Unsure market holds back on Conduit Capital
Shares in small financial services counter Conduit Capital have lost a good deal of traction since peaking briefly at 390c at the end of September 2015.
The shares have lost around 14% this year to settle (at the time of writing) at 215c — a level last seen in April 2015.
Clearly the market, which previously enjoyed flirting with Conduit, has turned wary.
The transaction that seemed to turn the market off was Conduit’s purchase of investment companies Snowball Wealth and Midbrook Lane for R465m and R168m respectively. The deals, settled in scrip, allowed Conduit to increase its positions in companies it was already invested in. But some observers felt it was a deal that benefited Snowball and Midbrook Lane, giving them an opportunity to sell out investment portfolios at net asset value (NAV) in exchange for paper, offered a discount on the underlying NAV of the same investments.
One asset manager, who asked not to be named, says Conduit has taken some big bets in its investment portfolio. "But what is the overall strategy? It’s something that it still needs to communicate clearly to the market."
On the other hand, listed investment company RECM & Calibre (RACP) appears upbeat about its significant minority shareholding in Conduit. In the latest annual report, RACP CEO Piet Viljoen wrote: "We have a high regard for management and its business and investment strategy."
Essentially, Conduit’s operational cogs revolve mainly around Constantia Insurance, a specialist insurance operation that has performed steadily over the years. The secondary angle — albeit the more intriguing aspect — is that Conduit mobilises Constantia’s insurance float to make selected strategic investments rather than, as most insurers do, compiling a portfolio with a multitude of diversified holdings (bonds, shares, cash and property).
Officially, Conduit has ambitions to "develop a high-quality diversified insurance group complemented by a noninsurance value-orientated investment programme".
There’s not much to fault at Constantia. In the year to end-March, its gross written premium decreased 4.2% to R481m — but net premium income increased 34% to R229m.
At that point directors explained that the intention, over time, was to increase net premium income at suitable underwriting profitability levels. "Increased retention allows us to build our capital base, which in turn allows us to write more premium for our own account."
Despite the solid showing by the insurance operations, Conduit’s interim pretax profits slumped 41% to around R18m. In fact, the insurance operations increased pretax profits by 62.5% to around R23m before head office costs, with the drop in profit at group level triggered mainly by lower returns from the investment portfolio.
At this point it seems investors are taking their cue from Conduit’s investment strategy rather than the fundamentals of the niche insurance operations.
The issue with the investments is that Conduit does not — either in its last annual report or its interim results — clearly and neatly set out the main components of its investment portfolio.
But recent Sens disclosures indicate that the Conduit portfolio has significant (or influential) stakes in small specialist banking group Finbond, Namibian investment company Trustco, industrial conglomerate ENX Group, fast food group Taste Holdings, low-cost housing developer Calgro M3 and vehicle retailer Combined Motor Holdings (CMH).
Without trying to sound disparaging, it is clear that Conduit’s investment portfolio is underpinned by small-cap counters, something that might be perceived as risky by "normal" insurance sector standards. Some market watchers may not feel reassured by the composition of the portfolio, with perhaps only CMH ranking as a "widows and orphans" stock.
Conduit CEO and major shareholder Sean Riskowitz, who is based in the US, has been reticent to engage openly with the media. But the Financial Mail managed to speak to Riskowitz over a cup of coffee in Cape Town last week.
Riskowitz stresses Conduit’s investment philosophy revolves around building positions in markedly undervalued stocks where there is a confluence of business factors and a competitive advantage that will compound value over time.
The modus operandi is conservative, and the approach has been mostly to snag a small stake in a company before building a bigger position once a hunch around the business mechanics and prospects is confirmed.
Riskowitz discloses that the Conduit portfolio consists mainly of nine shares, including Finbond, Trustco, Taste, Calgro, ENX and CMG, as well as a few where significant positions are still being built.
The company has already endured one notable blowout — low-cost housing developer RBA Holdings, which slipped into liquidation recently after a rescue plan fizzled out.
What is probably perplexing market watchers are the positions in Finbond, Taste and Trustco. All three companies have taken huge strategic bets — Finbond on expansion in the US; Taste on rolling out iconic consumer brands Starbucks and Dominos; and Trustco on diamond mining and polishing ventures.
Conduit has provided significant fresh capital to each of these companies to pursue these strategic goals.
Riskowitz says in the case of Trustco and Finbond there were initial misgivings about the dramatic diversifications, but after close consultation with executives a decision was taken to back the respective forays. In the case of Trustco, which has still not finalised a mining licence for its R3.6bn Namibian diamond operations, Conduit this month secured a convertible loan agreement that could lead to it growing its stake in the Namibian company markedly.
So are Conduit shares worth accumulating if the price dribbles down further? Investors will need to weigh up the positive attributes of a niche insurance operation against an eccentric small-cap investment portfolio. The hitch in the short to medium term is that successes in some positions could quite easily be offset by setbacks in others.
The Financial Mail reckons it’s prudent to rather watch and wait.