A debt spiral is a terrible thing and investment holding company Brait knows all about it. Cash flush in 2015, the company went on a shopping spree at the height of the equity cycle, acquiring itself a tidy portfolio of assets. But some investments, notably into UK fashion retailer New Look, turned out to be less than astute and the slowing global economy meant that even the good assets couldn’t help Brait dig itself out of the hole it was in.
This meant that in the last financial year (ending March 30th 2019) the net asset value of its investment portfolio declined by 25% to R41.80 per share (from R130 per share in March 2016). By the end of the next six months to September 2019, it had declined by a further 9% to R38 per share.
In the 2019 financial year, Brait’s net debt to equity at the holding company level increased to 61% from 29% the year before.
Making matters worse was the fact that the company’s convertible bond, worth about R6.5-billion, matures in September 2020. Similarly, its revolving credit facility, drawn by R6.4-billion, comes due in December 2020.
This was too much for many worried shareholders who voted with their feet. As a result, the share price fell by 34% over the year to trade at R24,00 at the March year-end. It was trading at R14,07 on the afternoon of 27th November 2019.
With this picture in mind, it is easy to lose sight of the fact that Brait holds some decent assets in its portfolio. For instance Virgin Active (53% of the investment portfolio) grew its membership base, revenue and earnings in the 9 months ended 30 September 2019.
Premier Foods (27% of the portfolio) grew revenues in its first six months, while earnings fell 4% in trying economic circumstances. Even New Look, which has been written down to zero on the balance sheet, showed growth in the year.
But not all investors are created equal, and the team at Ethos Private Equity, which has a reputation for picking the wheat from the chaff, spotted an opportunity in the beleaguered company.
“We recognise that Brait is an investment holding company with strong underlying portfolio companies, supported by strong cash flows. Yet the share is trading at a significant discount to fair value, largely because there is too much debt on its own balance sheet,” says Ethos CEO Stuart MacKenzie.
This scarcity of capital, he adds, creates an opportunity for the investors that do have capital.
Thus Ethos Private Equity, together with Ethos Capital, which is the listed entity, announced that Ethos (collectively) has partnered with Brait to support it in the efforts to recapitalise its balance sheet, realise value from the assets, and return capital to shareholders in the medium term.
What this means is that Brait will raise equity capital of up to R5.6-billion, which includes an R5.25 billion rights issue, to help refinance and restructure its existing debt.
Of this, Ethos Fund VII will contribute R750-million and Ethos Capital will invest R600-million (to be raised via a separate rights issue) to its overall R1.35-billion capital injection.
It will do this by taking up roughly half of Titan’s (Christo Wiese’s investment company) portion of the Brait rights issue (R1 billion) and an additional R350-million from other Brait shareholders who do not take up their shares in the rights issue, or a specific issue of new Brait shares.
Christo Wiese is Brait’s largest shareholder with 28% of the shares. His shareholding will be diluted following the recapitalisation, though to what extent is unknown at this point.
Ethos will hold about 12% of the company once the recapitalisation is complete.
Brait will also buy back £185-million of its £350-million convertible bonds and refinance the revolving credit facility.
“This is an elegant solution for a company that could not see its way out of its debt,” says PSG equity analyst Adrian Cloete. “For one, it gives Brait a sustainable future for the next five years and, certainty is a good thing.”
In addition, the rights offer is deeply discounted to the ruling share price, making it attractive to shareholders to follow. “At this point almost 70% of shareholders have voiced approval for this deal, so it is unlikely that the offer will fail,” he says.
Brait was exactly the sort of company that Ethos’ Fund VII, which will be an R8-billion to R10-billion fund once fully invested, was looking to invest in.
“We are looking for two sorts of companies,” says Anthonie de Beer, Ethos managing partner, large equity. “Those that will benefit from structural tailwinds and those that are sound, but over-stretched and require balance sheet support. There are many companies that have geared up over the last few years and whose shareholders don’t have the liquidity to bail them out.”
The recapitalisation plan goes further.
Ethos Private Equity will take over the investment management contract for Brait and will drive the investment strategy henceforth. The fee that Brait pays for this will be materially reduced, by about R100 million per year, though a new incentive structure will also be developed to align the interests of the Ethos Private Equity and Brait shareholders in terms of value creation.
Brait has also amended its strategy (or rather, reverted back to its original private equity strategy) to maximise value in the short to medium term – five years – and return capital to its shareholders.
“Brait’s strategy has changed from a long-term, open-ended focus to a five-year horizon which is a strategy that is very much aligned with the skills of a private equity firm,” says MacKenzie.
The combination of de-gearing, plus the new strategy, plus the [appointment of a] fit-for-purpose advisor is the catalyst to unwinding the discount, he says.
A new board will also be appointed after the recapitalisation, which is expected to be concluded once shareholders have voted their approval, most likely February 2020.
John Gnodde, CEO of Brait’s current corporate adviser, will step down, while four people from Brait’s investment team will join Ethos Fund VII. BM