Capricorn Hedge Funds Boost Bets on South African Firms: Q&A
(Bloomberg) -- Capricorn Fund Managers has increased its investments in companies in South Africa, signaling bullishness on the country’s new leadership following Jacob Zuma’s resignation as president.
The firm, which oversees $441 million in hedge fund and long-only assets from its offices in South Africa and the U.K., added to its positions in South African-based financial companies, Discovery Ltd. and FirstRand Ltd., as well as in retailers Shoprite Holdings Ltd. and Mr Price Group Ltd., according to portfolio manager David Cunio and co-Chief Investment Officer Emad Mostaque. It’s also investing in China’s Alibaba Group Holding Ltd. and military suppliers in Turkey.
Cunio and Mostaque were interviewed by Suzy Waite last month. Their comments have been edited and condensed.
Tell me about your firm.
Cunio: We launched our first South African hedge fund out of a family office in 2003. It’s now called the Capricorn Sanlam Collective Investments Stable Retail Hedge Fund, and has had an annualized return of 14 percent since inception. The long-short equity fund is down 1 percent this year through March 21.
In 2008, we launched our long-short emerging-market hedge fund. It has had net annualized returns of 7.9 percent since inception and was up 13 percent last year after falling 29 percent in 2016. This year, the Global Emerging Markets fund is up 1 percent through March 21.
Where are you invested right now?
Cunio: E-commerce is a big theme, particularly Chinese e-commerce, which we think is more sophisticated than in the U.S. and Europe. Alibaba is the behemoth of e-commerce in China. It’s able to capture much more traffic due to the breadth of its ecosystem and collect more data for its artificial intelligence-powered advertising engine. Its biggest and most potentially transformative foray is the attempt to digitalize the offline retail space, which is still over 80 percent of China’s retail sales. This will, among many other things, materially increase the pool for data and machine learning, which will enable even more sophistication in its advertising engine.
Alibaba makes up about 8 percent of our emerging-market fund. We think it will become a trillion-dollar company and beyond. It’s rare that one has such a big growth opportunity with so much optionality in a company that is already so big.
Mostaque: Alibaba is now automating its warehouses. We think it will achieve the target of getting orders delivered within 30 minutes for the vast majority of the most populated cities. For some of its more sophisticated HeMa supermarkets, it already only takes 30 minutes for online grocery delivery. There’s currently around only 30 of these stores, but we expect more to be rolled out much quicker than expected. China has capacity for over a thousand of these stores.
What are some other themes you like?
Cunio: Private education in South Africa. South Africa’s government has struggled to provide state education of any quality. There’s 40, 50, 60 kids in a class and some teachers don’t turn up to work, so there’s an enormous opportunity for affordable private education in South Africa.
We’re invested in Curro Holdings, a private education provider, and Stadio Holdings, which specializes in postsecondary education. Both companies are still in the early stages, but are redefining affordable private education in South Africa. They may be expensive, looking at traditional earnings metrics, but we think there’s a substantial opportunity for many years to come.
South Africa has been bleeding from an economic and social perspective, and has suffered from low business confidence. Following President Zuma’s resignation and Cyril Ramaphosa coming in as the new leader, there are many positives that can come from the improved economic momentum. The appointments of Nhlanhla Nene as finance minister and Pravin Gordhan as the man to restore respectability at state-owned enterprises also signal better governance ahead. As a result, there’s a reasonably good opportunity going forward to invest in South African companies that have been under-owned and unloved for many years.
What sectors will benefit under a Ramaphosa administration?
Cunio: Mining is low-hanging fruit in terms of improved legislation or even just the removal of the threat of extreme legislation. The much maligned Mining Charter is already up for discussion again and any improvement will boost investment. However, if the rand keeps strengthening it will provide some challenges to many companies, especially miners. But those that have the most robust fundamentals operationally will still be the ones to invest in and should benefit from any improvement -- perceived or actual -- in the regulatory environment.
We like companies that are more directly exposed to the South African economy. We covered some of our shorts and increased our long positions in insurer Discovery, supermarket operator Shoprite, industrial conglomerate Bidvest Group, retailer Mr Price Group and lender FirstRand.
Where are you short?
Cunio: Physical retailers that have defunct business models and management teams incapable of turning them around. The same dynamic is playing out in the media space. With Netflix and Amazon Prime providing better quality video on your own schedule, traditional television channels and media just can’t compete and will struggle. This will make a ripe environment for M&A.
It’s happening with Fox, Sky Plc and Comcast Corp. Amazon and Netflix will continue to penetrate emerging markets. Outside of the U.S. and Europe, Mexico is one of Netflix’s largest countries in terms of subscribers.
What other countries do you like?
Cunio: With America withdrawing from the international stage, every country has had to take stock of where they are and what their military aspirations are. No country is that more evident with than Turkey. It’s the epicenter of where wacky stuff is happening in the world, with Syria, Iran and Iraq all on the border. It’s massive with about 80 million people. There is a lot of political unhappiness and tension so you have to be careful. But it’s a young, vibrant and sophisticated economy in a perfect geographic location with a low cost of labor in terms of exporting, and they’re improving what they actually make.
One of President Erdogan’s big initiatives is to increase Turkey’s military power and boost Turkish-made components through their manufacturing chain. Due to Turkey’s structurally high current-account deficit and rather than importing expensive technology and products from overseas, he wants to build a domestic Turkish industry to supply the growing demands of his own military. Aselsan Elektronik Sanayi is the most well-known company that does this and it has helped grow a domestic industry practically out of nothing. Some names will be five-to-10 times their size in years to come. I won’t give specific names, but we are invested in some military suppliers in Turkey.
Mostaque: Another plus for Turkey is foreign ownership is low, and if you can play structural themes correctly, it makes it easy to construct a book.
What countries are you avoiding?
Cunio: We have zero South Korea exposure. We’ve never had a good experience with South Korea.
Mostaque: Now if the Koreas unite, you can be sure we’ll figure out a way to play Korea because that would become one of the biggest investment opportunities of our generation. It’s inevitable that they will unite at some point, especially after sending a joint ice hockey team to the Winter Olympics. I think in the next few years, they’ll do a 100-year experiment like what was done in Hong Kong, and they’ll reunite in the next 100 years and let the next generation figure it out.
Tactically and strategically, that’s the optimum outcome. It gives Kim a huge shield, he’ll get massive investment coming in and he gets to put a Disneyland in North Korea.
One would expect South Korean stocks broadly to benefit as well, particularly consumer and tech companies. It would also be dependent on the nature of the deal, but there is clearly significant infrastructure to be built which would benefit real estate and construction companies.
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