Mark Ingham assesses Steinhoff: Top SA entrepreneurs combine to make magic | Fin24
 
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Mark Ingham assesses Steinhoff: Top SA entrepreneurs combine to make magic

Sep 26 2016 11:46

Any ranking of South Africa’s top five entrepreneurs would have to include Christo Wiese (75) and Markus Jooste (55), the gifted business geniuses behind rapidly expanding global furniture retailer Steinhoff. Both come from humble beginnings, but with parents who invested in their education – Wiese’s in law; Jooste’s in accounting.

They met more than three decades back when Jooste was an articled clerk on a Wiese company audit, and have been close friends ever since. In 2014 they pooled assets into an enlarged Steinhoff, triggering an aggressive international expansion programme topped by the $3.8bn (R52bn) bid for the US’s largest bed retailer Mattress Firm.

The duo are betting on a combination of Steinhoff’s vertically integrated business model and their ability to pick companies run by the right people. After a surge in price following the initial excitement, the Steinhoff share price has been soggy of late.

Is this a reflection of over-reach or an opportunity to accumulate? In this in-depth assessment of South Africa’s newest global business champion, independent investment analyst Mark Ingham dives into the detail, and comes to some interesting conclusions. – Alec Hogg.


Mark, you’ve been doing a lot of work into Steinhoff. Let’s start at the end – you reckon the shares may not be the greatest trade right now but are an excellent long-term holding.

Yes, Alec. I think this is a great company that’s gone a long way over the last number of years. It’s truly international. It’s a vertically-integrated mass market retailer (manufacturer as well) and I think that the deals we’re seeing, entrench what I think is a well-executed strategy by the management team.

I’ve been in the market long enough to know that good companies can get a bit expensive from time to time and indeed, they can get cheap too. I’ve had a trading sell, but that’s largely because I felt that the stock was a little elevated and therefore, I continued to advise accumulation into weakness but I did retain a portfolio for those with a longer run investment horizon.

I think also for those who have share portfolios where they aren’t in a position to just chop and change…there are mandate issues possibly associated with that. There are tax issues and hence, the two recommendations may seem to be at odds with each other but nonetheless, speak to the fact that some with a trading point of view, may see opportunities to go short the stock in the short term and then they’ll pick up at low levels.

I’ve had a fair value of R75 on the stock for quite a while Alec, with a target price of R85.

These are really good companies to know more about because from time to time, when you do get those retractions of the market… When Mr Market gets all pessimistic, it’s nice to know what you should be buying at that point and this could be one of them.

Yes, Alec. I think if we just go back a bit – a year or so – to the announcement that the company was going to have its prime standard listing in Frankfurt, I think that got a lot of interest up. Also, in 2014/2015 and into 2016, we’ve had rand weakness too and given the spread of earnings of the group now, it means that from a rand point of view; on translation, you do a bit better, given that rand weakness.

I think the excitement over the Frankfurt listing and the fact that it’s quite a significant constituent now in that stock index also helped… Over the last few weeks and months, there’s been quite a bit of expectation built into what Steinhoff can achieve/deliver. I think some analysts and fund managers may have been a tad disappointed with the more recent results.

I actually thought they were quite good and so I think that with this retracement of the stock from well over R90 to under R80 at the moment; for those who are canny and those who can believe in management, I think this is a very good opportunity.

You set at the outset that this is a strategy that’s been well executed. Well right now they’re in the process of two more acquisitions, the biggest ever I guess, from a South African company – the acquisition in the United States, Mattress Firm, and then one that is just about concluded here in the UK with Poundland. Steinhoff has built its business primarily on acquisitions and often this is a weakness, or perceived to be a weakness, by some but you don’t view it that way.

I think we’ve had a combination of organic and fairly astute and acquisitive growth over the last number of years. I think just to give a better perspective around Mattress Firm in the US and Poundland in the UK, and Tekkie Town, which has just been bought domestically. Iliad, which was also purchased last year. They’ve had this good patch of opportunity and the management team are not slow to spot opportunity, so although there may be a flurry of deal making at the moment and very large, from a financial point of view.

I think that is also a function of the fact that these opportunities have come to the table in relatively short order and there are periods of time when they go through a shallow patch and there’s no deal making at all. The businesses just quietly get on with what they do and entrench the positions that they have in their respective markets, and I think we’ll go through that period again, after this flurry, once Mattress Firm, Poundland and Tekkie Town are part of the group.

I think we may see a process of taking the foot off the accelerator. They do have a history of integrating businesses fairly well. I think the challenges that they now face are increasing as the firm becomes global and this is the first move into the United States of America, some would argue that management focus could get a bit stretched.

It becomes more difficult to handle an increasingly expanding octopus, if you will, with tentacles in different geographies. There may be some concern around that but let’s remind ourselves too that Steinhoff does have quite a depth of management and I think that also speaks to the fact that they’ve consistently achieved good results.

What they also have achieved is the capability to raise capital, be that equity or debt, fairly well. As a consequence of that the number of shares in issue has increased quite sharply over the last number of years.

The United States has been the graveyard for many South African businesses, some of the very best. You’ll remember that DiData took a hiding there. Discovery even had to drop a million rand before it exited the market. Investec didn’t do too well. All companies that have done well in other parts of the world. What makes you think or do you think that Steinhoff will be an exception to this US graveyard rule?

Alec, a very good point that you make. Steinhoff have typically executed very well but what they’re very good at is buying into management locally. To use the expression – they think globally but they act locally, so you’ve got very strong domestic management in all the geographies that they operate.

This strong, strategic direction from head office, if you will, the CEO I think is a very positive influence over there. I think that they do have a culture which has embraced in the different territories in which they actually operate. The Conforama experience in France and other parts of Europe I think speaks well to that.

In the case of Mattress Firm, they’re going to be retaining US management. I think Steinhoff themselves realise that they’ve got far more to learn in the US than they can teach the management of this company. Whereas they see this as a good opportunity to move into the US and I think it integrates fairly well with their overall strategy, they have a lot of learning to do.

I think the next few months and years, is going to be one where they get to understand the nature of the US market and also understand the fact that the US is not a contiguous market. It’s very much a market made up of localities, if you will.

Each State has its particular ways of going about things, so although they are in the US I think we need to realise that they are in parts of the US. They’re in a business that I think has about a quarter of the market share in its specific category, so there’ll be a lot of learning coming out of that. They are familiar, of course with Britain.

I think the Poundland deal, although it may have raised the odd query in peoples’ minds, given the nature of the business. I think it squares with the budget aspect of many parts of their operations and it’s quite conceivable, for instance, together with the Poundland management that we may see an adaptation of the Poundland approach in the next few years, to square more with where Steinhoff is going with other parts of that group, Pepkor I think is a very good example of that.

A Steinhoff International Holdings NV logo sits on display outside the company’s offices in Stellenbosch, South Africa. Photographer: Waldo Swiegers/Bloomberg

They had two runs before the successful acquisitions, Argos and Darty, but it now is a lot to digest. Do you expect that Steinhoff will be quiet for a period of time, going back into that hiatus that you spoke about earlier or, given that you’ve got Markus Jooste and Christo Wiese in cohorts, working together that they’re going to just keep finding deals?

Look Mr Wiese has very much hitched his fortune to this vehicle. He has a substantial stake in the business. Therefore, he and his family, obviously over the longer term see this as a business that will expand, which will do well. Indeed, as it has been doing for many years.

I think what’s very interesting too and with the two gentlemen that you’ve just referred to, is the discipline that is brought to bear. For instance, walking away from a deal, if it starts to get too expensive is exactly the right thing to do.

Brian Joffe has done that over the years. If something is just simply too rich and you’ve got a bidding frenzy nothing is so valuable that you have to pay up for it and repent at leisure. I think them walking away shows capital discipline. It shows that they have return metrics that they abide by and I think shareholders should take comfort from that.

Although the Mattress Firm deal in particular is quite chunky – it comes with a price tag of $3.8bn, including assumed debt. The equity value of that is $2.4bn and that includes the net debt associated with the Mattress Firm’s own Sleepy’s acquisition recently, so there’s been two acquisitions effectively.

Sleepy’s as part of the Mattress Firm and now Mattress Firm as part of Steinhoff, so it is fairly large but clearly it’s priced at a level that management feel comfortable about and that they can get a pretty good foothold into the Continent of the United States that they probably would otherwise find difficult to do.

I think the multiple on that will unwind as time goes by. I estimate an EV/Ebitda multiple of about 11 times, which I don’t think is too much of a stretch, given the type of business they’re actually acquiring.

Quite an interesting point you make there that they’ve acquired this US company just after it has done an acquisition. It was exactly the same with Poundland in the UK. It had just done an acquisition as well.

Yes.

Both of those acquisitions taking time to settle down, I guess what the Steinhoff team or what Markus Jooste and Christo Wiese are betting on is that they’ll be able to really bring the perceived advantages of those deals to fruition.

Yes, it’s an interesting point you raise, Alec, they’re getting two birds with one stone in each instance and so, yes, I think there’s always challenges around acquisitions. Often times one plus one doesn’t equal two, it sometimes equals one or sometimes less than one, so I think people will be looking with interest as to how these two deals are bedded down.

It isn’t going to be easy.

They’re both fairly large in their own rights. The combined enterprise value of Mattress Firm and Poundland is €4.1bn, so this is quite large. I think a healthy period of, to use the pun ‘bedding down’ will be a good thing and I think the risks and the rewards would be highlighted to investors and I think that the Mattress Firm shareholders too, they saw a great opportunity here to, not only realise value from the purchase but also the fact that I think it was done at quite a good time for Steinhoff shareholders as well.

From a pricing point of view, as I say, it’s really not too bad. These deals don’t come along every day but certainly there’s going to have to be a lot of attention to detail to ensure that this adds value over time, rather than takes away value.

Markus Jooste is an old pal of mine. We’ve raced horses together. We’ve known each other for many years, so clearly, because of that relationship, I’ve been watching the Steinhoff story very closely. When I last met with him here, in London, he said that he’d changed his role and his role now is literally to go and make relationships. Get to know people and get to see people that might come into the group, sometime in the future, but actually to understand what it is that he might be buying or Steinhoff might be buying, and that is all about management and people.

Do you think that is part of the reason as well, why shareholders have more confidence that the Steinhoff deals or transactions will be successful? Whereas if you see a company of this nature making numerous acquisitions often there are alarm bells?

I think it’s a point that you make very well. There’s a certain statesman-like aspect that has to come with managing a group of this size and, whereas Markus will have good attention to detail, he will have a good grasp with the P&L and the various moving parts. I think that human dimension cannot be taken away.

Bidvest, in its time, Bid Corp now, has exactly the same sort of philosophy. The people factor is absolutely key. Get the people right, the P&L looks after its own self. I think that aspect shouldn’t be forgotten. Some companies are more technocratic and often, if you have that approach it does tend to cause complications, when you do complex deals of this nature.

I think reaching out, embracing the new team, if you will, welcoming them into the Steinhoff family and saying, ‘this is the way we do things’ and ‘you can learn from us and we can learn from you – let’s go forward and make this a better business than it was in the past".

Staff morale I think, typically, through the Steinhoff Group tends to be pretty good. Yes, it is difficult with a company that spans the globe but it’s not the only company that has been able to achieve that and I think as they grow, as they internationalise, so in turn those learnings come. Those learnings get rolled out, through the group too.

I think it’s worthwhile pointing out that in the 12 months to June South Africa was about 32% of reported revenue and about a quarter of operating profit. If we go forward South Africa is going to be reducing to around a quarter of revenue, that’s post the recent acquisitions, and probably less than a fifth of operating profit.

The contribution from dollar and the euro particularly, also is going to be fairly meaningful and I think that gives us a pretty good sense of the globalised nature of this group now. I think the slightly differentiated approach that you correctly refer to that needs to be taken are relative to where

I was talking to a serious trader who works on the Frankfurt Stock Exchange, and he’d never even heard of Steinhoff. It wasn’t a stock that had come across his radar much and in your research report you also point that out that Steinhoff is still primarily traded in Johannesburg, so they’ve got a lot of work to internationalise the shareholding of the group still.

The share register is still largely South Africa but part of the reason for the Frankfurt listing, I think was to reflect the increasing and accelerating the globalised nature of this group. I also think for a better price discovery in the process.

That’s not to say that you can’t get good price discovery out of Johannesburg because indeed many international fund managers, as you well know, do have exposure to a number of high quality South African business services through the JSE and can come and go as they please. I don’t think one would have an issue with that but this simply does reflect the fact that euro revenue, in particular, is the largest currently and will probably remain so for the next few years. It opens it up to a much larger base of fund managers and whilst the price is largely made in Johannesburg.

On average about three times the number of shares trade in Johannesburg relative to Frankfurt, and there are days when it’s much higher than that. In time, I think you’ll see that shareholding from abroad rise. I think as they go forward they will probably need to raise additional equity capital. They haven’t been shy to raise equity capital in the past, and they probably will do again.

I think what the last few months have been very good for is that they’ve managed to slowly raise their profile. You hear that on the conference calls that Markus hosts at the quarterly reviews. The number of analysts now calling in from Europe, from the UK, and other parts of the world, so there is that growing interest. I think what’s important for a company, and Steinhoff in particular, at this stage of its business lifecycle, is pitching to those who aren’t your shareholders but who you would like to be your shareholders in the future.

I think that’s a very wise approach and I think there’s a growing comfort factor now, with what the business is about and what it’s doing. The price discovery will speak to that, so I think with this price coming off. It’s come off both in Frankfurt and in SA, one can finesse one’s investment in the stock knowing, I think, in time that this will be a company that is no longer regarded as a South African company per say but which is a truly, international one.

Stick it in the bottom draw. Don’t worry too much about it. You’ve got good management employing an interesting strategy that seems to be working and they’re executing well.

Yes, it’s often difficult to call a stock a ‘Rip van Winkel stock’ where you just put it away and wake up in 20 years’ time and you’ll be nicely off. I think one does have to do ones’ homework, analysts particularly have to lend a critical eye.

Even if you like the management of any company, I think the job of the analyst is to lend that external, independent critical eye and also to advise those who are invested in the stock, in an impartial way, as to how you see the business developing and analysing the numbers too, as they’re reported, and questioning too. I think it is always healthy to do so but I feel fairly comfortable that the group is well anchored.

I think the governance is in place and I think if you’ve got those ‘people factors’ correct, even though the P&L may go up and down and there may be years where earnings disappoint relative to expectations.

If you’ve got that people factor right, if you’ve got the steering correct from the front, from the CEO, from the Chairman and from a solid, frontbench management team then I think this is one of those stocks that you would probably want to be exposed to.

Mark Ingham is an independent analyst and this special podcast was brought to you by Easy Equities.

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