Two years have passed since raising APEO’s initial capital. The portfolio’s returns to date are a reflection of the severe recession that sub-Saharan Africa has experienced since early 2016, resulting in steep local currency devaluations in most African economies against the US Dollar, negatively affecting consumer spending patterns and foreign investor confidence. We expect this situation to normalize in the next year, with the International Monetary Funds’ most recent economic growth forecast for sub-Sahara Africa projected at 3.4% in 2018, rising to 3.8% in 2019.
We are of the view that this recession will not have any significant effect on the medium to long term returns of the portfolio. The portfolio is starting to take shape with a healthy geographical and industry split to diversify risk. Notwithstanding the fact that Africa has had economic headwinds for the past two years (which may be prolonged if the major world economies end up in a trade war), the portfolio is generally positioned for good returns as alluded to in the individual company commentary below.
In the table 5 above, we have provided a split of the portfolio between investments that will rely very heavily on growth for performance (36%), versus investments that were made at relatively cheap prices and will thus generate value even at lower growth rates (64%). We intend keep weighting our portfolio structure towards value investing that leaves head room for an unexpected turn of events.
The net effect of valuation adjustments made during the quarter under review is a negative return of 1.2% after costs. We received fresh capital subscriptions for USD 0.1 million during the quarter and invested a total of USD 2.1 million into betPawa (USD 1.5 million), African Alpha (USD 0.5 million) and USD 0.1 million into Novare II as a result of drawn down capital against our commitment.
A summary of developments in each investment is set out below:
6. NOVARE AFRICA PROPERTY FUND II (“Novare II”)
Novare II develops retail and commercial developments in major African cities, comprising of projects in Abuja, Lagos, Lusaka and Maputo. Around seventy percent of the investment commitment towards the fund had been drawn down by 30 June 2018. We expect that the remainder of the undrawn commitments of USD 700k will be called for within the next year to complete building projects. Novare is currently reflecting an annualised IRR of 9.8% in the APEO portfolio
The Nigerian Naira devalued from NGR 180/USD to NGR 350/USD shortly after we committed to invest in Novare in 2016. The unofficial NGR exchange rate, which retailers had to use at times to import stock went as high as NG R550/USD. Retailers (other than food anchors) could not get foreign currency to import shop fittings or stock at times, resulting in delays in opening line shops and a lack of stock. Secondly, as a result of the currency devaluation, Nigerian consumers’ USD based disposable income halved, resulting in much lower spending in malls than anticipated over the past two years.
Novare Fund II’s first mall, Lekki in Lagos, opened in August 2016. The Novare leasing team responded to the new economic reality by assisting USD based lessees on a case by case basis with “currency concessions” – that is agreeing to lower rentals for set periods in time to assist retailers to continue trading in order to ensure that the mall remained viable until trading conditions normalize. A similar strategy is being followed with Novare Gateway in Abuja which opened in December 2017, and Novare Matola in Maputo which opened in March 2018. Novare also reduced gearing levels on some projects to bring debt levels in line with cash flow.
As a consequence, valuations of Novare’s trading malls have been based on the lower rentals (than originally budgeted) and on more conservative exit yields to reflect current muted investor demand. Given higher oil prices, the Nigerian economy is currently growing at around 2.5% pa, and the currency position has improved significantly in recent months, with the unofficial exchange rate moving to virtually match the official exchange rate, and USD being freely available for imports. This is starting to show up in improved rental collections on a quarter by quarter basis. We are expecting a gradual improvement in sentiment in Nigeria, pending outcome of the Nigerian elections next year. As regards Mozambique, the long awaited foreign direct investment into gas fields is likely to start strengthening the Metical in the next year, whilst in Zambia the Kwacha is expected to remain at present levels for the next year, with copper prices again under pressure after the recent recovery.
Novare II acquired land and built (or is building) quality properties at relatively low cost given quality of project management that has been applied. The leasing management and mall marketing activities are being tightly controlled by the Novare in-country teams – this is a major asset and a big differentiator compared to other property developers in these countries. Very little new rental property stock has been developed by other developers in the target countries since 2015, putting Novare in a great position to realize good value for its properties once positive market sentiment returns.
The original average projected annualised IRR of more than 20% per project is however unlikely to be achieved given the slump in economic conditions, and the likely longer time period to exit. The final achieved IRR on Novare Fund II is largely reliant on (a) Nigeria, Zambia and Mozambique fully recovering from the commodity slump over the next two to three years, and (b) leasing terms normalizing from a currency concession point of view, which is then likely to bring renewed international interest in African property and improved exit valuation yields. Assuming a continued recovery, we believe an IRR in the 12% to 18% range to be achieved.
7. ALPHAMIN RESOURCES CORP. (“Alphamin”)
Alphamin owns the richest known orebody of tin in the world, situated in North Kivu Province, DRC. The company drilled out and proved only a small portion of its prospecting licensed area, large enough to start a small mine and prove the concept. The greater licensed area was occupied by 13,000 artisanal miners up to 2013/4 (supplying an estimated 4% of global tin demand), after which the Dodd- Frank Act in the USA cut off the route to market for illegally mined tin. APEO elected to take up a shareholding in Alphamin after a decision to mine was taken in September 2016 and the mine build peak funding capital raising was underway on the back of our close relationship with Denham Capital/ Pangea, the main funder and driving force behind the project. A major driver for the decision to invest was that Alphamin would be one of the lowest cost tin producers in the world, and with tin selling prices being double Alphamin’s cash production cost. Alphamin is listed on the Toronto Stock Exchange and where it is trading in low volumes at approximately APEO’s investment cost of CAD 0.30 per share.
Alphamin raised USD 80 million in debt plus the balance of required equity capital, and the mine’s construction is progressing more or less in line with original plan, which is to be commissioned in May 2019. The DRC Government has made a number of changes to the tax treatment of mining companies earlier in 2018. The full likely impact is not yet clear as a number of matters are subject to ongoing discussions/negotiations with government, but Alphamin management do not believe that the overall economics of the project will change substantially as a result of the tax changes.
The mine will come into full production in the second half of 2019 and is forecast to produce EBITDA of USD 110m per annum, or USD 0.12 per Alphamin share. Given the quality (and likely size once drilled out) of the orebody, and notwithstanding the current negativity around the risk of doing business in the DRC, we believe Alphamin will be acquired by one of the major global mining companies in due course at a significant multiple to the cost of our investment.
8. ADDIS PHARMACEUTICAL FACTORY SHARE COMPANY (“Addis Pharma”)
Addis Pharma manufactures a broad range of pharmaceuticals at good EBITDA margins for the Ethiopian public and private sector, in a country with over 100 million people. A small investment was made on the back of the strong contingent of existing African private equity players that had invested in 2015. Only 20% of Ethiopia’s pharmaceuticals are manufactured in Ethiopia, with the balance being imported. The Ethiopian government has a stated policy of preferring local manufacturers over importers, creating an opportunity to grow sales in the Ethiopian public sector. In addition, the company has plans to grow its sales to the private sector beyond 30% of its total turnover to lower its dependency on the public sector. Addis Pharma supplies approximately 10% of the local Ethiopian market and has plans for a major factory expansion that will allow it to supply up to 30% of the local market. Addis Pharma is currently reflecting an annualised IRR of 17.6% in the APEO portfolio.
The past quarterly sales figure was disappointing as the company battled with governmental red tape to obtain foreign currency to import raw material, an issue all Ethiopian manufacturers are currently having to deal with. In addition, the devaluation of the Birr against the USD has not been fully compensated for by increased local price increases as negotiations with the public sector to this effect are being drawn out. As a result, certain sales to the public sector have recently purposefully been held back by the company. Sales to the private sector comprised 70% of total sales in the quarter ending March 2018, up from 43% in the prior quarter, and 30% in 2016 when we bought in. The operating margin remains in an acceptable band of 25% to 28%.
The new factory expansion in Adigrat is expected to be completed early in 2019, creating significant additional manufacturing capacity. The focus of the management is firmly on making sure it has foreign currency to import essential raw materials, and growing its private market sales, including cross border expansion to neighbouring countries. The recent positive political changes in Ethiopia, and signals that the new Prime Minister is following a more open approach to managing the economy, bodes well for alleviating foreign currency shortages - improving investor confidence should boost business confidence and foreign direct investment.
On the assumption that the company gets onto a strong growth path, a trade sale at an attractive price to a foreign pharmaceutical manufacturer is the most likely exit in three to four years once the new manufacturing capacity in Adigrat has been commissioned and its capacity utilised.
9. AFRICAN ALPHA FCMG GROUP (“African Alpha”)
The company offers Fast Moving Consumable Good (“FMCG”) exposure to the high growth Ethiopian economy (8% plus economic growth p.a.) with over 100 million people, which is still at an early stage of urbanisation. We backed a strong private equity team on the ground against FMCG competition which is generally undercapitalised and fragmented, in addition to a lack of committed international FMCG competitors. The plan is to aggressively grow revenue and profits by extracting economies of scale through combining management resources in procurement, marketing, administration and sales across the various businesses, collectively referred to as Bluebird Holdings (www.bluebirdholding.com/) for four to five years before selling the business as a unit to an international FMCG business wishing to enter Ethiopia. African Alpha is currently reflecting an annualised IRR of 12.9% in the APEO portfolio.
The Edible Oil division is currently growing exceptionally fast after a major production capacity upgrade completed in 2017. The Soap business is also growing rapidly with plans afoot to expand production capacity. The combined sales of Oil and Soap for Q3 2018 exceeded sales for H1 of 2018, with combined EBITDA for these businesses in Q3 2018 being 80% higher than for the preceding six months. We decided to increase our exposure to Bluebird in May 2018 as a direct result of seeing the growth in sales and profits coming through. The Pasta and Flour businesses are still subject to negotiations with minority shareholders before their brands are relaunched and the businesses fully integrated into the management structure. The bottled mineral water business has had major production problems in its bottling plant and also suffered from increased competition in the past year. The production problems have been resolved through the installation of a new bottling plant completed in July 2018, followed by a strong new marketing campaign, which has also seen the Ethiopian Airline business secured. The Diary business has completed a major management, capex and rebranding restructuring completed in June 2018, and we expect the full benefits to come through in the second half of 2018 and 2019.
Brendon Jones and Rudolf Pretorius will be visiting Ethiopia in July 2018 to meet with the 54 Capital management team and visit the various factories.
10. NEW LOOK RETAIL GROUP LIMITED (“New Look”)
New Look is a leading fast-fashion brand, with 593 retail stores in the UK and over 297 across Europe, China and Asia. It dominates the fashion trade in the female 18 to 35 age group in the UK. New Look is owned 100% by Brait, who took New Look private in 2015 at which time it raised and listed three tranches of Loan Notes totalling GBP 1.3bn on the Frankfurt Stock Exchange. The Loan Note tranches have bullet capital payments in 2022, and 2023 respectively. New Look reported weak results in mid - 2017, which was in line with European retail industry trends. As a result, its Loan Note prices declined significantly, and offered attractive yields if held to maturity.
An analysis of the Loan Note trust deeds shows that it would be extremely difficult for New Look or Brait to restructure the terms of the Loan Notes without putting New Look into liquidation, as it needs 90% of the Note holders of each tranche to agree to a change in the term of the Loan Notes. Given that New Look is a very important asset in the Brait portfolio, we felt that they will (in order to protect their equity value), provide the necessary support for New Look to service its debt obligations and trade through this difficult period. We initially acquired USD 500k of New Look EUR 2023 Unsecured Notes bonds in September 2017 at a 45% discount to face value, giving a yield of 26% if held to maturity.
Shortly after acquiring the Loan Notes, New Look’s trading results worsened resulting in the replacement of the New Look management team with the previously successful management team that built up New Look in the first place. In addition, Brait’s anchor shareholder, Christo Wiese became embroiled in the Steinhoff saga in December 2017 losing a significant percentage of his wealth. This created doubts in the market about Brait’s (and Wiese) ability to support New Look with additional capital if needed. As a result, the 8% Unsecured Notes traded down to as low as 12 cents in the EUR, but following the latest more positive outlook for New Look, they have recovered to 26 cents in the EUR. We have already banked 16 cents in the EUR in interest since buying these Notes.
The freshly appointed New Look management team have taken tough measures to halt new Look’s poor trading situation, and to restore it to health. We believe the first evidence of green shoots will be available by August or September 2018. After a detailed analysis of New Look’s 2018 annual report, as well as extensive market enquiries, we are of the view that notwithstanding the unexpected deepening of New Look’s financial crises, our initial stance that Brait will have the skill and resources to see New Look through this difficult trading period, will be borne out.
None the less, New Look’s absolute debt levels remain very high, and there is some risk that Brait could attempt to convince the holders of 2023 tranche of Unsecured Notes to convert their holdings into New Look equity – note that the mechanism or ability to do so without facing liquidation remains very murky. Although the projected annualised IRR on further purchases of the EUR 2023 Loan Note tranche is currently 56%, we decided to instead buy an additional USD 500k of New Look 2022 Secured Notes in July 2018 (i.e. post the reporting date of this report) yielding an IRR of 29% to maturity, and a running interest yield of 12,5%.
11. BETPAWA GROUP HOLDINGS LIMITED (“betPawa”)
Established in late 2013, betPawa is a UK registered holding company with licensed African online (smart phone) sports betting subsidiaries. betPawa was established by a Danish entrepreneur by applying or acquiring betting licenses in - country over the past five years, and the software was acquired via an acquisition it made in Estonia. Currently it is operational in Kenya, Uganda and Zambia with leading market positions. It is about to launch in Nigeria and has just obtained a license for Ghana. It has plans to expand to Tanzania, Zimbabwe and Cameroon in 2018/9. We invested in order to get exposure to a fast-growing consumer business in Africa with a strong technology platform and limited physical footprint, managed by a dynamic management team.
The business showed growth of over 100% in Kenya and Uganda at the Amounts Wagered line for the first five months of 2018, but the Net Gaming Revenue margin was 20% below expectation, and expenditure on Marketing and Gaming Taxes was above expectation. The Kenyan gaming tax rate which was increased in January 2018, will be lowered again in July 2018 after industry objections. We are awaiting the first results from the relaunch of Nigeria, and Ghana during the coming year before commenting, having only recently invested.