African Rainbow Capital Investments (ARC) is a listed investment holdings company on the JSE.

This little company has a net asset value of R11.44, whilst its share price is below R5. That’s a discount of more than 50%.

Sounds attractive right?

Yet the stock just crashed 14.82% in the past month.

And despite this crash – I still call it as one to avoid!

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What sent ARC down 15%?

ARC just told shareholders that it is doing a rights offer to raise capital.

It will sell eleven new shares for every one hundred in existence. And it is selling these shares at R5 a share to shareholders.

This means it is offering these shares at a 7.3% discount to the 30-day volume weighted average share price of the company.

And directly following this announcement the share price dropped further to 477c.

The company gave the following details about what it would do with the capital (R750 million):

• Capital for further expansion of RAIN Group
• Capital for further expansion of Tyme Bank
• Support for investment strategies of other fast growing investee companies
• New investment opportunities

Why is this bad for ARC?

Well this means that the current discount to net asset value will narrow.

In short, an investment holdings company like this wants to raise capital when shares are selling at a premium to net asset value. If it raises capital when it trades at a discount to NAV it comes across as desperate, or simply that management doesn’t care about investors, as this dilutes investors holdings in the company.

As a simplified example – if a company has ten shares worth R10 each, but with assets worth R20 a share (total asset value of R2000), it is selling at a 50% discount. Now, let’s say it issues two more shares at R10. That means its assets go up to a total of R220, and it now has twelve shares in issue, still trading at R10 each. But this suddenly means the asset value per share is now only R18.33, compared to the R20 it was before. This also means the 50% discount shares traded at has now narrowed to 45.44%.

In short – value for investors has been destroyed.

It also means that the new investments the company makes need to outperform to just recover the value that was lost because of the newly issued shares.

Deeper concerns with ARC

The company’s managers get management fees based on the net asset value of the company.

That means, irrespective of whether it is good for shareholders – management is incentivized to do a rights offer like this because it increases the assets of the company, and thereby the fees they stand to receive.

A month ago, in the company’s annual report it also suggested that it was considering delisting because of the big discount to net asset value.

This rights offer increases the shareholding of core shareholders, at the expense of minority shareholders. And if it is followed by a delisting – would prove to honestly be prejudiced against minority shareholder interests.

ARC’s two main investments, Tyme and Rain, are both in growth stages and will require further capital injections going forward.

The discount on ARC is likely to remain big. Unless it realizes value for shareholders by selling a significant investment. And that won’t happen soon as Tyme, Rain and Kropz, its largest three investments are far from mature businesses it can sell.

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