One of the great advantages of listing on the JSE (or any market) is that it re-rates a company’s shares from their pre-listing level as a private company (which is usually between 3 and 5 times their most recent after-tax earnings). Most listed companies can look to trade on the JSE at somewhere between 10 and 15 times after-tax earnings – depending on their track-record and the type of business they are in (service companies tend to trade at higher multiples than, for example, manufacturing companies – because they have much less working capital risk).
The difference between the value of an unlisted private company and a listed public company opens an opportunity to play what we call “the P:E game”. This consists of a listed company buying an unlisted company for somewhere between 3 and 5 times its annual after-tax profit – and then adding that profit to its own at which point it is immediately re-rated to between 10 and 15 times. The result of doing this is that the shareholders of the listed company see an immediate gain in the value of their shares.
A current example is Premier Fishing’s (Premfish – PFB) acquisition of 53,5% of the Talhado Group. This controlling stake was bought for R106m and for that gave Premfish 53,5% of Talhado’s after-tax profit of R51m (in the year to August 2017). If you do the maths, this means that Premfish paid roughly 4 times Talhado’s most recent after-tax earnings.
But Premfish is trading on the JSE for 15 times its after-tax earnings. Once the deal goes solid (and there are some conditions), Premfish will add 53,5% of R51m to their annual earnings – and those additional earnings should immediately be re-valued to 15 times. This means the acquisition which cost R106m will immediately be worth roughly R409m – quite a nice addition to Premfish’s market capitalization of about R1 billion prior to the deal.
By making this deal, the directors of Premfish will effectively hand their shareholders a tidy 30% capital gain. That is playing the P:E game.
Of course, the acquisition must be a good acquisition. It must integrate well with the company’s existing business and it must have a stable earnings rate and not bring with it any major unforeseen problems (for example, in the fishing industry the allocation of quotas can sometimes be a problem).
And as a private investor you need to consider whether the share is sufficiently liquid on the JSE – otherwise, you won’t be able to execute your stop-loss should you need to. Premfish has clearly not attracted much institutional investment so far. This can be seen from the fact that over the past 3 weeks it has traded an average of only R100 000 worth of shares, on average, each trading day. This makes it useless for the big institutions who want to see at least R2m trading per day before they become interested. But for you, even this volume would warrant an investment of R30 000 (our rule on volume is that you must see at least 3 times what you want to buy passing through the share each trading day).
Technically, it appears that the share has found some clear support at around 365c and is in the process of preparing for a major upward move. Consider the chart:
So, we believe that this share is worth buying at these lower levels and given the acquisition of Talhado – which does not appear to be discounted into the price yet. Once the directors get a taste for playing the PE game, you can be sure that more earnings enhancing acquisitions will follow. Premfish raised over R500m when they listed in March – so they still have plenty of balance sheet “head-room” to work with.