Leila Fourie, the newly minted CEO of the largest stock exchange on the continent, bristles when asked if the wave of delistings from the JSE this year — 21 and counting — represents something of a crisis for the local market.
"We saw this before in 2008. We’re at a low point in the cycle because our economy is in a downturn, and people typically shift their money out of equity into bonds or cash.
"But is that a reason to despair? I would strongly argue ‘No’," she says.
The environment is hostile for small caps and IPOs, but due to the cyclical nature of economics, things can only improve
— What it means:
Still, it’s not exactly the easiest homecoming for Fourie, who replaced Nicky Newton-King at the helm of the JSE three weeks ago, after a three-year stint in Sydney as the CEO of the Australian Payments Network.
"Since I’ve come back, I’ve been quite taken aback by the negative psychology of the country. Sure we have problems, but we could be dealing with Brexit, or living under the uncertainty of a trade war in the US," she says.
Perhaps. But for a country that is supposed to be emerging from a Jacob Zuma-inspired slump, the metrics are going the wrong way. While the 21 delistings from the JSE so far this year are still better than 2017, when 32 companies went private, it’s a shift that is reducing the choices for investors. This month alone, services company Rolfes joined the exodus.
Nor is this an arcane issue, of interest only to investors. Legally, the 5,144 pension funds registered in SA can invest up to 75% of their fund in local stocks. But with a shrinking universe from which to choose, it means your pension is hostage to an increasingly narrow slice of the SA economy.
This year alone, the delisting roll includes such august firms as platinum company Lonmin (which was bought by Sibanye-Stillwater, ending decades as a public company); industrial equipment supplier Howden Africa; dairy stalwart Clover; retailer Verimark; and building supplies firm Distribution & Warehousing Network. There were others you’ve probably never heard of, such as Master Plastics and Mainland Real Estate, that went the same way.
By contrast, just three companies have listed in 2019: Prosus (which was spun out of Naspers), MultiChoice (another Naspers graduate) and Tsogo Sun hotels.
You can see why — amid a parlous economy, with GDP growth below 1%, margins are vanishingly thin, cash flows are anaemic, and sentiment for new listings is anything but welcoming. And for those companies brave enough to stay public, any slight setback or misstep can result in a frightful flaying of their share price.
Entrepreneurs, who would typically see the stock market as the obvious way to raise cash and propel their companies onto the public stage, are thinking twice about launching fledgling businesses into such a hostile environment.
Perhaps partly because of this narrower basket of options, investors are trading less. For the six months to June, the JSE revealed that the value of trades was 11% lower than the same period in 2018, with foreigners selling a net R30bn in SA stocks.
Veteran investor Chris Logan, CEO of Opportune Investments, says it’s not surprising the JSE is viewed in such a dim light. "The bourse is enduring a perfect storm with the government destroying the competitiveness of the local economy via the likes of Eskom tariff increases and its bloated bureaucracy, as well as chasing away investment and talent through misguided policies," he says.
Fourie admits there is a "reticence to be listed" with the economy so weak, but she says that’s only part of the story; it’s also in line with a global tide. "This year, we’ve seen the number of [new] listings in London fall 55% to just 24 new IPOs. It’s part of the global policy uncertainty, that we see from time to time."
She points out that SA has in fact done better than other global exchanges this year, on average, when it comes to trade.
"Globally, according to the World Federation of Exchanges [WFE], the value of equity trades is down 18%, compared to SA, where on a like-for-like basis, we are down 13%," she says.
So, it may be cloudy here, but we’re hardly the exception.
Worse than just a coma?
PSG Capital is one of the many investment banks that make money by listing new companies on the stock exchange.
Johan Holtzhausen, who heads PSG Capital, says he’s felt a noticeable chill on this front in recent months. It’s not unjustified at this point, he says, to ask: is the JSE dead?
"In the short term, there is a lot of doom and gloom. But the big institutional asset managers still need to invest their money somewhere, and that should provide some underpin. But if the economy stays slack for another two to three years, we might definitely have a problem," he says.
Nor is the pipeline especially thrilling. Next year, the only major company set for a debut on the JSE is fuel-forecourt owner Engen. "In this depressed market, we are much more likely to see corporate action around mergers, takeovers and minority shareholder buyouts," says Holtzhausen.
But, he says, sentiment can turn quickly.
"It’s not to say new listings won’t come back to the JSE. It is, after all, a cycle. The big question is how long the down-cycle will be? At the moment the cycle is still very negative."
Of course, one of the central reasons companies are shying away from the JSE specifically is that sentiment has been so badly shaken by a dizzying number of disaster stories since January. Think Tongaat Hulett (a 75% share price fall due to "accounting irregularities"); Rebosis (88% down as profits nearly halved); Blue Label (down 49% as its investment in Cell C bombed); or EOH (down 51%).
"Nothing shakes investor confidence quite like a hard, fast capital loss," says Keith McLachlan, a small-cap portfolio manager for AlphaWealth.
Rather than risk such a gamble, entrepreneurs are opting to sell their companies to private equity buyers, rather than go public.
Says McLachlan: "For the past 12 to 18 months these private equity players have been telling me that unlisted SA businesses are coming across their desks on valuations that are higher than where small caps on the JSE are trading."
It’s a perversion of what you’d expect. Usually, an unlisted company should sell at a discount to a company whose shares you can trade easily on an exchange. But it illustrates how hostile the market is for IPOs.
And it’s scaring away ordinary retail investors too, as they see share prices fall below what is considered solid value. Fourie says: "Though I don’t deny that we face macroeconomic headwinds, we need to avoid a catastrophe-thinking mentality, as this does not reflect reality."
Patrice Rassou, head of equities at Sanlam Investments, says the desire to avoid all risk whatsoever after the recent scandals is part of the problem. "Investors are now so gun-shy in this post-Steinhoff world that when something starts to wobble, they just flee. That’s why we have so many zombie companies on the JSE trading at ridiculously low valuations.
"Anything that seemed slightly weak or vulnerable has been left for dead."
Perhaps, says Rassou, this sort of detox is needed after a heady few years when it seemed there was a new listing — certainly a new property listing — almost every week.
"It got ridiculous, so now we’re in a phase where there’s a whole lot more scepticism. Valuations have come down, and the delisting wave we’re seeing is a sign that companies are cheap.
"We were all taken by surprise when Pioneer Foods was bought by PepsiCo and delisted this year, but there have been lots more since then," he says.
But Rassou, like Fourie, believes this is just a nasty cycle that will play out, rather than an inexorable descent into the end times. When business confidence and GDP recover, he says, you can expect a spate of new listings.
McLachlan agrees that local investors are overly pessimistic right now. Typically, he says, markets "overextend to the upside and to the downside and I think there is an over-extension to the downside".
Which may seem obvious, but it has created a self-reaffirming loop.
"Because of all this fear in SA, guys have quite simply been sending their money offshore," says McLachlan. It’s a trend that has hurt SA’s smaller-cap companies the most, since they’re perceived as the riskiest assets.
For example, retail investors with a stock exchange portfolio might be happy to keep big-hitters Naspers and British American Tobacco, whose businesses are almost entirely offshore, but they are likely to dump their local, smaller shares.
It means veteran SA companies are trading on ludicrously low valuations. Airline Comair, for example, can be bought at a p:e of just 1.6; paper company Sappi is trading on a ratio of 5.1; and small bank Sasfin on a ratio of 5.3.
If this isn’t necessarily a crisis for the JSE’s all share index (Alsi), which is dominated by large-cap stocks that make their money offshore, it certainly is catastrophic for the small-cap sector.
The upshot, as McLachlan says, is that SA’s small-cap market "is the cheapest equity index out there in the entire world".
McLachlan should know. He has been tracking the JSE’s small companies since university, when he used his scholarship money to dabble in the stock market. He soon discovered that he loved researching the companies that are mostly ignored by the major investment houses.
"You get diminishing returns researching something a thousand people have already researched," he says. "In the small-caps space it’s not just more colourful, but there’s a lot of value in doing that."
The potential rewards are huge; the fewer people analysing a company, the higher the odds of finding, say, the next Capitec.
Dan Rasmussen, a portfolio manager at US researcher Verdad, cites Eugene Fama, the US economist who won the Nobel prize in economics partly for work that found small-cap value stocks outperform the broader market.
But, says Rasmussen: "Attempting to follow this seemingly sound advice — and strong empirical work — has not exactly benefited investors of late.
"Based on our research, small-cap value stocks have lagged the broader US market by a huge margin. International stocks have lagged US stocks by a huge margin. And international small-cap value has been a wasteland from a return perspective."
But Rasmussen believes the bloodletting among small caps may be nearing an end. In the past two months, he says, there has been a "sharp shift" in momentum and "some of the most insightful quantitative analysts on Wall Street believe this reversal has legs and that international and small-cap stocks could be set for serious outperformance."
If that happens, there are any number of small shares on the JSE, now trading at immense discounts to fair value, that could make small fortunes for investors.
The Class of 1987
If today’s delistings are what happens at the bottom of the cycle, it’s instructive to consider what happens at the top. Like 1986.
At the time, the JSE launched the "development capital market" to woo smaller entrepreneurial companies. The result: 82 companies listed on the JSE in 1986, and 211 in 1987. It was during this phase that heavyweights like luxury goods company Richemont, transport giant Imperial, hospital group Mediclinic, Investec bank, Northam Platinum and IBM SA came to market. And popular JSE second-tier firms used their listings to grow by acquisition into formidable businesses. This list includes industrial groups Invicta, Hudaco, Grindrod and Cashbuild, as well as private education group AdvTech and Sasfin.
But a critical point was that the listings boom lured a swathe of new retail investors, excited at the sudden smörgåsbord of weird and wonderful small-cap companies.
In some cases, that excitement was short-lived: by the time the 1990s rolled around, many of the smaller companies had vanished. Some of the more colourful companies with short stints on the JSE included World of Music, Video Lab Holdings, Furniture Fair, Skirtskip Clothing, Ancom Jet Aviation, as well as food groups Juicy Lucy and Mighty Meat Holdings.
Others lasted longer, but eventually left the JSE after giving investors third-degree wallet burns — Toco Holdings, Ilco Homes, Oakfields Thoroughbreds, Saambou and Macmed should rekindle bitter memories.
Yet some famous (and infamous) stalwarts had their genesis in the late 1980s. Jannie Mouton’s PSG Group was built from a takeover of human resources specialist PAG; fruit farming group WB Holdings became AfroCentric; United Bank was a component in the formation of Absa; Ceramic Industries was incorporated into Italtile; and the Unispin share register was instrumental in the listing of Steinhoff. Glodina and Unitrans became KAP Industrial.
And some people made a killing. For example, a R10,000 investment in PSG when it listed in 1994 would today be worth R1.2m. And PSG was also the nursery for banking star Capitec — into which R10,000 invested in March 2002 would be worth a gravity-defying R15.3m today.
The poster child for the JSE’s technology boom, Dimension Data, was also listed in 1987. By 2000, it had grown into one of the JSE’s biggest listings, before it shrivelled up as investors grew sceptical of its aggressive acquisition strategy.
Incredibly, there are just four graduates from the Class of 1987 that might be awarded top marks for consistency over more than three decades: packaging group Bowler Metcalf, restaurant franchiser Spur Corp, motor vehicle retailer Combined Motor Holdings and consumer goods distributor Nu-World.
The point is, for ace stock-pickers, the late 1980s were when fortunes were made.
Demise of the retail investor
If you look only at the size of the market, you might not realise there’s a problem. After all, over a decade, the market value of all the shares on the JSE has tripled (though this is largely thanks to Naspers).
But dig deeper, and you’ll see that investors have far less variety and choice of where to put their money. And on the other side of the fence, there are also fewer investors dabbling in the market.
David Shapiro, Sasfin Securities’ deputy chair, says the "natural trade" — genuine investor participation in the market — "is shrinking".
It’s a factor that’s often ignored, but markets need a wide range of retail investors to operate efficiently.
Says McLachlan: "It’s actually the retail investors, the combination of thousands, if not millions, of people bidding [for shares] that creates price discovery and pricing efficiency and liquidity and does so many wonderful, healthy things in capital markets."
No wonder then that after a decade of economic underperformance, during which unemployment has peaked at 29% and disposable income has shrunk, there has been a slump in the amount of cash available to invest on the JSE.
And critically: what disposable income there is, is now being sluiced into exchange traded funds (ETFs) and unit trusts, rather than a portfolio of shares.
ETFs are, as investment behemoth BlackRock put it last year, "the most powerful investing trend of this century". While the 21st century dawned with less than $100bn in ETFs globally, this has now soared to more than $5-trillion — growing at nearly four times the rate of other funds.
It’s a compelling story: ETFs have democratised investment, slashing the cost of buying listed assets. Whereas 20 years ago you’d call your broker and buy, say, 10 stocks, today your financial adviser is putting all your money into cheap index trackers.
Shapiro says it’s a structural shift: as financial planners dominate investors’ money decisions, the retail investor trading his or her own shares has disappeared.
"The financial planners play it safe by going with the index, or funds that emulate the index. In that way they can’t be sued or leant on by their clients. What is the index? The big caps! So naturally the small-and medium-cap stocks are ignored. They linger in no-man’s land," he says.
This is a source of acute frustration for small listed companies and the few analysts, like McLachlan, who cover them. He says it underscores how the incredible success of ETFs has distorted stock markets. "Passive investing taken to the extreme is like a cancer on efficient markets," he says.
ETF advocates would howl in outrage at this. But McLachlan argues that passive investment inflows create markets that "reward size with size".
Consider this example: a highly valued large-cap business — such as Apple or Google — will have a large weighting on the S&P 500 index. But as passive funds push more money into these indices thanks to record low interest rates, valuations automatically rise. This creates a self-reinforcing cycle: the large company becomes larger, in turn attracting more passive money.
McLachlan says the goal of a listed company used to be growing sales; now it is simply to get bigger. If this sounds strange, he says, bear in mind that the core rationale of one of the largest corporate events in the history of SA and the JSE — the unbundling of Prosus from Naspers — was to become part of an index.
Prosus specifically planned to list on Amsterdam’s Euronext to become the largest European technology stock, which would make it part of the index. This would attract passive funds, helping to unlock the discount between Prosus and its outsize Chinese investment, Tencent.
Looking for solutions
So what will stem the delisting tide? The experts say it’s simple: economic growth.
Asief Mohamed, chief investment officer of Aeon Investment Management, says if SA’s economy begins to show meaningful and sustainable growth, the flows into the JSE will improve.
"The prospect of a bull market tends to solve all of these things. We’ve had poor growth for a number of years, so nobody’s been using the JSE to raise significant amounts of new capital to invest. If the tide turns, people will want to invest," he says.
Karl Leinberger, chief investment officer at Coronation, sees no need to panic. "We saw this back in the early to mid-2000s too. Some companies have been unduly punished, and they’ve been bought out by private capital and their own management.
"But that’s the cycle. We have a weak economy creating weak profits. Once we get growth again, it’ll change."
Fourie, too, is convinced that the JSE will get to a point where valuations become "appealing" again. "We have a bedrock of institutional investors and our capital markets punch way above our weight in terms of the size of our economy. We’re positioned, in terms of the WFE, as the world’s 18th-largest exchange by market cap," she says.
What’s more, even though the past five years might have felt like an arduous bout in a boxing ring, investing on the JSE has still made proper cash over the longer term. Says Fourie: "Real returns over the past number of decades, after inflation, have averaged 8%."
And while the picture might seem dismal now, just one decade ago it looked remarkably different.
Back then, US markets were flat, the dollar was weak — the rand was trading at around R7.40/$ — and emerging markets were flying. That year, the Alsi rose 28.6%. Thanks to the dollar’s slide, the local market rose 61% in dollar terms.
It’s a scenario that could easily be repeated — if the US economy wobbles, the dollar weakens and money starts chasing higher-yielding assets, then SA could get its GDP growth groove back.
Says McLachlan: "We have the highest real-yielding sovereign bonds in the world, so the moment that we [recover], money can flow in faster than people realise."
But for that to happen, SA must avoid costly mistakes. Overregulation, for one thing, could snuff out enthusiasm among smaller companies. Already, the JSE is considering extra listing rules to try to prevent another Steinhoff.
Fourie, who has a 25-year career in capital markets and a PhD in economic and financial sciences, is all too aware she needs to tread a fine line between tightening up rules and encouraging entrepreneurs to use the JSE.
"We are contemplating what we can do in the small and medium enterprise space to facilitate flow, but we are also looking to other spheres of growth," she says.
It’s an intriguing idea: using the JSE as a platform for small companies to tap into funding lines, in the same way they look to angel investors or venture capitalists to finance their growth.
And certainly, some of the JSE’s biggest listings booms came from similar ideas, such as the development capital market launched in the 1980s and the AltX in 2007.
Corporate advisers canvassed by the FM agree that backing local entrepreneurship will drive investment and trading activity.
Logan says significant success stories began on similar platforms. "A few great companies like Capitec and Afrimat have continued to deliver and relative newbies like Cartrack and Stor-Age appear to be potentially set to deliver further excellent returns," he says.
Finding another dozen Capitecs or Afrimats would do wonders to restore the JSE’s zest. And you’d be more likely to find the next "10-bagger" — shares that increase 10-fold in value — among the JSE’s small-cap offerings.
McLachlan says that of the 355 companies on the JSE today, 90% fall into the often-ignored small-and mid-cap category.
"Is there another 10-bagger in the space? Absolutely. Which one it is, I would love to tell you. Our risk in SA is that the next Capitec chooses not to list or lists on another exchange," he says.
Would you like to comment on this article?
Sign up (it's quick and free) or sign in now.
Please read our Comment Policy before commenting.