OPINION: EOH Holdings is healing, but …

JOHANNESBURG – The market is seemingly unimpressed by the cleaning up by EOH Holdings’ new chief executive Stephen van Coller. The news media also has a field day as accusations of wrongdoing and assumptions continue to fly in the face of the company.

But what is really behind the stock’s implosion? Are there perhaps other market forces in play causing an abnormal market in EOH shares?

EOH’s success story as measured by the strong growth in its share price eventually led to growth at all costs as its highly rated share price allowed it to overpay for assets with shares, resulting in goodwill and intangibles going through the roof.

Goodwill and intangibles as a percentage of shareholders’ interest grew to 74 percent in the 2018 financial year from 64 percent in 2013 and was 81 percent at the 2019 interim stage. Since 2014, 40-50 percent of the increase in capital employed was financed by borrowings.

While the company was able to achieve a return on the incremental capital employed of more than 15 percent or 50 percent higher than the prime overdraft rate in 2014 and 2015, margins were squeezed in 2016 and 2017.

In a rising interest rate environment the company was barely able to achieve returns higher than the prime overdraft rate. Total borrowings increased to 55 percent of shareholders’ interest in 2018, up from 35 percent in 2013. Borrowings were secured by trade debtors and cash and near-cash assets.

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The falling margins, increasing competition and untenable borrowings position put the company under severe strain. The company’s share price collapsed by 76 percent from R172 at the end of the 2015 financial year to R41.5 at the end of the 2018 financial year.

On 12 March last year, as part of a proposed BEE transaction to enter into a long-term strategic partnership with Lebashe, EOH would establish a R5 billion domestic medium-term note programme pursuant to which EOH notes would be issued by EOH and listed on the interest rate market of the JSE.

“Pursuant to the Lebashe Facility, Lebashe shall undertake to subscribe, at EOH’s request for EOH notes up to an aggregate nominal value of R3 billion ” This would have alleviated the debt burden of EOH as the company’s long-term and short-term borrowings reached R3.1bn and R1.3bn respectively at the 2018 interim stage. Yes, maybe the white knight had arrived.

It seemed that Lebashe and/or its financiers got cold feet though as the final transaction excluded the R3bn funding as envisaged in the proposed transaction. Instead, the agreement entailed a total equity investment of R1bn where Lebashe would initially subscribe for R250 million worth of new shares at a 10 percent discount and a subscription for R750m worth of new shares at a discount of 10 percent to prevailing market prices in 3 tranches over a 12-month period. Furthermore, 40 million “A” shares would be created by EOH and issued to Lebashe for a nominal sum of R1 in total.

The 40m “A” shares issued to Lebashe are effectively European call options which are exercisable four years from now at a strike price of R90 per share but the shares have voting rights as if they were ordinary shares. To date the total number of shares issued to Lebashe amounts to 22.494 million shares at an average price of R33.34 per share and consists of the initial issue and two of the three tranches of R250m each.

Lebashe is committed to hold the 7.371 million EOH ordinary shares subscribed for in the initial issue for five years after the subscription date. According to the circular to shareholders, in August last year the shares issued in the three tranches subsequent to the initial issue “will not be subject to any disposal or encumbrance restrictions ”

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The total number of shares subscribed for in the first two tranches amounts to 15.1 million. Lebashe’s current holding in EOH equals an average of two months’ volume (June 2018 to January 2019) traded in EOH on the JSE. Lebashe would have felt very uncomfortable when Microsoft South Africa terminated partner agreements with EOH in February this year, specifically after subscribing for 8.3 million EOH shares on December 11 last year.

At a price of R17 per share, Lebashe’s impairment on the shares already subscribed for is already more than R360m. It is reasonable to expect that Lebashe and/or their financiers would have and still are managing their position to limit losses.

Perhaps the tail that is wagging the dog or EOH’s share price movements at the moment is Lebashe’s obligation to take up the third tranche of R250m worth of shares before October 1, a year after the implementation date. The price will be at a 10 percent discount to the 30 day volume-weighted-average-price (VWAP).

No announcement of the take-up of the third tranche has been made on SENS yet.

Lebashe therefore has a call option to the value of R250m that can be exercised at any time until September 30 by issuing a notice to EOH offering to subscribe for EOH ordinary shares. The 30-day VWAP of EOH is currently sitting at R20 a share. At a discount of 10 percent it means that EOH will issue about 14 million new EOH ordinary shares to Lebashe.

Surely, Lebashe and/or its financiers are managing the obligation.

Should Lebashe issue the notice today or in coming days it will mean that the average price Lebashe has paid for its holding in EOH will be R27.50, spot on EOH’s net asset value at the 2019 interim stage.

But what about EOH as company? Will it survive the onslaughts? From the 2019 interim results it became clear that the company could be in serious trouble if it was not for the R750m capital injection by Lebashe. My “debt death cross”, when total borrowings exceed shareholders’ interest, would have set in.

The funds raised by the sale of 70 percent of CCS (R444m) and other asset sales of R110m in the next six months as well as the Lebashe’s pending subscription for R250m worth of shares are likely to underscore EOH’s net asset value of R20-plus per share. Yes, even after allowing for another impairment of one R1bn.

Van Coller and his team of advisers should be commended for what they are doing and achieved under extremely difficult circumstances. Allegations of wrongdoings and other negative news will probably continue over the next few weeks and are likely to work in favour of Lebashe.

At some point in the market, EOH shares will normalise. It is unknown what the situation with EOH shares is in regard to scrip lending or short positions – where money is made by selling an asset not owned by the seller.

The normalisation of the market in EOH shares is likely to lead to the covering of short positions and reversals of scrip lent.

As trust is earned, it may take a long time before the company may attain a market capitalisation of several multiples to its net asset value. What is certain though is that EOH is healing but when will the 37 percent discount to net asset value narrow?

uAt the time of writing, the author held no finwancial interest in Lebashe or EOH.

Ryk de Klerk is an analyst-at-large. Contact rdek@iafrica.com. His views expressed above are his own. You should consult your broker and/or investment adviser for advice.

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