Analysing Remgro’s claim that Vumatel and DFA are worth more than Telkom

Remgro’s financial results for the six months to 31 December 2023 revealed that it valued CIVH at R22.9 billion — significantly higher than Telkom’s market cap of R13.3 billion.

Many analysts and investors are sceptical of valuations from investment holding companies because their management is incentivised to increase their assets’ net asset value (NAV).

Management fees are often linked to the intrinsic net asset value of the companies a holding company owns. The higher the NAV, the more fees it gets.

Executive remuneration can also be linked to movements in the net asset value, which may incentivise executives to inflate valuations.

High valuations are typically achieved using discounted cash flow (DCF) models. A valuation model that is extremely sensitive to small changes in expected growth rates and discount rates that often lead to inflated valuation results.

This is one of the reasons why many investment holding companies trade at big discounts to their net asset value.

In Remgro’s case, the company’s intrinsic net asset value per share at the end of December 2023 was R236.95.

Its share price, in comparison, was only R162.48. It means the share price was trading at a 31% discount to Remgro’s intrinsic NAV.

Since then, the share price has fallen to R130.98 per share. This translates into a discount of 45%.

Unsurprisingly, many analysts questioned whether Remgro’s valuations of its unlisted companies were too high.

Myuran Rajaratnam, an analyst and portfolio manager at the Metal Industries Benefit Funds Administrators (MIBFA), questioned Remgro’s management team about their valuations.

He highlighted that Remgro’s incentive structure is linked to intrinsic net asset value (iNAV) growth.

It raises the question of whether there are enough checks and balances, including dissenting voices within Remgro, to ensure valuations are not inflated.

Remgro CEO Jannie Durand said there are numerous checks and balances to keep the valuations accurate.

These include an internal check, reasonability checks by EY and Deloitte, a valuation committee, an audit committee, and the Remgro board.

“There are enough people that are not incentivised at all to have an increase in the intrinsic net asset value,” he said. “There are enough dissenting voices and robust discussions around the valuations.”

CIVH valuation analysed

Remgro’s valuation for CIVH provides a good example of why many analysts question whether the value of unlisted companies is market related.

Remgro owns 57% of CIVH, which in turn owns 100% of Maziv. Maziv owns 100% of Vumatel and DFA.

Over the six-month reporting period, CIVH’s revenue declined by 0.5%, from R3.157 billion to R3.140 billion.

While revenue remained flat, CIVH’s headline earnings plummeted 97% from R323 million to R11 million.

The decline in earnings resulted from a 400 basis point (bps) increase in the repo rate since the start of the comparative reporting period.

Maziv had debt of R19.434 billion in December 2023. The higher interest rates and rising debt resulted in interest payments increasing R664 million to R896 million year-on-year.

Despite the bigger debt burden and increased interest payments, which destroyed earnings, CIVH’s valuation only declined by 9%.

Questions were raised about why a 400 basis point increase in the interest rate did not cause a greater fall in the CIVH valuation.

Higher interest rates would significantly increase the weighted average cost of capital (WACC) discount rate, given the company’s elevated debt levels.

It raises the question of whether the DCF model used to value CIVH is accurate, as DCF valuations are highly sensitive to changes in the discount rate and cash flow growth rates.

Daily Investor compared CIVH with listed operators to see whether its valuation was comparable to that of other telecommunications companies.

We used popular valuation ratios for this comparison — price-to-earnings (P/E), price-to-sales (P/S), and EV/EBITDA.

The results were telling. CIVH’s ratios were significantly higher in all cases than those of Vodacom, MTN, and Telkom.

CIVH’s lofty valuation may have been justified if it was still in a high growth phase. However, this is no longer the case.

Vumatel, the main growth driver for CIVH, has slowed its fibre rollouts and significantly cut capital expenditure.

The result was that Vumatel’s revenue only grew by 10.7% year-on-year, while its headline earnings plummeted 166% from R151 million to a negative R99 million.

DFA’s revenue only increased by 3.4%. Operating earnings declined by 5.3%, and headline earnings declined by 27%.

These numbers do not represent a growth company. Instead, they point to a company facing a challenging future and in need of a turnaround.

The challenging environment and cutbacks will result in less expected future growth already being experienced in CIVH, which should significantly affect a DCF valuation.

The table and charts below compare CIVH’s valuation with JSE listed telecommunications companies — Vodacom, MTN, and Telkom.