With ESG coming of age, it is tempting to think shareholder value maximisation theory — the idea that the number one priority for boards and executive committee members is to maximise the share price — has taken a back seat. It has not. That’s not necessarily a bad thing.
For one thing, the growing popularity of ESG as one of the major policy issues for the investment community has rightly forced boards to take into account the interests of staff, customers, suppliers and the environment when pursuing their primary shareholder value-creation goal that traces its roots to the thinking of late free market economist Milton Friedman.
Earlier this week, African Rainbow Capital Investments (ARC Investments), an investment house backed by Patrice Motsepe, became the latest example of a company that is working on behalf of shareholders even as it takes into account competing interests and objectives.
It unveiled plans to slash by more than half the fees it pays a team that runs a fund housing its underlying assets. Some of the proposals on the table include moving the fee General Partner charges ARC Investments — a passive investor in the fund — for growing and running the fund closer to the actual cost incurred in doing so plus a 5% profit margin.
The proposal, which is subject to shareholder approval, will deliver an immediate value uplift. The fee, calculated at 1.5% of the average opening and closing invested net asset value per quarter, is typically R200m a year. But under the new proposal it will be between R70m-R80m.
It comes two years after the company angered investors for floating the idea that it would use a portion of the R750m proceeds from a rights offer to pay outstanding fees to UBI General Partner for its day-to-day management of ARC Fund, ARC Investments’ only asset.
The review of the fees is an explicit acknowledgment of a long-standing investor complaint that shareholder and management interests are not aligned, because UBI General Partner is paid a fee for growing the value of underlying assets, while shareholders are not seeing the same value reflected in the share price.
ARC has grown rapidly since its listing in 2017, counting stakes in fast-growing start-ups such as data-focused mobile network operator Rain and TymeBank and boosting the value of its underlying assets from just over R5bn to nearly R14bn.
But that valuation has not been matched by the share price, which has fallen by nearly one-third since the company went public, leaving it with a market capitalisation of R8bn, 42% less than the sum of its parts even for a holding company.
It is not uncommon for investment holding companies to trade at a discount to asset value, but the acceptable shortfall is usually 15%-20%. Nor is ARC the only company grappling with this financial inefficiency.
Under such circumstances, it is easy to sympathise with the cynical sentiment of some shareholders that UBI’s valuation of the assets is motivated purely by the prospect of lining its investment committee pockets with fat management fees — something ARC senior rank routinely denies, saying auditors sign off the valuations.
Sure, the fee structure is not the only factor behind the shortfall. Investors are reluctant to pump their money into the stock to close the gap because they’re not able to work out for themselves the value of the underlying assets because most of them are not publicly listed and ARC Investments is not often the controlling shareholder.
Take Rain for example. ARC owns just over a fifth of the company, putting it in a weak position to push for the disclosure of company books for investors to make their assessment about whether its R18bn valuation is justified. That valuation means Rain is worth three quarters of Telkom, a sprawling telecoms conglomerate with assets spanning internet fibre and masts and towers to an IT business and a property portfolio the size of Luxembourg.
Still, the management fee structure was a big part of the problem, if the share price reaction is anything to go by. The share price of ARC Investments surged more than 90% since March 2021, when it acknowledged that the fee structure may be partially responsible for the valuation gap.
The result: the discount has narrowed from as wide as 70% at times to about 40% today, a sign that when management rewards are aligned with the interest of shareholders, everybody is a winner.
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