ARC investors vote with their cash

I have been openly critical of the way the African Rainbow Capital Investments (ARC) story has played out. Without rehashing what I’ve previously written, I thought I should touch on the news that ARC’s capital raise has been less than ideal.

To be clear: they’ve raised the full R750m they wanted. The problem is that shareholders didn’t give them as much support as a management team might hope for.

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There is no greater example of a company where the share price and management egos are perfectly negatively correlated. In other words, as the ARC share price has marched downwards, management has continued to treat criticism as water off a duck’s back.

The financial press has been just as critical of this company as I have been. It’s a universally held view in the investment community that ARC isn’t a share you would recommend to your friends at the braai.

The optics suck

The problem is that the management fee is calculated as 1.75% of net asset value. When your market cap (i.e. company value) is trading at a colossal discount to your net asset value (in this case an over 70% discount), this becomes an unpalatable fee as a % of the much lower market cap. If the fee was calculated based on the lower of market cap or net asset value, management would take a bath along with shareholders and all parties would be aligned.

Instead, management is rewarded for deploying capital rather than creating shareholder value.

The company tried to patch up the management fee debacle by noting that the unpaid fee would be settled by “internal reserves” instead of the proceeds of the rights offer. This means the company would use existing cash to settle the management fee, rather than fresh cash raised from the market.

Frankly, it doesn’t make much of a difference.

Even if there is fancy structuring in the back-end, the optics are terrible. Whichever way you look at it, the management fee structure has ripped enormous value out of the hands of shareholders. Settled through internal reserves or otherwise, the company is still shelling out cash to a management team that has not delivered a good result for shareholders.

The trouble with optics is that they are extremely difficult to change. Institutional investors have a tremendous amount of information to work through on a weekly basis. Once a company gets put into the junk folder, few investors take the time to assess whether it should be moved to the inbox.

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Motsepe takes a larger stake as underwriter

ARC only managed to raise 83.2% of the R750m rights offer from existing shareholders following their rights. That’s a poor outcome considering how depressed the share price is. Investors holding nearly 17% of the company would rather see their shareholding diluted than continue to put money in.

Motsepe’s Ubuntu-Botho subsidiary acted as underwriter, which requires the company has to take up any rights not subscribed for by investors. This ensures that ARC raises the capital it wanted and gives Motsepe a larger stake in the company than he had before.

Whether or not this makes him smile at the dinner table, we can’t be sure. After all, ARC must be one of the most consistent destroyers of shareholder value on the JSE, registering a share price decline of nearly -30% per year for three years in a row:

Any silver linings?

It will take something quite special for the discount to net asset value to close and for the share price to turn the corner. We don’t know what ARC plans to do with the R750m, but unfortunately their track record isn’t much to write home about.

Good luck to the 83.2% of you who decided to give ARC another chance with your money.

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