Archive 1Q 2018 Letter

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Disclaimer: This letter is an archived letter to shareholders of the SaltLight Investment Holding company prior to the formation of the SaltLight SNN Worldwide Flexible Fund. The purpose of this archive to provide a historical narrative of our thinking and how it has evolved over time. We find that writing down our thoughts and allowing the passage of time to judge them are helpful in our learning and improving the art of investing. Results, past investments held and our thinking may have changed.

Dear Fellow Shareholders,

During the quarter, our Growth in NAV per share was [redcated] vs. the market return of
-5.97%.

If optimism could be bottled, the store shelves would have been ‘out of stock’ at the end of the quarter. Almost every company communication reflected a positive outlook and renewed hope that business confidence will return. I have a concern that optimism without near-term deliverables will have a short shelf-life. I remain cautiously optimistic that political micro-decisions will continue to improve in the right direction.

In our domestic context, there has been a multi-year damage to the South African economy after severe impairment of institutions, confidence and a worrying loss of skills. South Africa Domestic Inc. is still a deep-value investment.

Well-owned large capitalisation companies have disproportionately benefitted from the renewed optimism. The dominance of Naspers continues to distort market indices. Smaller/mid cap businesses that are not featured in passive indices or followed by the sell-side have yet to show signs of life.

In this letter, I talk about our exit of Mr Price and reflect on our Trellidor investment. It is certainly a ‘Tale of Two Cities’.

Mr Price – A Price for Everything

During the quarter we exited our shareholding in Mr Price. We initially deployed our first tranche of capital in November 2016 and exited fully during the quarter with a pre-tax IRR[1] of 88%. For more background on Mr Price, I wrote extensively about the opportunity in SaltLight’s June 2017 Investor Letter (link). 

SaltLight’s core philosophy is to be a long-term partner with our investees; owning them for the decades – if possible. I would characterise this ‘fling’ as an aberration due to market over-valuation. Back in 2016, I initially estimated that if market participants valued Mr Price at my intrinsic value in 2021, it would, with some conservative odds, offer a 15% annual compounded return on shareholder capital over those five years.

After the political events of December last year, yield-hungry foreign investors returned and started bidding up Mr Price aggressively to drive the price well in excess of my estimate of 2021 intrinsic value – and then some more.

How do I make decisions to exit an investment?

Whilst most participants seem to use a ‘price target’ methodology in determining intrinsic value. I have found that valuing a business as a forward yield on the market price is more instructive than a point-in-time price estimate[2]. My valuation indicated that if I continued to hold onto Mr Price, the most likely future return would be a return comparable to a risk-free bond[3]. For the rational investor, it makes no sense holding on to an asset to realise ‘risky’ 9% returns when one could own ‘risk-free’ 9% bonds. Of course, a caveat is due; my estimates could be too conservative.

It is always psychologically difficult to part with a superior business such as Mr Price. The heart-burn that one gets when selling a great business was somewhat alleviated when shortly after we exited, management and one of the founders also sold significant portions of their personal shareholdings. Should ‘Mr Market’ get manically depressed again, we would certainly look to reinvest back in to Mr Price.  

Trellidor – Two Years On

We deployed our first tranche of capital into Trellidor in February 2016. Trellidor had listed a few months earlier in October 2015 at R6.00 a share[4]. The principal reason for listing was to provide a liquidity event for their former private equity owners. Only R50m in primary capital was raised in the IPO at a healthy earning’s multiple.

Within two months after the IPO the, now infamous, political events of December 2015[5] caused the South African market to tumble and Trellidor’s share price with it, to R4.00 a share. It was here that we started buying Trellidor as there was a sufficient margin of safety for such a high-quality business – albeit an extremely unsexy one. I wrote extensively about the business in my 2016 Annual Letter (here).

Within a month of our first deployment, the company announced the acquisition of Taylor Blinds at a forward PE of 5.3x, financed partially by the R50m of equity raised, internal cash resources and an amortising 5-year loan.

Today, the market’s assessment of Trellidor has not reflected the strong operating metrics in the business and the share price is still below the IPO price at R5.50 per share. This, despite earnings power growing 45%. Our current return on capital, based on market prices, is a pre-tax IRR of c. 12% and, thus far, I could not be happier partnering with management on this investment.


Trellidor Historic Operating Metrics (FY15A – FY18E)

 FY15A (Pre-listing)FY18E[6]Change
RevenueR294mR550m+87%
Operating profitR66mR105m+59%
Operating margin22%19% 
Earnings per share42c61c+45%
Tangible ROIC62%27% 
Share priceR6.00R5.50-8.3%
Share count100m108m+8%
PE Multiple14.29x9.02x-37%


No Razzmatazz

Market participants love to come back from a management meeting and report back to their investors about the seductive investment story. The ‘razzmatazz’ of the CEO’s oratory skills, gourmet canapés and salacious growth prospects lures many investors to pay hefty multiples for ‘The Story’. Everything about the event is choreographed to convince the investor to leave the room and think, ‘Yes! I made the right investment decision’.

Conversely, our Trellidor management meetings are utterly uneventful. The CEO, Terry Dennison, usually arrives at our meetings by himself, accompanied by his sturdy backpack and a pile of self-printed roadshow slide decks under his arm. Two weeks ago, he recounted to me that in the previous day, the company had held its first investor conference call. The company was ecstatic to have 30 participants. Hiring out a venue to make a presentation still seems like a long way away. Yet, I always leave the room thinking “Yes! I made the right investment decision”.

Trellidor is the ultimate boring business. Conservative management, no tech, no social media graph. Just home fixtures, margins and free-cash flow.

The ‘toughest’ year… really?

Trellidor’s recent December first-half results reflected the toughest domestic economy since the late 1980s. The butcher’s bill for Trellidor was somewhat better than I was expecting. Rising material costs knocked the gross margin from 47% to 46%. 1H18 Group Revenue was up 5% YoY and operating profit was up the same. Domestic steel import tariffs and the lag effect of the weaker ZAR pushed up steel and aluminium prices to point that could not be recouped within the short timeframe – gross margins have expectedly suffered. Trellidor historically has been able to pass on prices to end-customers effectively and will likely recoup margins in February and September price increases. Irrespective, the spot price inputs are considerably better than last year.   

Ex-growth?

When I talk to smart capital allocators about Trellidor, their initial belief is that Trellidor is ex-growth – hence the poor investment rating.

To some extent, this is true as the traditional security barrier is now a mature product. However, the company is no slouch when it comes to introducing new products. Products introduced from 2011 are now 34% of Trellidor revenue. I encourage readers to watch this Shutter Guard video (link) demonstrating how tough it is for intruders to break in to a Trellidor-fitted home[7]. Trellidor makes 50% gross margins on this new product and costs are incremental.

It is often not appreciated that Trellidor now earns 17% of revenue from Rest of Africa and 1% from other international operations. In December it won contracts to supply the London Underground.

New products provide juicy returns on incremental capital as the only additional capital is R&D. Trellidor’s franchisee base requires no additional capital to deploy a new product.

Capital Allocation

The current operating business requires minimal incremental capital:

  • Taylor Blinds has organic growth opportunities that will require marginal demands on capital to open branches in other regional areas outside of its strong base of the Western Cape[8].
  • The existing Trellidor business is likely to grow with real homebuilding industry growth rates (c1-2%). This means top-line growth is likely to be 7-8% a year on current invested capital[9].

The group throws off significant free cash flow and the future investment thesis will be determined by management’s capital-allocation ability. It is here that the future becomes murky.

We presently only have a sample of one to determine management’s ability to successfully deploy shareholder capital through M&A. At a 5.3x forward PE multiple for a 20% operating margin business, the acquisition of Taylor was, ostensibly, a disciplined transaction.

Roll-Up Reticence

I am generally reticent when it comes to the prospects of ‘roll-ups’. Rich premiums, debt and deal-making fixes leave sellers, investment bankers and debt-funders with all the economic value and shareholders digging in their pockets. I am mindful that the ‘base rates’ on the odds of success for M&A deals are not encouraging.

Michael Mauboussin, in his seminal note titled Capital Allocation[10], adroitly doused the hopes and dreams of shareholders who cheer on management’s M&A prowess. The rationale for the deal becomes an important factor that determines value creation for shareholders.

Deals advertised as ‘transformational’ have less than a 25% probability of success whereas deals that are operational bolt-ons or opportunistic ‘bottom trawling’ appear to have much better 80%+ odds of success.

Reallocating excess capital generated from a business with a successful legacy moat to a poorly-chosen acquisition often allows opportunistic competitive invaders to sneak in through the gate – undetected. 1) capital is drained away that should have been shoring up existing economic moats and 2) management’s attention is diverted. SaltLight treads here with caution.

The future risks are mostly internal as Terry transforms from an ‘operator’ to a ‘capital allocator’. However, having interacted with Trellidor management over the last two years, I am comforted by their conservatism, their stated acquisition criteria and the fact that they own c. 10% of the business.

Trellidor sits in a small-cap no-man’s land as its market cap is well below the R2bn necessary to feature on mutual fund radars. Until then, I believe the inherent business qualities will remain hidden.

We remain patient capital partners albeit ‘alert’ to a poorly-chosen acquisition.


[1] Internal rate of return or 102% absolute return. High IRR’s are often deceptive for short-term holding periods and should be taken with a pinch of salt.

[2] Rather than a simple yield on market price, SaltLight includes an adjustment for the company’s ability to compound retained earnings in excess of cost of capital.

[3] With some bullish estimates and forecasted returns on capital, the forward yield was likely to be 7%-8% over time.

[4] This equated to a trailing multiple of ~14x diluted earnings

[5] Herein I refer to ‘Nenegate’ where the Minister of Finance was inexplicably fired by the former President.

[6] FY18E for year-ended 30 June 2018

[7] https://www.youtube.com/watch?v=UpiYk2fRfeE

[8] Taylor Blinds needs 20c of working capital for each R1 of additional revenue. Source: company

[9] Trellidor’s existing business requires 13c of working capital for each R1 of additional revenue. Source: company

[10] Source: Capital Allocation: Evidence, Analytical Methods and Assessment Guidance by Michael Mauboussin