Description

We are currently involved in a activist trade which we plan to escalate in June. I am acutely aware that South African management teams pay far more attention to the opinions of foreign shareholders and hopefully this idea will appeal to some members who are prepared to pressurize the management team. The main thrust of our attack will be directed at a misleading document which the management team published to defend their decision to diversify. I am not a stats expert, but, the statistical arguments used to  support their views can only be described as selfserving. Do people really get paid to produce this crap? We do not like being treated as fools.

The arbitrage

The idea is to go long Rand Merchant Holdings (RMH SJ) and short Firstrand (FSR SJ). RMH is a holding company which owns 34% of FSR. Historically RMH traded very close to it’s intrinsic value, but, a recent decision to diversify into property has seen the discount widen to 11.4%. We are attacking the new strategy as it is not feasible given the billions lost by shareholders as a result of the widening discount.

Before describing the mechanics of the trade I thought the following facts would be useful

• FSR is the largest bank by market cap in South Africa. The current market cap is R337bil.

• This means you end up being long and short the largest bank is South Africa allowing one to make the bet in size and reducing any chance of a short squeeze.

• We have put the position on using CFD’s. Because of the strong correlation between the stocks the brokers allow positions to be geared 40 times.

• Management have blamed the widening discount on foreign inflows. Their view is that foreign capital is dumb and is not aware of the cheaper entry point through RMH. We disagree with this view and their poorly constructed argument which they have used to deflect from strategic and execution errors.

• When the respected finance minister was fired in December 2015 the discount vanished. We are obviously trying to make an arbitrage profit, but, we are also using the position as a hedge against economic shocks.

   

RMH

RMH’s assets are dominated by it’s position in FSR. RMH owns 34% in FSR (1 910mil shares). At the current FSR share price of R61.50 the holding is worth R117 492mil.

RMH has 1 411mil shares in issue giving a nav R82.45 per share. RMH currently trades at R73.00 representing a 11.4% discount.

RMH also own property assets worth R743mil (0.6% of Total Assets). These properties represent management’s desire to diversify its holding in FSR. Since this strategy was announced the market started to price in a holding company discount  which has continued to widen as the strategy has been implemented. We are agitating the board to rethink the strategy which is effectively costing shareholders over R13bil.

Leakage

Below is a table showing dividends coming in from FSR and being paid out by RMH. Leakage was 3%, but, has widened to 5% as the properties were acquired.

We don’t see any reason for any leakage at all. Similar holding companies in South Africa have miniscule levels of leakages. It really does not cost that much to monitor the price of one share.

The Property Strategy

Ok, I am biased, but, this is my theory. The current CEO, Herman Bosman, is being paid R3mil a year for doing what? Watching the FSR share price? So he dreams up a vision for the company “Diversify, Optimize, Modernize” (Ugghhhhhh) and jumps right into buying minority positions in property developers. Modernize?, electric vehicles maybe, but, he chooses property development. I don’t even want to comment on choosing property development to diversify a position in a bank. My experience is that both assets tend to blow up at the same time.

To date RMH have made 4 property investments

• July 2016: 25% Atterbury Property Holdings, Property Development

• October 2016: 34% of Propertuity, Property Development (urban renewal)

• December 2016: 40% Genesis Property, mezzanine funding

• January 2018: 43% Atterbury Europe, develops properties in EU, bought from Steinhoff 

   

The investments were disclosed as follows in the financial results

While management were prepared to rehash the whole “Diversify, Optimize, Modernize” bullshit in the December 2017 results, no explanation was given for the R166mil impairment to investment in associates. You would expect investors would be interested to hear how a R703mil property investment made in late 2016 is only worth R537mil one year later. How does this reflect on management’s ability to execute the strategy? Do they have the expertise? Have they heard of this dd thing? Is this why the market is pricing in a discount? No, just silence.

To be fair, they did address the holding company discount. The results referred investors to a statistical master piece which blames the discount on dumb foreign inflows. And believe it or not, they conclude that when the market is volatile the discount can widen or narrow. Yip, when the Cubs play at home they can win or lose. Eating ice cream can cause hot or cold weather. How the board could refer to this rubbish in a public document needs to be understood and investigated.

I am in the process of attacking this drivel as I believe it is misleading and self serving. As I said I am in the process of drafting the letter and if anybody wants to raise any issues or comment on their analysis please bring these up in the discussion. The sad document can be found here

http://www.rmh-online.co.za/downloads/2018/Reflections_on_RMH_recent_trading_in_relation_to_underlying_intrinsic_value.pdf

One last point. RMH want to grow the property assets to R10bil (8% of assets) over 10 years. Is this diversifying or is this just fiddling around with the deck chairs desperately trying to justify a salary? When we ask management about the feasibility of losing R13bil now to gain R10bil over 10 years I am told their feasibility studies are top secret. And if you ask for details about the latest transaction with Steinhoff they want you to wait until the next set of result which will be published in September. They really dont seem to have any idea for the negative feelings towards anything to do with Steinhoff. Its the dumb foreigners remember, not us.

Discount History

There is not much to say here. The property strategy was announced in June 2016 and from then it’s just been one way traffic with a small recovery over the last few months. I like to think that is us starting to agitate and create awareness.

Also, note the discount goes to zero during the December 2015 economic shock when the respected finance minister was fired by he disastrous president Zuma. As I said above we think this position could provide protection against economic shocks.

Conclusion

We will start to agitate in June ahead of the next board meeting. I will post my letter to the board once it is completed. In the mean time I welcome any input from members.

Given that this is the largest bank in South Africa one can take on large positions with significant gearing. Again, offshore investors are taken very seriously by South African management. If you are going to take on this position please understand the power of your voice and opinion. I guarantee it will make the headlines.

To help those interested in crunching the numbers I have included a table of data in the appendix.

Appendix

Catalyst

Agitation before the June 2018 board meeting or dumb foreigners money smartens up.