ICT hardware and services company Mustek is a ubiquitous South African brand for buyers of computer and related hardware and software products.
The business is the largest assembler of personal computers in the country and, via its Rectron subsidiary, has a wide ICT reseller business in branded hardware, software and networking solutions, besides offering technical support and training
Mustek also moved into the green energy sector as there was significant growth in demand for solar solutions and alternative power supplies due to Eskom’s erratic performance. But as Eskom has recovered and load-shedding has eased, demand for green energy solutions has fallen.
Mustek, like the entire global technology sector, benefited from the step-up in demand for laptops and home office automation and peripherals as a result of Covid and the work-from-home trend in 2020. The replacement cycle is traditionally about five years and with the rise in AI-related services such as Copilot, ChatGPT and Gemini, there is hope that the coming upgrade cycle will bring demand for more powerful computing products because of the memory and processing needs of AI. Also, Microsoft is ceasing upgrades of Windows 10 in 2025, which should provide an upgrade push.
All this optimism has not yet been baked into the Mustek share price, as weak earnings, hit by a slide in green energy profits, weighed on it. The need to pare debt and inventory levels also affected the company.
However, not all is gloom and doom. An investor has apparently seen a glimmer of opportunity at Mustek over the past weeks.
The share price has rallied 50% since mid-July to a recent peak of R13.70, with significant share movement between long-established shareholders and a new nominee. Market watchers ponder whether the small cap is the next activism stock in play.
After trading at 800c in April, Mustek started to move higher from July 19 to its August 1 peak of R13.70. Since then, with the global market in turmoil, the stock has drifted back to R12.50 to value the business at R719m. But activity in the counter bubbles.
IM speculates that the unnamed investor that has suddenly accumulated a 23.09% stake in Mustek is eyeing the positioning of the company and its recovery prospects
From May 3 to July 26 a series of JSE Sens announcements detailed selling by established shareholders — mainly Old Mutual, which was at 26% in 2020 but has whittled down to just 4.65%.
The Mustek share had a flurry of movement in those weeks. Initially a Standard Bank nominee admitted that it owned a 14% stake, only for that holding to be shunted in late July to prime broker Peresec, which then disclosed a 23.09% stake in Mustek. Presumably Peresec is a convenient nominee for an entity, yet to be formally named — but market whispers abound.
In the past fortnight, trade in Mustek has been lively. IM ponders when the next Sens announcement will be and if the Peresec proxy will be named. Perhaps by the time this issue of IM hits the newsstands the wider market will have become aware of the identity of the underlying new shareholder, which has rapidly become Mustek’s largest.
Why has Mustek attracted sudden stake accumulation?
With a NAV of R27.25, the company trades at a fat discount. Further, the untimely death of founder and CEO David Kan in May 2022, aged only 62, potentially opened up the counter for corporate activity interest. The Kan Family Trust owns 17% of the company’s stock and IM has long been aware of rumours that the company and its management, bemoaning the low share price, have considered a management buyout.
With the passing of Kan, the financial wherewithal to undertake such a move has presumably dissipated. Indifferent recent results and a challenging environment may have stymied such a move, but could an external party now be sniffing around, sensing an opportunity?
Results for the year ended June 2023 showed that Mustek was starting to turn the corner from the Covid hangover, but domestic economic conditions continued to weigh on the company’s operational performance.
Revenue rose 14% to R10.1bn, with operating profit increasing 12% to R454.8m. However, profit before tax fell 9% to R292.6m as rising inventories and a 127% increase in finance costs from the Reserve Bank’s rate increases hit the company’s bottom line.
FY2023 was a period of two distinct halves. Interim results were 6.5% lower to 221.74c per share from a tough operating period. A reset in the second half, aided by growth in sustainable energy — which now makes up 20% of the business — and better management of inventory saw headline earnings per share (HEPS) for the year ended June rise 5% to 375c per share, and a final dividend of 77c per share was paid. The last abnormal results were in FY2021, when HEPS roared to 441.81c per share on the pandemic sales boom.
However, the seeds of weakness were sowed in 2023, especially at the November 2023 AGM.
A sudden slowdown in consumer demand for green energy solutions, a division that had rapidly become the growth node within Mustek, made earnings guidance slide. Ongoing high finance costs and a bloated inventory weighed on it.
In its trading update for the first half of 2024 in February, the company disclosed that a sharp slump in green energy and a softer consumer environment would result in HEPS falling 55%-65% for the period. Reported results issued on March 6 showed a revenue decline of 13% to R4.26bn, with operating profit down 25% to R180.6m. HEPS dropped 59% to 91.34c per share. Of concern was that inventory rose 17% to R2.4bn and cash on hand fell 45% to R2.451m, indicating the challenging nature of the ICT and green energy segments.
With the June year-end 2024 results ahead, IM believes some stability has returned to Mustek. Inventory in the past six months should have been reduced, especially in the green energy segment, though much more needs to be done to rightsize the business and its working capital demands. It may take a further six months to flush excess inventory through the system.
On the ICT and software side, Mustek’s business has slowed, but certainly not as drastically as in the energy solutions division. IM believes management is excited about the replacement cycle from both the government and the retail sectors.
In the government sector replacement was under way, though the election delayed some tenders. Government business is estimated to be 20%-30% of Mustek’s revenue, but only 17%-18% of the group’s. A greater move towards cloud computing and the increased need for data rooms present an opportunity.
On the ICT and software side, Mustek’s business has slowed, but certainly not as drastically as in the energy solutions division
IM speculates that the unnamed investor that has suddenly accumulated a 23.09% stake in Mustek is eyeing the positioning of the company and its recovery prospects alongside the fat NAV of R27.25. With the death of Kan, the lowly valuation the market has ascribed to Mustek is clearly the opportunity.
If Mustek were to revert to a five-year average HEPS, that would result in earnings of about 288c per share or a p:e of 4.3 — hardly demanding, given the nature of the business and its NAV support.
The first quarter of 2024, or Mustek’s third-quarter period, IM understands, has been reasonable to fair. The company was aiming to pare inventory and free working capital to reduce its finance costs, and there is a tight control on costs. In short, investing in Mustek now involves a lot of assumptions about inventory reduction, the trading improvement and interest rates.
After a dire first-half earnings profile, IM believes the market has now factored in a slide in like-on-like earnings to June 2024 and potentially no dividend, as the company aims to reduce its financial exposure. It is this baked-in assumption that may have attracted the interest of an investor and their recent accumulation of Mustek stock to make them the single-largest shareholder.
If IM is correct and a shareholder activist is now circling Mustek, what could the permutations be? Investors need to be aware of the impact of activists. Some are aggressive, pushing for value unlock and material business changes to improve shareholder returns. The more benign scenario is what IM calls the family office scenario. This is where an activist assists the company in restructuring, capital access and strategy in a nonconfrontational manner to work alongside management rather than be combative. The activist has a meaningful but nonthreatening stake and partners with management and family shareholders to revitalise the company. This is the win-win situation IM believes could be in play at Mustek.
Mustek’s earnings peak was in FY2021, and its share price zenith was at R18.05 in mid-July 2023. The FY2024 results will not be kind, given the terrible interim results. However, the sudden appearance of a 23.09% shareholder and the speculation on their intention will keep the Mustek share price bubbling, regardless of results.
IM cannot, at this stage, add much more to the Mustek story, as we, like the market, await the disclosure of the entity behind the 23.09% stake. However, activist investors have the money and the influence to change the direction of company strategy, and do more besides.
For retail investors in listed businesses, an understanding of the power that activists can bring to bear, and the historical context in which they have developed, could be invaluable when it comes to making money themselves.
IM maintains its standing special-situation recommendation on Mustek at R12.50 and awaits developments.
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