Alexander Forbes Preference Shares

Instrument:

Alexander Forbes Preference Share Investments Ltd

JSE share code: AFP

Price: 710c

Volume (average shares trade/month): 1 053

Perhaps people stay away from it because it’s difficult to understand, but Alexander Forbes Preference Share Investments (AFP) looks a clear winner for long-term investors at the current price. Each share in the vehicle gives a right to two different assets.

The first is a debenture — an unsecured fixed rate debt instrument ultimately issued by the Alexander Forbes operating company. The second is a redeemable participating preference share that gives the holder pro rata see-through economic and voting rights in a 26,5% equity stake in Alexander Forbes.

Valuing the listed instrument takes valuing each of the legs to it. The debenture is quite straightforward — with an R7,50 face value, interest is compounded semi-annually and capitalised at 17% a year until 2017 when it will be paid out to the unit holders. If we discount that by the prime overdraft rate of 10,5%, it works out to a present value of 940c per AFP share.

… the cost of buying the unit is more than covered by the debenture alone.

The only risk is that Forbes collapses and can’t meet the debenture obligations, but we think that’s pretty remote.

Assuming no discount for default risk, the cost of buying the unit is more than covered by the debenture alone.

Then there’s the equity part. This is harder to value. Alexander Forbes’ balance sheet contains masses of goodwill and intangible assets — the tangible net asset value is negative. So we turn to using profit ratios. Alexander Forbes has been profitable at the operating profit level, reporting R883m in the 12 months to September 2009.

The majority shareholder is private equity group Actis which is very focused on turning the business around. There are significant debt financing costs so the bottom line is negative, but on a five times EBIT basis (which is what nearest competitor Glenrand MIB is trading at), Alexander Forbes is worth R4,4bn. That works out to just short of R5 per linked unit. So between the debenture and the shares, the linked unit is worth R14,40. And that’s without any of the equity growth that Actis is focused on achieving.

It’s probably not a good idea to buy if you aren’t willing to hold until 2017, although we expect the price of the unit will converge with the underlying value closer to the expiry date.

It’s also a pretty illiquid share, but if you have some patience you should be able to pick them up at close to R7 per unit. That’s a 110% upside.

Investors Monthly – an essential read for every serious investor. It is the place to turn for considered opinion and investment advice that rises above the noise of the day-to-day. Brought to you by Intellidex and inserted in the Business Day newspaper every month.