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HCI WAITING IN THE WINGS

20 Oct KWV Holdings

The worrying lack of returns at KWV has already prompted an influential minority shareholder, Chris Logan of Opportune Investments, to confront the company.

Perhaps it’s not the best tactic to rattle minority shareholders at unlisted liquor group KWV Holdings. After all it was less than a year ago that consummate deal-makers PSG (via Zeder Investments) saw minorities fiercely resist, and eventually snuff out, proposals for a merger between KWV and Pioneer Foods’ Ceres Beverages. And this despite Zeder being a shareholder of reference at both KWV and Pioneer Foods.

It’s probably instructive that PSG — a company accustomed to getting its own way in deal-making endeavours — opted to walk away from KWV rather than hang around in the hope of working out a new deal later.

Maybe PSG/Zeder sold out to Hosken Consolidated Investments (HCI) before the full value flavour had been released. But recent operating profit performances suggest PSG/Zeder may well be relieved to have banked a fairly decent profit from proceedings.

Poor profit performances have made KWV’s shares drift under 900c on the OTC (over-the-counter) market — well off the 1180c/share paid by HCI to buy PSG/Zeder’s stake at the end of 2010.

The sales mix remains uninspired (see graphic) with the core brandy and wine offerings both subject to significant margin squeeze in competitive markets abroad and locally. It’s obvious product diversity is needed urgently .

The worrying lack of returns at KWV has already prompted an influential minority shareholder, Chris Logan of Opportune Investments, to confront the company in a bid to dramatically ratchet up returns by buying back its own shares.

Logan was instrumental in rallying resistance to plans to merge KWV with Ceres. Though Logan might concede mixing KWV and Ceres may have brought out much-needed operational efficiencies, there was a much more critical question around how much balance sheet value would be given away in such a deal.

It’s essentially KWV’s balance sheet that comes into question again in Logan’s resolution — which seems unlikely to be presented to shareholders at the upcoming AGM.

What Logan is asking is for KWV to put its balance sheet to good use at a time when the unlisted shares — thanks to an insipid operating performance and sullen prospects — are trading at modest levels on the OTC market.

To date KWV, resorting to technicalities around ownership of shares through nominee companies, has stymied efforts to table the resolution. This is all rather baffling since the resolution is not contentiously aimed at forcing through board changes or calling for a strategic turnabout … it’s simply about advancing shareholder value.

To most impartial observers, a buy- back of under valued shares (currently bid at 815c and offered at 860c) would probably seem reasonable, even prudent.

It’s worth considering that KWV’s last stated net asset value (NAV) was north of R18/share. Some punters (arguing that accounting treatment of assets is extremely conservative) put a value of around R24/share on the company. There is certainly enough cash (nearly R170m at the end of June) on the balance sheet for KWV to take a good tonk at buying back the heavily discounted shares.

KWV may argue cash needs to be retained with a view to acquiring assets that would fortify the current brand bouquet — which is limited largely to wine and brandy. But a surfeit of valuable noncore “heritage” assets — including some iconic Winelands property and a collection of paintings — could easily be mobilised to generate additional capital. Controversially, these assets are valued at cost in KWV’s balance sheet, making a mockery of the officially stated NAV of R18,45/share.

Curiously, the disposal of noncore assets does not look imminent, even though HCI executive and acting CEO Andre van der Veen, writing in the new KWV annual report, concedes return on equity remains very low and will require “continued attention in the future”.

Van der Veen says the continued attention could include a reassessment of non-productive assets. But then he notes the mandate from the KWV board and key shareholders is to focus on the core operations and to use its resources to grow the group. “ The disposal of non productive assets is not a business priority at the moment and we have retained our accounting policy with heritage assets valued at historical cost less depreciation.”

This is a red flag to activist shareholders like Logan, who could again be looking to rally minorities, including 18% empowerment shareholder Whitmore, ahead of the AGM later this month.

Logan says the extreme comfort KWV has derived from having excessive and grossly undervalued assets has consistently allowed the company to “get away with murder”.

“The company has run an operational cost base at twice the level of Distell, and has overpaid dramatically for a host of poorly performing acquisitions.”

There are also glaring inefficiencies compared to larger listed rival Distell. For instance, KWV’s percentage of debtors to turnover is 37% compared with Distell’s 10%, while KWV’s inventory as a percentage of turnover is a staggering 107% compared with Distell’s 32%.

Logan says the share buy-back proposal, on which there would be a 960c/share price limit, would not only begin to address these issues but materially enhance shareholder value because of the extreme discount at which KWV trades to NAV.

“The buy-back proposal is the proverbial ‘no brainer’, but unsurprisingly given KWV’s history has been ‘rejected’ by KWV on extremely dubious grounds …”

There could be an argument that fobbing off a share buy-back resolution is undermining minority shareholder rights. It’s not exactly in the spirit of the new Companies Act either.

But there are more pressing practicalities that a share buy-back could address. The OTC market — in which KWV trades — places a large discount on KWV’s NAV, which has been worsened by poor operational returns since the unbundling of the “associate” stake in Distell. This has made the company the constant target of corporate action in the past two years (Zeder, Pioneer, Halewood and most recently HCI).

It’s also worth remembering that recent submissions to the competition authorities confirmed that new “shareholder of reference” HCI intends to build a bigger stake in KWV — something that might be at the forefront of minorities’ minds if there is indeed a reluctance by the board to enhance value by buying back shares.

Source: Financial Mail – Marc Hassenfuss