Archive 4Q 2019 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.

Build Something That’s Enduring

In December 2015, I took a giant leap and apprehensively redirected the vast majority of my liquid capital to seed the second business that I had started over my lifetime – fusing the lessons learned whilst working in traditional investment banking and the hustle earned whilst founding a business. Once you leave a large corporate environment and join the world of entrepreneurs, there is a wealth of worldly knowledge to be gained (I recommend all investors should do it once). If there is one observation that stuck with me, it is: 1) it takes time to build something of worth and 2) it’s really hard to do.

So, after my business was sold, I had the desire to merge the two worlds that I had been exposed to over my career. The vision for SaltLight was to create a different kind of investment firm that ‘builds’ rather than ‘rents’, it ‘partners’ rather than ‘extracts’ and, importantly, would facilitate a direct connection between capital provider and the businesses that they invest in.

The notion of building is something that I wanted to introduce at the heart of SaltLight’s investment process. Some define ’building’ as a temporary product that fits in with the fad of the day (thereby making a quick buck and then moving on to the next thing). The inspirational entrepreneurs and managers seem to see it differently. They see ‘building’ as the establishment of an enduring creation, a cathedral of sorts, or a way of doing something that changes society forever. These builders are wired to understand that the ingredients of longevity and impact involve time, scepticism, failure, patience and importantly perseverance.

A foundational idea was that SaltLight should operate in a way that partners with these ‘builders’ to solve their customer’s needs and create value for society. This is rather different to how most capital is managed today where investment managers ‘rent’ a business for a short period of time until they get what they want, and then move on to another opportunity.

The where to participate was an easy decision: I wanted to focus on the country and continent that I grew up in – South Africa. An opportunity set where I believe it is possible for investors to still have an ‘edge’ by getting out of the building and moving away from ‘spreadsheet’ research. Scuttlebutt work still matters and can create substantial value. A CEO reflecting on business in South Africa once said to me, it is easier to make R20 than a £1[1].  

The data shows that, over my lifetime, the African continent will be a land of immense opportunity (history shows that there will be a few fits and starts to be sure). South Africa is a great place to start; its advanced infrastructure, financial market depth and managerial talent is leaps and bounds ahead of other African countries.

He’s Fired

In the first week of that December, I deployed a portion of the seed capital into a few public companies that I had come to know over time. And within three weeks, South Africa was hit with a crushing left-tail event that launched an environment last experienced in the 1980’s. The sudden news of the firing of the Finance Minister by former President, Jacob Zuma, was the same shock as a CFO suddenly resigning for personal reasons. This was an unusual occurrence from South Africa’s past macro-economic practice. The reason for the dismissal resulted in the scales falling from the public’s eyes of what had been going on. The equity markets unsurprisingly sold off; bond yields widened, and the prevailing narrative changed to “oh dear, another African country has lost its way”

What poor timing to start a South African-focused investment fund! 

Four Years On…Same Price, More Value

If one simply observes market indicators[2], on the fourth anniversary of SaltLight’s operations, it appears that the investment environment has remained in stasis:

JSE All-Share (ZAR)25% (total return)
Bond yields30 bps better to 9.015%
MSCI South Africa (USD):+15% (total return)

Beneath the surface, the price-to-value gap has widened meaningfully over this long winter and remains at extreme levels.

I am a realist. The South Africa’s business mood is sombre and business confidence is at a multi-decade low (same levels as seen during the Asian financial crisis in ‘98 and the sunset of nationalist government in the 1980s). One can attempt to offer consoling words that after each of the previous gloomy periods there were bountiful returns to be had. A contrarian would characterise the situation as a 1 in 20-year opportunity, but for most participants, it fails to lift financial melancholy. When there is ‘blood on the streets’ it seems like there will never be an end to the predicament. 

Bayesian Inflections

As market participants, we earn our bread and butter from expectations of the future. We always need to be mindful of the zeitgeist, but we should also avoid over-shooting a prevailing narrative, attached with absolute conviction, of what the future will look like. In developed markets, the prevailing narrative observed through market valuations is that a rosy future will continue without abatement. South Africa’s prevailing narrative is that a national decline will continue… indefinitely and with certainty.

However, what if the prevailing assumptions have changed or there is at least a tiny alteration in the probabilities of outcomes – even – if considered negligible? In the 1700’s, the Presbyterian minister and hobbyist statistician, Thomas Bayes, developed a helpful analytical method called Bayesian updating that principally addresses this question. Old information (incorporating probabilities of certain outcomes) should be continuously updated with new information thereby adjusting the odds of the future outcomes. 

This process of refining odds is where market participants often miss meaningful inflection points. These prevailing narratives (be it fear or greed) can often behave like a pendulum that overshoots the true reality. As the pendulum swings to extreme levels, the slowing momentum is subtle until the recoiling direction is set. Market participants fail to recognise that new trend has begun until it is midway through the next swing. By then, much of the upside is already priced in.

Readers might be expecting a big market call. This is a fool’s game and I demur from making any such calls that particular outcome will occur with certainty. However, I would go as far as pointing out that over the last year, the odds have, indeed, begun to shift in a more favourable direction. Some pessimists might object that the change is not enough and cling to the narrative that we’re still headed towards a doomsday scenario. I would argue that one must look at data.

Small Steps but Bolder Decisions

Let’s step back a bit. In August 2018, the Ramaphosa Administration attempted to communicate several structural reform goals in a speech entitled the “Economic Stimulus and Recovery Plan”[3]. The aim was to create a much-needed shift in investor confidence – unfortunately the contents of the announcement could hardly be characterised as a Deng Xiaoping moment[4] and the result was the very opposite outcome. There are two fundamental challenges that Ramaphosa has:

  • The fiscal cupboard is bare: As Ramaphosa admitted in another speech, the economic stimulus would be one with “South African characteristics” and would not look like a bet-the-fiscus kind that developed markets have used in the past. Nevertheless, reforms with “South African characteristics” would be structural in nature to roll-back some of the more absurd policy decisions from the previous administration.
  • SA is a democracy: Contrasting to Deng Xiaoping, Ramaphosa operates in a democracy with a fragile position in his own party. Careful steps would need to be taken otherwise he would be voted out like another hopeful reformer, President Mauricio Macri of Argentina[5].

Fast forward a year and I would argue that policy decisions are evolving to be more meaningful – particularly when it comes to tough choices that directly affect the ANC. JP Landman, a political analyst, has been keeping track of the structural reforms announced by Ramaphosa since August 2018. I have condensed his writing into a table at the back of the letter (see appendix).

South African readers may be pleasantly surprised how many it-will-never-happens have been realised. Foreign readers might be underwhelmed, but as one who has grown up here, these are some tectonic shifts in the prevailing ANC mindset. Of course, there are considerable reforms still needed. Near-term fiscal sustainability risks remain brutally high. It is likely that the sovereign credit rating will be downgraded to below investment grade this year (I suspect much of this has already been priced in). 

Continue to Build SaltLight’s Analytical Flywheel

Back to SaltLight. I continue to build on SaltLight’s Investment Flywheel by deploying capital into businesses that are:

  • Run by able and trustworthy management (our portfolio is skewed to businesses run by founders);
  • Have the potential for high returns on capital with a widening moat;
  • Favourable opportunities to reinvest capital and;
  • At favourable prices

I believe that these businesses will generate significant shareholder returns over the coming years because they are solving fundamental needs that are struggling to be solved. In managing our portfolio, the question has become, not whether there is value and sufficient upside, but rather, is the portfolio positioned to maximise when markets do turn?

Of course, anaemic GDP growth is a drag on potential performance of our investees where they could be growing at 25%, they’re now growing at 10-15%. Yet, I estimate that over the next three years[6]:

  • Curro will add 16,000 students
  • Calgro will add 10,000–15,000 housing units
  • SA Taxi will extend R5bn of new loans to taxi operators
  • Discovery will add 300–500k new banking customers

Despite the environment, SaltLight has been blessed each year as our assets under management have grown considerably (albeit from a small base) and, so far, we have only had one redemption. I am truly grateful to our partners who are the true long-term thinkers. 

Accountability and Making Positive Choices

My conversation with a new investor starts like this: we are accountable not just to our clients but God. Our mission is to be a faithful steward of the capital that is entrusted to us and to have a positive impact in all of our activities.

One fundamental measure of SaltLight’s economic success will be the long-term shareholder value created (if given the opportunity – over many decades). We are not in the game of trading to make 15% or 20% here or there, anticipating how the market will react on an earnings release or the outcome of a federal reserve meeting. Our ‘game’ is making fundamental, research-based, bets on industry opportunity sets and, at the business level, how management will be able to create value with shareholder capital over the long term (5–10 years). 

SaltLight’s telescope is aimed at what South Africa could look like in 2025 to 2030:  what is not likely to change and what might change. This involves building our flywheel of knowledge, collecting data, building relationships and making judgements about the likelihood of outcomes. Some investments will not turn out as expected and we will with 100% certainty, make mistakes.

Over the long-term, we would like our partners to be proud of what their capital enabled to build. SaltLight’s philosophy is explicit: we narrow our choices of businesses that add value to society. Shareholder value at any cost ultimately becomes a short-term return and likely a long-term loss. 

Long-Termism, Time…and Patience

A key lesson that I continue to learn every day in our investment process is that management and culture matters – particularly how a culture operates in challenging times. I have been enthralled with the management team at Calgro in how they’ve weathered the harsh economic environment; making a tough decision to cut their incentive scheme structure and reduce production to preserve the balance sheet. These are not managers who operate with “heads I win, tails you lose”. 

Despite the quality of management, the illiquidity of the share has exaggerated Calgro’s price declines. To illustrate: the total value traded during 2019 has been 2.5% of Calgro’s market capitalisation[7]. This is because Calgro’s shares are tightly held by management and key shareholders. Therefore, when there was a seller last year, the traded price moved down by 58%!  Who were the buyers on the other side? Management. They have been a quarter of the volume traded which, I believe, provides a strong signal of management’s views about the share price.

In 2019, Calgro was the largest detractor of returns in the portfolio. As a reminder, accounting rules dictate that we mark our positions to the last traded price at at the end of the reporting period. Clearly, it is hard to argue that 2.5% of value traded is a strong indicator of true value but these are the rules that we need to apply. I believe that there is a considerable margin of safety inherent in our investment. As of writing, we have to risk 40c to earn $1 on our bear case intrinsic value. These are wonderful odds and therefore I’ve increased our position during the period.

Over time, I have gravitated to founders and managers who have proven to endure short term market scepticism, financial losses and demonstrate delayed gratification for the ultimate end of long-term value creation. Adrian Gore, the CEO of Discovery Holdings frequently presents a chart of each of the underlying Discovery businesses from germination to graduation. Empirically it has taken 5–7 years for each new business to follow a process from ‘startup’, to scaling up, to achieving reasonable returns on capital. Each time, investor scepticism about the prospect of success has resulted in a meaningful decline in Discovery’s share price and each time, patience was rewarded. 

In our context, I continue to learn the virtue of patience and that compounding take time. As I’ve analysed our portfolio data, it is extremely insightful to learn that most of the positive contribution to our portfolio returns has come from investments that took more than two years to emerge. If there is one skill that I hope to develop further, it is excelling at the long game (with creative risk mitigation when I get it wrong). Given the growing trends of short-termism in investing, it appears that there is minimal competition in being a shareholder with patience. 

I must remind shareholders that our portfolio composition looks nothing like the JSE All Share Index. For starters, we don’t own any resource shares (~30% of the index). Secondly, we have a more focused portfolio than the All Share and lastly, our portfolio is dominantly tilted towards domestic companies that show considerable value to the upside. Therefore, our returns will look rather different year on year and will be lumpier over time.

Now, to the part that you have been waiting for. Still awake?

Portfolio Update

During the year, I deployed capital to Curro (see June letter) and three new undisclosed positions which I shall discuss in future letters. A strong market sell-off in July offered a wonderful opportunity to increase our position in Discovery Holdings (see June letter).

I’ve sold out completely from our FirstRand holdings, principally as I see upside is limited in the medium term and, encouragingly, we have ample opportunities to recycle capital into. FirstRand is an investee that we have held since December 2015; our total pre-tax IRR was 17%. 

Our special-situations book continues to generate wonderful returns in a zero ‘beta’ market. African Phoenix has been a three-year investment with many twists and turns. We’ve sat with two aces in our hand (pure cash on the balance sheet) and the last came up on the river in November with an announced unwinding of the private equity structure and merger with another investment vehicle. The board elected to pay a special dividend (essentially returning our initial capital) and our position value now is based on profit to date. At the time of writing, our pre-tax IRR sits at +20%. 

Earlier in the year, I exited out of Taste Holdings (Starbucks and Domino’s SA franchises) after realising that I had utterly misjudged the new management and how they would take the business forward. Whilst we incurred a permanent capital loss, the current price is 73% below from where we exited.

Predicting in an Unpredictable Future: Needs and Supply

Predicting exact economic outcomes in a complex system like a financial market is inherently impossible. Having more conviction about future needs and solutions to those needs is a little easier. 

One can reliably predict that the housing shortage will not be solved by 2025, or a substantial portion of SA Taxi’s customer base (15m) will own their own means of transport. I am reliably certain that the SA government will not be able to build the 2000 schools to accommodate the 3m new school-going age children.

What Opportunities Lie Ahead?

There are a wider set of potential outcomes for digitisation of the SA economy:

  • E-commerce: E-commerce penetration remains at just under 1.5% of retail sales (incredible given that Capitec Bank has 6.5m digital customers). The cost of mobile data remains stubbornly high, suffocating any chance of penetration to the mass market. Government is using various means to widen access to the internet (some positive and others absurd).  When data costs in countries like India where slashed, it created fertile ground for new internet-based businesses.  
  • Cloud: SA Enterprise-level corporates have yet to truly adopt cloud computing at mass scale (Amazon is launching its first AWS data centre in the middle of this year). Low latency cloud computing should facilitate new opportunities in the coming decade.
  • Private energy generation: I have a niggle that the energy sector is going to go the way of healthcare, education and security and the middle-class will look to private solutions (at scale) that the government cannot offer. At this stage, large scale private generation is not allowed under current regulations. 

My desire is that as our capital base develops, we can participate in some of these opportunities – if – they meet our investment criteria.

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To our partners and shareholders; it is my hope that your patience will be rewarded in the coming year. I am certainly excited about the portfolio of businesses that we own and the future opportunities that they may bring.

To the CEO’s and managers that read my ramblings (you know who you are), I thank you for your continued engagement and partnership. My encouragement is that you keep on building your businesses, some of the most enduring opportunities were built during tough times like these.

As always, please feel free to get in touch with me if you have any questions.


[1] This is the exchange rate between sterling and one Rand (the actual GBPZAR exchange rate is R18.84/£1).

[2] Source JSE and Koyfin: Returns from December 2015 to December 2019.

[3] Source: Presidency link

[4] Historians call this the Four Modernisations announced over time during the leadership of Deng Xiaoping. These modernisations were targeted in agriculture, industry, defence, science and technology

[5] Economist: A stunning reversal for Argentina’s President Mauricio Macri. Source: link

[6] SaltLight Capital Management Estimates

[7] Market capitalization on 1 January 2019 of ~R1.5bn