Should investors bet on Tsogo Sun’s rejig?
As Tsogo and Hospitality restructure, the question for a gaming industry investor is: just how lucky do I feel?
Which should you buy: Tsogo Sun, Hospitality Property Fund, or investment group and parent Hosken Consolidated Investments (HCI)? If it feels a bit like a game of rock, paper, scissors that’s because Tsogo and Hospitality will have a very different investment proposition once their split and restructuring is complete.
Last week, Tsogo and Hospitality announced the terms of a transfer of seven casino properties, which both parties valued at R23bn, from Tsogo to Hospitality as a prelude to the creation of three separately listed entities: a hotel management company, a gaming outfit and a property group with gaming and hotel assets.
After the transfer, Tsogo will end up with 87% of Hospitality, whose own portfolio will grow to R36bn of assets, with the ultimate plan of unbundling that stake to its shareholders.
And atop it all is Johnny Copelyn’s investment holding company, HCI.
Says Tsogo CEO Jacques Booysen: "I suppose you’ve got to take a view on HCI but if you wanted pure exposure to the gaming industry you’d go into Tsogo. If you like hotels, you’d go into hotels and if you want to stay in income, you would go into Hospitality."
Booysen says some investors who want a stable, escalating income might avoid gaming companies, but: "Then you’d have the people who say, as a gaming company that’s now fairly capital light, there’s quite a bit of upside if the economy turns."
The hotel entity — now under the management of former Tsogo CEO Marcel von Aulock, who rejoined the group after quitting unexpectedly in June last year — will likely be spun off within a year.
Booysen says the "only" rationale for Tsogo is to unlock value.
At the moment, Tsogo’s share trades at a p:e of just over nine times which "doesn’t make sense", says NeFG portfolio manager Gerbrand Smit.
"Even if you don’t do the break-up, the p:e for a quality asset is too cheap," he says.
As for the valuation of the casino assets that have been transferred to Hospitality, Booysen says this was done on the basis of expected rental income of an initial R1.9bn a year under a 15-year "triple net lease" — a sort of all-in rental that includes maintenance and insurance as well as rates and taxes.
"There’s no risk of vacancy," says Booysen, "and as long as you’re happy that Tsogo can afford the rental you’ve got a solid tenant on the other side so we think it’s absolutely reasonable."
Booysen says two things were important to Tsogo: that the group had security of tenure and that it didn’t end up with a lease it couldn’t afford, as happened to Netcare when it split its UK assets into an operating company and a property entity.
Independent valuations will be provided along with the circulars that are about to be sent to shareholders ahead of a vote on the deal.
Asked if Tsogo and Hospitality are mere puppets in a grander HCI scheme, Booysen says: "Every single institutional investor and analyst we’ve seen asks: ‘Is this an HCI idea?’ It’s not. This idea came from Tsogo."
But both RECM chair Piet Viljoen and Lentus Asset Management chief investment officer Nic Norman-Smith prefer HCI as a means to access the Tsogo-Hospitality plan.
Strategically, says Viljoen, HCI is "doing the right thing" in creating "focused, smaller businesses". Buying shares in HCI means "one is able to buy into the strategy at a large discount to the sum of the parts".
For Norman-Smith, investors who buy HCI get access to a wider spread of assets as well as Copelyn’s dealmaking ability.
"If you’re concerned about the relative merits of the assets, you could do worse than leave the decision in the hands of Johnny Copelyn, who is one of the country’s most renowned dealmakers. The fact that you are able to do this, and get a discount on the assets, is an added bonus" he says.
Hospitality has certainly come a long way since Tsogo first took control of the floundering hotel-focused property group in September 2016, when it shifted 10 hotels, worth almost R1.8bn, into the company.
Overnight, Hospitality’s shares went from R3.90 to R13, peaking at R14.62 in May 2017, before slipping back to a low of R9 earlier this month, a day before the separation plan was announced.
That drove the stock almost 25% higher to above R13, but the shares were back below R10 this week.
Hospitality CEO Keith Randall says investors in the company were previously subject to a much more volatile income stream from what he calls "distinct little micro- businesses".
"A 200-to 250-bed hotel will go through its ups and downs and can be quite volatile so, traditionally, leases have been quite tough for hotel operators."
But with the advent of the JSE’s real estate investment trust structure and the inclusion of the Tsogo assets, he says: "You’ve now got a structure that gives both parties a sustainable business."
According to Randall, "with diversification we can take a bit of distress", citing the knock that the Western Cape’s drought had on hotels in the region. "Because of our scale we can handle that," he says, "where an individual hotel might not be able to."
As for the casino assets, why buy into a sector that is at the sharp end of consumer distress?
"What we’re finding now, and these are tough times, is that people are spending the same as last year," says Booysen. The theory is that casino spend, over time, should grow at inflation plus GDP.
"What happens in the bad times, such as the period we’re in now, is you go to a casino once a week and you spend R100 and you keep on spending R100, because you’re not feeling good and the economy isn’t doing well," he says.
"But when the economy turns and you feel good, you don’t spend R106, in line with inflation.
"You might go from R100 to R120 or R150 — so in the good times we outperform, and in the bad times we lag it, but over the long term we should at least be at inflation plus GDP."
The kicker is how long the bad times will endure.