The JSE of today reminds me of a hotel under lockdown rules. The infrastructure is there, but the utilisation is low and very few people are making new bookings. The long-standing guests are getting tired of empty swimming pools and boring games nights and are checking out in search of greener pastures.

New listings on the JSE are becoming more unusual than a pothole-free road in Joburg. This excludes unbundled companies like Thungela, which is just a reshuffling of cards by corporates. To make it worse, there has been a steady stream of delistings.

It wasn’t always like this, mind you.

When the hotel pool was full and the cocktails were flowing

The 2014 – 2016 period in the market was characterised by energetic teams of M&A experts trying to build large, listed groups through mopping up private companies at a 7x Price/Earnings (P/E) multiple and hoping the listed company would trade at 14x P/E.

Many of these deals were concluded on a share-for-share basis. In other words, the entrepreneur sold to the listed company and received listed shares in return. Entrepreneurs were promised that they would get far higher values for their companies in this way, with an ability to sell the shares after an initial lock-in period.

For a while, it worked. Inexplicably, the market happily valued a basket of 7x P/E companies at a multiple of 14x P/E. “The benefits of diversification!” the advisors shouted.

Because, you know, two dicey businesses combined can only be wonderful. Everyone loves a premium-priced fruit basket of rotten apples and soft bananas.

It was a honeymoon that didn’t last.

Shark! There’s a shark in the water!

The share-for-share appeal died when the Steinhoff scandal broke. As the Tekkie Town founders will certainly tell you, it can be catastrophic to swap shares in your own, clean business for shares in a great unknown. Instead of a value unlock, you watch your life’s work go to zero.

It’s no wonder that they are so angry and are fighting Steinhoff in court. I would be doing the same.

Entrepreneurs watched the Steinhoff destruction in absolute horror. If that wasn’t enough, EOH followed suit. Clearly, selling to a listed company in exchange for shares was far riskier than anyone had thought.

To make it even worse, the South African economy looked unhealthier by the year. People who had spent 20 years building their businesses were not about to bet their money on a future in South Africa. They wanted to get the money out of the country and that’s not possible when you are selling to a listed company in exchange for shares with a lock-in.

Suddenly, that private equity cash offer at 5x P/E looked far more appealing.

Maybe a basket of 7x is worth 7x. Or even 5x.

Do you know why private equity was only willing to pay 5x P/E for the business? Because it was only worth 5x.

The listed companies had relied on a dream of “multiple arbitrage” where the share price would make up for any expensive mistakes in acquisitions. When you believe the listed group will trade at 14x, you don’t mind paying 7x for a portfolio company that was only worth 5x. It’s the “greater fool” approach in all its glory.

Of course, the banks were only too happy to lend money into these structures, accompanied by lengthy debt agreements that would hand the front door keys to the bank if things went wrong.

And boy, did things go wrong.

As dealflow dried up, investors realised that their fruit basket was actually a pack of lemons. Share prices collapsed as acquisition machines re-rated from 14x to 5x. The company’s net asset value (NAV) was built based on raising money and making acquisitions at 7x.

Discount to NAV, anyone?

Where are these companies now?

There are two types of these companies left on the market.

The first type is the Bear Grylls Survivalist, with top executives appointed to navigate through the wilderness. Fending off banks, regulators and the court of public opinion, it’s literally a battle in the toughest of business conditions. Companies like Ascendis (which I call Descendis after the name stuck with me from an ex-colleague), EOH and Tongaat perfectly fit this bill. Steinhoff is the Antarctic special, with the survivalist dropped in the snow with only a jersey and a box of matches for assistance.

Companies ended up in this bucket because of unsustainable debt, fraud or a combination of the two.

The second type is the Share Buyback Enthusiast, generating cash thanks to a reasonable balance sheet and quality underlying companies. Despite these fundamentals, the market now hates all investment holding companies and always prices them at a discount.

Except, inexplicably, logistics property funds. The market is quite happy to pay a premium to NAV for those.

As the name suggests, the second type focuses on share buybacks to try and close the value gap. Inevitably, this results in an illiquid share and low volume traded because the float (public shareholders) has been mopped up. The multiple never unlocks as a result.

Are there any exceptions?

Unsurprisingly, most private company founders have absolutely no interest in getting involved in this mess. They don’t want to swap their shares in a company they know and understand for shares in a complicated group that could have some wild skeletons in the closet.

Of course, they are quite happy to sell for cash. This is where listed companies should be able to compete against private equity buyers. Listed companies don’t have set holding periods (private equity typically needs to sell after 7 years) and are more likely to buy founders out completely, where private equity investors want to hold smaller stakes and go for the ride with the founders.

Just last week, Transaction Capital raised nearly R1.2bn on the market for acquisitions. The most important of these is the WeBuyCars deal, in which Transaction Capital is increasing its stake considerably and taking control of the business.

The market is willing to support this because of the quality of the underlying business and the significant respect for the Transaction Capital management team.

Founders of genuinely high-quality businesses can still sell to listed companies and get paid in cash. The days of selling marginal companies to listed groups are largely over. That’s probably not a bad thing.

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