westbrooke eyes small- and mid-cap value
26 June 2018
Source: HedgeNews Africa
Research finds deeply discounted opportunities, which stand to benefit the Westbrooke Special Opportunities Fund
Westbrooke Alternative Asset Management has undertaken extensive research into the South African small and mid-cap sectors, finding significant deeply discounted opportunities, which they plan to act on to benefit the Westbrooke Special Opportunities SNN QI Hedge Fund.
The fund is focused on special opportunities in South African small-mid cap listed companies, and Westbrooke’s approach is closely aligned to private equity. It follows a fundamental research-driven valuation approach and uses its strong networks, principal investing and investment banking expertise to enhance the value of the companies in which it invests.
The team undertook research recently to establish the extent of the undervaluation of the sector, as well as its prospects for recovery.
The research universe comprised companies with a market capitalisation of between R100 million and R10 billion. This provided 130 companies including 97 operating companies, 10 investment holding companies and 23 real estate companies.
The research showed the research universe is trading at a discount relative to historical valuations, but those operating companies with a market cap below R2 billion and investment holding companies really stood out, presenting a compelling, deeply discounted investment opportunity.
Despite valuation in the sector being under pressure since 2014, the price earnings’ multiple of operating companies below R2 billion market cap has de-rated by 10% to 7.9 times since March 2017 and they are trading at a 22% discount to their five-year average of 10.1 times. Measured on an EV/EBITDA basis, these companies have de-rated significantly with an 11% derating to a multiple of 4.4 times since March 2017 and are currently valued at a 16% discount to their five-year average.As a comparison, Westbrooke looked at the valuations of corporate and private equity M&A transactions. These have been at a significant premium to current listed valuations with transactions of a similar size to the universe below R2 billion being at EV/EBITDA multiples of around 6-8 times.
In addition, the research revealed that the universe of operating companies have managed their balance sheet conservatively, with declining gearing over the last few years. They therefore have balance-sheet capacity to fund growth initiatives and corporate activity.
Investment holding companies
The research included analysis of historical valuation metrics of 10 South African investment holding companies. The research universe is currently trading at a 33% discount to intrinsic NAV while the four-year average to March 2017 was a discount of 10%. The universe traded at a premium to intrinsic NAV during 2014-2016.
To compare, the Thompson Reuters Datastream, World Investment Companies Index comprises 26 international investment holding companies and currently trades at a 14% premium to NAV while its four-year average discount to NAV was 14%.
Westbrooke Alternative Asset Management believes that the discount of South African investment holding companies to intrinsic NAV will narrow to levels closer to historic norms as these companies generate attractive returns on capital or through an increase in corporate activity.
Westbrooke unpacked the key risks to the small-mid cap sector, which has less liquidity and greater share price volatility. South African economic growth may take longer than expected to recover and there is political uncertainty related to the upcoming election. In addition, the country may face capital outflows from emerging markets as the US Federal Reserve continues to hike interest rates.
It concluded that the small-mid cap universe currently presents an attractive investment opportunity over the medium term, particularly those operating companies with a market capitalisation below R2 billion. The potential for an increase in earnings across small-mid cap operating companies is strong with significant operational leverage driven by revenue growth and a reduction in operational expenses over the last few years. These companies have significant balance-sheet capacity for corporate activity, and corporates also have significant cash on hand to resume capital expenditure and acquisition activity. Small-mid cap investment holding companies are also trading at discounts far beyond historic norms and much higher than comparative valuations internationally. That discount is, therefore, likely to narrow.