Empowered investment company, African Rainbow Capital (code: AIL), reported its FY 21 results last week. The Group reported a +16.3% rise in their so-called Intrinsic Portfolio Value to R12.3bn, albeit once the recent dilutive capital raise is excluded, the Group saw its Intrinsic NAV (INAV) fall -8.1% y/y.
Plenty has been written about this HoldCo’s expensive external ManCo and the fees it charges (ARC Investments caves, will revisit management fee structure), so I won’t revisit this other than to suggest to investors looking for an appropriate discount for this HoldCo to do the math…
What I want to focus on is their investment in Rain, the young and fast-growing data-only telcos start-up.
Firstly, it is great to see this telcos hitting its targets. Significantly helped by lockdown-induced consumer demand data access for remote-working, gaming and the like, Rain appears to be performing really well.
I say “appears” because we know very little about it. No separate numbers or even subscriber stats are released. In ARC’s presentation on its results, management did reference that it is EBITDA positive and, in the absence of the cost of the 5G roll-out, would be doing much better.
But that is the nature of telcos: you have to keep spending vast amounts of capex just to stay in the game. Can we really exclude 5G capex from Rain’s performance, cash flows and profits, or is it just the cost of keeping a seat at the telcos table? Is it really “expansionary” capex if you need to spend to remain relevant?
Secondly, ARC wrote up Rain’s fair value in their INAV and the telcos remains their largest single exposure: a whopping c.27% of their portfolio!
This large weighting of Rain in ARC’s portfolio makes the lack of detailed disclosure even more bizarre and frustrating.
So how reasonable is ARC’s valuation of Rain?
Well, we have no idea—we just have to trust management—but I can highlight two interesting facts to give us some much-needed context:
- Rain’s valuation is higher (partly) due to a lower discount rate:
Rain is valued used the Discounted Free Cash Flow (DCF) methodology. As an early-stage, fast growing and, likely, free cash flow negative business, this methodology makes sense. A key input here, though, is the discount rate used.
Simply put, for the exact same free cash flows, a lower discount rate will arrive at a higher valuation, and visa versa.
In FY 20, ARC used a discount rate of 17.25% but in FY 21 this discount rate has been lowered to 15.26%. That is quite a large drop in this discount rate and, surely, is a material contributor to the higher fair value of Rain in ARC’s INAV.
I would argue, if this is the case, then this “growth” in fair value is particularly low quality.
- Rain’s valuation implies that it is almost the same size as Telkom:
ARC’s R3.3bn fair value for its 20.2% shareholding in Rain is after respective c.12.5% minority and marketability (i.e. liquidity) discounts. While we will keep the minority discount (this will make sense later), if we add back the marketability discount and then gross the fair value up to 100%, we get what the implied “market cap” for Rain should be if it were listed on the JSE.
(We keep the minority discount because JSE share prices reflect what minorities are willing to pay for small stakes in the companies, thus this discount is still applicable even for a listed company’s shares.)
Doing this math, Rain’s implied listed market cap should be c.R18.8bn. To view this in context, Telkom SA SOC Ltd (code: TKG) has a market cap of only R18.6bn!
Can Rain really be worth more than Telkom’s entire operations and their >26m subscribers?
Furthermore, if we look at Blue Label Telecoms’ (code: BLU) carrying value of their investment in Cell C, it is currently worth zero on their books. Cell C has 12.3m subscribers.
How many subscribers does Rain have? Well, last data point we have was some months ago that they were signing up between 60,000 and 80,000 subscribers per month (link). Even if we assume that they are now signing 100,000 per month and have been for the last five years (unrealistic, I know…), this still only implies that Rain would have c.6.0m subscribers, which is far short of both the above noted (and lower valued) tertiary telcos…
Thus, Rain’s valuation just looks odd. As mentioned earlier, plenty has been spoke around ARC’s fee structure, but I don’t think enough has been asked about their valuation of Rain. While Rain does sound like it is performing well, is it performing well enough to justify the valuation that has been attached to it?
ARTICLE ORIGINALLY APPEARED ON MONEYWEB