2019 has seen buy-out offers for three of my core holdings, namely Metrofile (MFL), Rolfes (RLF) and Clover (CLR). This number of take outs is unprecedented and the trend is further supported by other JSE-listed small and medium caps such as Interwaste and Pioneer Foods going through similar processes this year. There is much common ground between these transactions, all of them showing just how cheap small cap shares are in the South African market at the moment.
In February beverage and dairy group Clover announced that Milco, headed by CBC, a bottling and beverage business based in Israel will delist the company for R25/share or R4.8bn. This represents a 35% premium to the trading price of around R18/share prior to the deal, but three years prior, the group had traded at R25/share. The deal closed in October 2019. The acquisition was at a PE of 13.5 and at around 8.5 times 2017 EBITDA.
In October chemical group Rolfes announced that Phatisa, a Mauritian domiciled private equity fund, would delist the company for R3/share or R480m. This represents a premium of 33%, as the company was trading at around R2.30/share, however, as recently 30 months ago the company was trading at R6/share. The deal is expected to close in early 2020. Phatisa is acquiring RLF at bottom of the cycle earnings of 27c or a PE of 10. EBITDA was R92m, so the acquisition is 5.5 times EBITDA.
Yesterday document management company Metrofile announced that Housatonic Partners, a US based private equity firm, intends to acquire and delist the company at R3.30/share or R1.4bn. This represents a premium of 126%, as the company was trading around R1.50/share, but around 30 months ago, the share was at R5/share. The deal is expected to close around Q2 2020. Housatonic is paying a for 20c of earnings or a PE of 16. EBITDA was R225m, so the acquisition is 6.5 times EBITDA.
The following trends are apparent from these three deals:
- Whilst the acquisitions are at significant and fair premiums to the recent share prices just prior to the announcement of the deals, in two cases they represent large discount to the price of the business a mere 2.5 years ago. This shows just how much these smaller companies have fallen out of favour in the last few years and how this is being recognised by private companies.
- The acquisitions are all undertaken by non-South African players, who are seeing the value in Africa’s most mature economy. With global valuations stretched, South African businesses remain very cheap and outsiders are not blinded by the general negativity pervasive in South Africa at the moment.
- All three companies are strongly cash generative in a tough economy. The average EBITDA multiple of these transactions is 7, around half of global businesses (prior to any control premiums).
- The average PE ratio of 13 is equally undemanding, in particular, if we consider that earnings are at the very bottom of a cycle in a local recession.
- All three acquired companies did not have a major founding shareholder with a large controlling stake. It is unlikely that a founder would have excepted a take out at these low valuations.
- All three companies are too small to be included in the Top 40 index or any other index tracker. In fact, most equity funds would also consider these businesses too small to hold.
The streak of buy outs on the JSE clearly reflects that small caps and, in particular South African small caps are extremely out of favour and are therefore trading at valuations that make them attractive targets for private buyers. The premium paid to suffering investors offers small consolation, as minority shareholders with a long term focus cannot participate in the upside that is sure to materialise when the economy and sentiment turn.
So what can we small investors do?
Or we can invest in businesses that share the same characteristics but that are unlikely to be sold at current bargain prices due to the presence of strong founder shareholders. These businesses may not benefit from a short term acquisition premium, but they are likely to benefit all shareholders in the long term. These are companies such as ARB Holdings (ARH), Balwin (BWN), Masterdrilling (MDI), Bowler Metcalf (BCF) or Nuworld Holdings (NWL).