Over a period of about 20 years between 1991 and 2011, private equity company Brait delivered an internal rate of return above 30% — very healthy by most investment standards. In 2011 the company changed strategy, shifting from an unlisted private equity company to a listed investment holding entity.

The theory was that it was easier to raise capital as a listed entity; and without the pressure to exit the investment within five years, investors could be patient and enjoy the upside over the longer term.

That theory applies when all is going well. When it’s not going well, and when high levels of debt are involved, few investors are truly patient, least of all the shareholders in a listed company.

It all went swimmingly at first. Investments were made in Pepkor and Premier Foods; Brait was an investors’ darling and by 2016 the share peaked at R170.00. Since then the downhill slide has been undignified and well documented, with the value of the company falling by 32% each year to close at a net asset value (NAV) of R41.80 as of 31 March 2019.

As a result, Brait delivered an internal rate of return in the low single digits between 2011 and 2019 – somewhat of a turnaround in fortunes from the previous two decades.

If one narrows the time frame from 2015 to 2019 it becomes clear that the investment team has presided over enormous destruction of value.

That’s because in March 2015 Brait sold its 37% stake in Pepkor to Steinhoff, notching up a tidy 69.5% annual rate of return for the previous four years.

Unfortunately, these gains have come undone at a rapid rate.

For shareholders, the problem was compounded by the widening discount between the value of the company on paper and the value they could actually realise on the market, particularly as the share continued to fall.

Aside from questionable capital allocation decisions, the write-down of New Look to zero on the balance sheet, and high head office costs, what is concerning investors is the R12-billion worth of debt on the balance sheet, and looming repayments that are due in September 2020.

The share is currently trading at R15.71, making the discount to NAV more than 100% — insane even for investment holding companies where a discount is normal.

Over the past few months, a number of investors have knocked on the door of Brait’s largest shareholder, Titan, owned by Christo Wiese, with ideas to turn around the ailing company.

Mergence Asset Managers was the company whose proposal to unlock value and support the repair of the balance sheet found favour with Titan’s Wiese.

In an agreement announced this week, Mergence has acquired 27.2-million Brait shares from Titan at R15.40 per share, taking its stake in Brait from 4% to 9%. In addition, the two parties have entered into a voting pool agreement that together holds 46.3% of Brait.

The pool will be controlled by Titan which remains a committed investor, according to Mergence.

“Brait is trading at a massive discount to management’s estimation of net asset value,” says Bradley Preston, Mergence head of listed investments. “Even on our conservative valuation, we value the company at well north of R30. That means at these levels Brait is cheap, providing value can be unlocked.”

In addition to this transaction, Mergence has entered into an agreement with Titan to co-operate in supporting the repair of Brait’s balance sheet and the unlocking of value at the company.

Part of this agreement will see Mergence propose a nominee to the board of Brait.

The first priority is to strengthen the balance sheet. This could be by way of an equity raise, restructuring of the terms of the debt and a sale of assets — or a combination of all three.

Negotiations are “delicate” and further detail is not forthcoming.

“At this point we have an agreement and are in negotiations with the Brait investment team and the board as to how to go about it,” says Preston.

“We as shareholders can push for a certain direction, but it is up to the investment team and the board to execute the strategy agreed upon.”

Investors outside the action will be watching with interest. BM