African Rainbow Capital (ARC) released its annual results for 2021 (FY21) last week. The group reported a 16.3% increase in its so-called intrinsic portfolio value to R12.3 billion, although after excluding the recent dilutive capital increase, the group saw its intrinsic net worth (INAV) drop 8.1% year over year.
Much has been written about the expensive external management company of this holding company and the fees it charges, so I will only come back to this to suggest to investors looking for a suitable discount for this holding company. to do the math.…
What I want to focus on is his investment in Rain, the young, rapidly growing data telecommunications start-up.
First of all, it’s great to see this phone company achieving its goals.
Dramatically helped by the demand for data driven by consumer lockdowns for remote working, gaming, etc., Rain seems to be doing just fine.
I say “appears” because we know very little about it. No separate figures or even subscriber statistics are published.
In ARC’s presentation on its results, management referred that it is EBITDA (earnings before interest, taxes, depreciation and amortization) positive and, in the absence of the cost of deploying 5G, would be fine. better.
But that’s the nature of telecom operators: you have to keep spending huge amounts of investment just to stay in the game. Can we really exclude 5G capital spending from Rain’s performance, cash flow and profit, or is it just the cost of keeping a seat at the telecom operator table? Are these really “expansionary” investments if you have to spend to stay relevant?
Second, ARC has accounted for Rain’s fair value in its INAV and the phone company remains its largest single exposure: in the region of 27% of its portfolio.
This heavy weighting of Rain in ARC’s portfolio makes the lack of detailed disclosure even more bizarre and frustrating.
So how reasonable is the CRA’s valuation of Rain?
Well, we have no idea – we just have to trust the management – but I can point out two interesting facts to give us much needed context:
- Rain valuation is higher (in part) due to lower discount rate
Rainfall is assessed using the discounted free cash flow methodology. As an early stage, fast growing, and likely negative free cash flow company, this methodology makes sense. A key entry here, however, is the discount rate used.
Simply put, for the exact same free cash flow, a lower discount rate will result in a higher valuation, and vice versa.
In FY20, the CRA used a discount rate of 17.25%, but in FY21, this discount rate was lowered to 15.26%. This is a fairly large drop in this discount rate and, certainly, a significant contribution to Rain’s higher fair value in ARC’s INAV.
I would say if it does, then this “growth in fair value is of particularly low quality.”
- Rain’s assessment implies he’s almost the same size as Telkom
ARC’s fair value of Rand 3.3 billion for its 20.2% stake in Rain is after respective discounts of around 12.5% for minorities and marketability (liquidity).
Read: Rain Attracts R12.5 Billion Valuation (September 2019)
While we keep the minority discount (this will make sense later), if we add the marketing discount back in and then gross the fair value up to 100%, we get what the implied “market cap” should be for. Rain if it was listed on the JSE.
(We keep the minority discount because JSE stock prices reflect what minorities are willing to pay for small stakes in companies, so this discount is still applicable even for shares of a listed company.)
By doing this calculation, Rain’s implied market cap should be around R18.8 billion. To see this in context, Telkom has a market capitalization of just R18.6 billion.
Can Rain really be worth more than all of Telkom’s operations and its more than 26 million subscribers?
Also, if you look at Blue Label Telecoms book value of its investment in Cell C, it is currently worth zero on its books. Cell C has 12.3 million subscribers.
How many Rain subscribers does he have?
Well, the last data point we have is a few months ago, they were having between 60,000 and 80,000 subscribers per month. Even if we assume that they are now signing 100,000 per month and have done so for five years (which is unrealistic, I know), that still implies that Rain would have around six million subscribers, which is well below the two ( and of lesser value) tertiary telecom operators.
So, Rain’s assessment just seems odd.
So while there has been a lot of talk about ARC’s fee structure, I don’t think enough questions have been asked about its assessment of Rain. While Rain seems to be performing well, is it performing well enough to warrant the rating attached to it?
Listen to Fifi Peters’ interview with ARC Co-CEO Johan van der Merwe (or read the transcript here):
Keith McLachlan is Head of Investments at Integral Asset Management.