Capital Appreciation Group – right place, right time

The JSE was a hot place to raise capital back in 2014 – 2016. Red hot.

At the height of this capital raising frenzy, the JSE allowed a new type of company to be listed: a Special Purpose Acquisition Company (SPAC).

Enter the SPAC

Normally, a company listing on the JSE must have a decent track record and meet stringent criteria. Newer or smaller companies may be eligible to list on the AltX, the alternative board of the JSE for companies that don’t meet Main Board criteria. Before you stick your nose up too high in the air, Capitec started out on the AltX, but that’s one of very few success stories.

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The ability to list a SPAC brought a new flavour to the market. Plucky entrepreneurs could come to market with little more than a good story. The basic requirement was that a company must have defined acquisition criteria and must execute its first acquisition within 24 months of listing. As long as a company raised R500m in the process, it would be allowed to list on the Main Board of the JSE as a SPAC.

If an acquisition isn’t concluded in the first 24 months, the entire thing is unwound and some very embarrassed executives cancel their lease in Bryanston.

On 16th October 2015, Capital Appreciation Group (CAPREC) became the first ever SPAC to successfully list on the JSE, raising R1bn in capital from the market.

Why am I writing about this company that you’ve never heard of? Well, just a few years after listing and at a time when established JSE companies are cutting dividends left and right, Capital Appreciation Group has increased its dividend by 17.6% this year.

That’s impressive and means this company is worth a more detailed look.

CAPREC: early days as a SPAC

16 months after listing, CAPREC announced the simultaneous acquisition of 100% stakes in three companies:

  • African Resonance
  • Dashpay
  • Synthesis Software Technologies

Additionally, CAPREC announced an intention to acquire 17.5% in Resonance Australia. This deal was concluded, but the Australian business was subsequently disposed of.

It’s worth touching briefly on the topic of % ownership and what this means for investors. Investors in listed companies want to have as much control over the underlying “portfolio companies” as possible. So, if the listed company holds at least 50.1% in most of its underlying investments, the investors feel good about their level of influence over what’s going on.

If the listed company holds “minority stakes” (i.e. anything below 50%) then investors have limited rights. That significantly reduces the value of the investment holding company, because it simply becomes a conduit of value rather than a living breathing organism that can drive strategy and become something meaningful one day.

The market would’ve welcomed CAPREC’s ability to put together a deal to buy 100% stakes in three different companies, plus a small stake in a related offshore entity.

In June 2017, just over 2 years after listing, CAPREC formally migrated its listing to the Software and Computer Sector on the JSE. It was no longer a SPAC, but rather a fully-fledged operating company. In this case, the SPAC regulations had worked exactly as intended.

Getting the basics right – swim downstream

To CAPREC’s credit, they recognised two things as being critical:

  • Invest in attractive verticals with market growth and appealing long-term prospects
  • Strong B-BBEE rating to assist portfolio companies in winning corporate and public sector business (as Black Ownership flows through to subsidiaries)

CAPREC attracted R250m from the Public Investment Corporation (PIC) at the time of listing. Patrice Motsepe’s investment vehicle African Rainbow Capital subsequently took a stake in CAPREC as well. Combined with other transactions, including with trusts supporting communities and entrepreneurs, the company is over 30% Black-Owned. That’s so valuable in this sector in South Africa.

By focusing on a growing market and targeting large corporates who are highly focused on procuring from suitably empowered companies, CAPREC’s management team gave themselves a chance to swim downstream in a country where most people are economically swimming upstream while being chased by sharks.

A tech business with profits. Real profits.

CAPREC’s portfolio has all the right buzz words: payments / mobile / big data / multichannel retailing / digital currency. It even says “fintech” which always sets tongues wagging.

However, unlike many other tech companies, CAPREC is highly profitable. Management don’t wax lyrical about user numbers that might one day make money. This is a tech company with proper cash flows.

The company operates two divisions:

  1. Payments (R506m revenue)
  2. Services (R195m revenue)

Total revenue of R700m is genuinely small by JSE standards, but the margins in this company are incredible.

EBITDA (Earnings Before Interest Taxes Depreciation and Amortisation) is a reasonable proxy for operating cash flow generation in many companies. With EBITDA of R205m, CAPREC runs at 29% EBITDA margin.

Believe me, you don’t see numbers like that every often.

The company generated Profit after Tax of R150m, a remarkable net profit margin of 20%. Most companies I’ve worked with previously would be thrilled with a net profit margin of 10%.

What do these divisions actually do?

If you’ve ever been involved in a business that accepts consumer payments, such as a small shop, you’ll know that accepting payments is one of the most important elements of the business. I’m no expert in that space at all, but I do know that card commissions can become costly and really eat into your margins. A saving of even 1% on commission is 1% of revenue that drops straight to the bottom line i.e. profit.

Next time you pay on your card at a merchant, have a look if the card machine is branded “Ingenico” or “Newland” – if so, it’s been supplied by CAPREC, which now operates 185,000 terminals like this in South Africa, up 32% from last year. That’s a powerful annuity income base for the business.

The Services division operates through a business called Synthesis, which is a specialized software development, consulting and integration company. Their clients include banks, financial services organisations and government. The division has made a song and dance about the launch of Amazon Web Services in South Africa, which certainly creates opportunities for partner businesses like Synthesis.

The general acceleration of cloud computing is a trend that does Synthesis many favours. From an investment perspective, it’s exciting when a company is fighting for market share in a growing market rather than a shrinking market.

Investment performance

Despite seemingly impressive fundamentals, the share price hasn’t had a great run since listing at R1 per share. After an initial dip, it returned to a R1 valuation and stayed there over the May to August 2018 period. As costs increased substantially to deliver on the revenue strategy, investors started to lose hope and the share price dropped to 73c after reporting March 2019 numbers.

The share price dropped as low as 56c in the COVID-19 trough, but has recovered to 95c per share, a tidy 170% return for the brave few who ventured into small caps during the worst of the crisis.

The share price hasn’t told a great story over the past few years, but could investors be missing something?

48% of revenue is recurring in nature. CAPREC has R500m cash on the balance sheet after generating R200m cash in the year ended March 2020. It has has largely shrugged off the impact of COVID-19. The margins are delicious, as already discussed.

Smaller companies are always riskier, but with a market capitalisation around R1.25bn, CAPREC trades on a Price / Earnings ratio around 8.3x (R1.25bn / R150m). That’s well below the multiples usually demanded by large JSE companies, which are often in excess of 20x.

A prospective investor in CAPREC must ask whether the growth trend in CAPREC can continue with these profit margins being maintained. If so, this has all the makings of another South African business success story. Those who can get their heads around the risk of investing in a small company may reap the rewards, but will likely have to be patient. Small companies take a long time to really be noticed by the investment community.

I’ll certainly be watching this company with keen interest.

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