viceroy research

In a football league, the team that becomes the champion at the end of the season is the team with the most points¹. Three points are awarded for winning a game, one for a draw and zero for losing. A game is won by scoring more goals or conceding less than the opponents.

Recent irregularities, scandals, rumours, and negative reports on various companies have created lots of angst amongst investors. In this article, we dwell on some of the companies that have been caught up in these events and how it impacted the Lunar BCI Worldwide Flexible Fund (Lunar), if at all.

Did we concede any goals that we could have prevented?
Did we save any goals that would surely have been scored if we didn’t defend well?
Did we miss goals that we should have scored?
Did we score goals because we were well-positioned?

Viceroy Research

It started in December 2017, firstly with the sudden resignation of Marcus Jooste, CEO Steinhoff. This was followed a day later with Viceroy Research’s report on Steinhoff. Steinhoff’s shares drop by approximately 90%.

Since then, we had rumours of negative reports on Aspen, a published report on Capitec by Viceroy, a published report by 360One on the Resilient group of companies and a scandal involving DSTV, a subsidiary of Naspers.

How was Lunar affected?

• Steinhoff (SHF): Lunar was not invested in Steinhoff. Our main reasons for not investing in Steinhoff were 1) as a group, it did not fit in with our investment themes; 2) we also viewed the company too complex to understand; 3) we were uneasy with the company’s strategic direction. Steinhoff had large holdings of PSG and Shoprite in its portfolio, and Lunar was invested in both of these. So, tactically, we decided to reduce our holdings in these 2 businesses even though we liked them. Our view was that Steinhoff (and management who were highly leveraged) would be forced sellers of their holdings to repay bondholders and lenders. We would thus be able to acquire both PSG and Shoprite at better prices later. As it turned out, this was correct for PSG but not for Shoprite, as PSG’s shares dropped, but Shoprite’s in fact rose. We avoided the Steinhoff issue but were marginally caught in the waves that it created. The net result was no significant impact to our fund. We view this as a goal saved.
• Capitec (CPI): When Viceroy did come out with its second report, it was a surprise that its report was on Capitec. Lunar was not invested directly in Capitec, but we were invested in PSG. Approximately 50% of PSG’s net asset value was and still is made up Capitec. This report came at an inopportune time for us, as we had started rebuilding our holdings in PSG. We successfully bid in the Steinhoff sale of PSG shares. PSG, in our opinion has excellent underlying businesses, a very strong management team, and it was trading at a discount of approximately 17% of its net asset value. Their businesses fit in well with our investment themes. We were of the opinion that Capitec was overvalued because the share price was implying much higher growth than what it could likely achieve. But, our view was that the discount was a sufficient cushion. Once the Viceroy report came out, we stopped building up our position and again reduced our stake in PSG. We do not agree with most of Viceroy’s allegations and would most likely add to our holdings in PSG once the dust settles and Capitec is trading at a better price. This has impacted the fund marginally and we view it as a goal conceded. The question we ask ourselves is: Could we have avoided it?
• Aspen (APN): Before Viceroy’s report on Capitec came out, the market speculated that one of the companies that Viceroy is targeting is Aspen. This put some pressure on the Aspen share price. Lunar was and still is invested in Aspen. In fact, we increased our stake somewhat when the share price came down. The business fits in well with our investment themes and whilst in the past valuation was an issue, it is trading at much better value now. There is no impact on the fund holding Aspen, in fact it allowed us to buy increase our holdings at better prices. We view this as a goal scored.
• Resilient (RES) and related companies NEPI, Fortress, and GreenBay: We have generally been quite negative on the property sector, especially those with large shopping centre holdings. We were and are still not invested in any of these. In the property sector, we prefer the logistics warehouse plays, those leased to logistics and internet retail businesses like DHL and Amazon. Goals saved.

• Naspers (NPN): The issue with Naspers is not the same as those above, other than one of its subsidiaries (DSTV) was involved in some dubious transactions with the SABC and ANN7 (previously owned by the Guptas). This scandal may have had a marginal impact on its share price. However, Naspers was one of the top performing shares on the JSE last year on the back of a significant increase in the share price of Tencent, its Hong Kong based investment. Lunar was not invested in Naspers, even though it met our investment themes, for the following reasons:
  • A large portion of Lunar’s offshore investments are in technology companies (Amazon, Facebook, Alibaba, Nvidia). We did not want to over-expose the fund to the technology sector by also adding Naspers as an investment;
  • Whilst Naspers trades at a discount to its net asset value, our view is that the discount is justified as the remaining businesses in the Naspers stable run at a loss, and that Naspers does not own its shares in Tencent, it only has rights to the earnings and dividends in the company.

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So, how did we perform as a fund in the five scenarios above? Overall, we played a good defensive game, avoiding many goals that could have been scored against us. We got caught somewhat in the whirlwind of activity around Steinhoff and Capitec, which created repercussions for our holding in PSG. But, we also managed to take advantage from the situation around Aspen. Perhaps we missed a big goal by not investing in Naspers, but we would have been proper fools if there was a big correction in the technology sector.

Lessons learnt

This is a good time to reflect on our investment guiding principles:

• We buy quality businesses at fair prices.
• We debate and identify the thematic trends that will deliver growth in the 3-10 year horizon. Our portfolio will be concentrated, reflecting the thematic trends and companies we want to be invested in.
• We only buy companies that we understand: how they make their money, what their risks are, and what their strategy is, etc.
• When prices are low, we gear up; similarly we sit on cash when prices are high.
• We measure and report our performance – and we strive to be honest about the reasons for our success/losses.
• We meet regularly and debate as a group what the investment themes are, the companies to consider investing in, the investment philosophy/style, etc.
• We take every opportunity to learn and refine our investment management skills and our knowledge of the companies we are invested in.
• We keep an investment diary: we write-up the investment philosophy, the selected investment themes, the investment case for each company we consider investing in and then check back when we divest, the reasons for our success/failure.

We think that these guiding principles are still intact and some valuable lessons have been learnt in the last few months:

• Aggressive short-sellers will become a more prominent feature of the South African markets. This will present both risks and opportunities.
• The risk of permanent loss of capital increases as the market becomes frothier. But, staying out of the market can be even more hurtful to the investor. Finding, the right investments and balance in the portfolio becomes even more critical during these times.
• Volatility is not risk. Risk is being invested in a bad or over-valued business.

1 If two or more teams have the same points, then the team with the largest goal difference is the winner. There are further rules if goal difference is also the same, but we won’t go into that detail here.