stratospheric valuations. However, the successful ones are building strong network advantages and loyalty where users beget more users, creating momentum and self-reinforcing growth. Amazon founder, Jeff Bezos calls this the ‘Flywheel Effect’. These platforms have discovered that if one side of the market is incentivised to join (via free or discounted products or services for example), the flywheel can move faster.

Large numbers of users result in scale economics with higher revenue, reach and scale potential. The companies generate revenue from this through advertising, charging a small fee or making a small profit margin on a very large revenue base. They can also increasingly address more of their users’ needs by selling more products and services to them.

Using Amazon’s Marketplace as an example, investments by Amazon in customer experience (e.g. price and selection) drives customer traffic. Sellers are attracted by this traffic, increasing selection for customers. Amazon earns a commission for the resulting transaction and uses this to further invest in price repeating this cycle. The flywheel effect is shown below:

Closer to home, Uber is another example of a marketplace in action. The taxi app increases convenience for customers which increases traffic. This attracts more drivers improving convenience further and the loop repeats. Uber charges a commission for this traffic and becomes more valuable as this increases.

Types of platforms

Platforms can be broadly split into three types

1. Transaction platforms facilitate transactions between individuals and organisations, e.g. Uber, eBay, Gumtree.
2. Innovation platforms provide technological building blocks which are used as a foundation on top of which a large number of innovators can develop complementary services or products, e.g. Android’s Play Store or Apple’s iTunes which allow the development of apps by 3^rd parties or SAP which allows companies to build their own systems on top of their program. This is a powerful method for a company to create an innovation ecosystem with an unlimited pool of external innovators attracted to a network of users. This in turn will accelerate innovation.
3. Integrated platforms are both transaction and innovation platforms, e.g. Google (Marketplace and Android), Amazon (Marketplace and Publishing).

 

Source: Global Platform Survey, The Center for Global Enterprise

Note: The size of each bubble represents its market cap as at the beginning of 2016

Which will last?

It is incredibly difficult to build successful, pervasive platforms as they require critical mass of two groups of participants who in turn gain value only with access to the other group. It may therefore take many years of investing to expand network advantages before profitability. Furthermore, competition is usually fierce both from other platforms and incumbents in an industry. As incumbent firms realise the disruptive effect, many are also trying to build their own platforms of loyal users.

The most successful ones will be those that have the greatest enduring appeal to users and lock them in for a long period of time. Ultimately however, platforms are usually disrupted by more innovative versions.

Click here to download article