Description

GP Investment.  A Brazilian PE leader trading at 60% discount to NAV

GP Investment was posted on the board twice at the end of 2014, by skw240 and briarwood988. I go through the fundamentals again as I believe the investment case is even more attractive now.

I - The big picture

II - What has happened to the stock price?

III - Potential inefficiencies and interesting catalysts to unlock the value

IV - How does the current NAV look like?

V - Conclusion

VI - Appendix: Spice investments (The Rimini case + Bravo Brio & The craftory)

I - The big picture

GP Investments is one of the main Private Equity funds in Latam. Based in Sao Paulo, the company was founded in 1993 by the trio Lemann, Beto and Sicupira. The listing in 2006 provided the company with permanent capital to invest alongside the funds it manages. GP Investments had raised over $5bn capital since inception from external investors, mainly invested in controlling stakes of non-listed Latam businesses with an active management approach. Over the last couple of years, GP has also been investing internationally. The company uses its own balance sheet to invest in the funds it manages, aligning its interests with those of investors. They also hold direct stakes in some companies which make NAV approach more appropriate to tackle valuation.

Since inception, the track record of the various 5 PE vintage funds looks decent overall considering all Latam macro challenges. The table below sums up the different funds followed by relevant comments:

-     The performance of the first two funds GPCP I and GPCP II was more than satisfactory given the context of the Mexican peso crisis (1994) and the Emerging Markets/Asian Financial Crisis.

-     The following funds GP Tech & GPCP III had an outstanding performance in an overall very supportive economic context.

-     However, the latest two funds GPCP IV et GPCP V, which are still running, suffered from a couple of bad investments (LBR, San Antonio), despite some very good achievements (Sascar, BR Towers, Magnesita, Par Corretora). Overall, the macro context in Brazil has been rather weak during that period.

II - What happened to the stock price?

The stock used to trade with a 50% premium to NAV. The market was willing to buy the value creation potential from the good management team following the success of the first funds. However, following the Brazilian crisis, the premium has progressively disappeared with the stock trading today at a historical low discount of 62%. The economic crisis in Brazil and the loss of confidence do probably justify most of the derating. But one can also argue that the bad investments in LBR and San Antonio that GP bought with the intention to restructure but failed to do so have been detrimental to the excellent reputation that the management team enjoyed till then.

What happened to GP is somehow common to the Asset Management industry. The company raised a lot of money for GPP IV and GPCP V following their excellent track record and was forced to invest rather quickly at market peak levels just before the market collapse.

With the stock trading well below NAV, the company did the right thing by using a a big portion of its net cash to implement a very aggressive buyback. Between 2009 and 2015 GP Investments bought back 34% of the market cap.

III - Potential inefficiencies and interesting catalysts to unlock the value

I highlight three potential catalysts that could help narrow the current discount. I will come back on these elements in my detailed NAV analysis below in which I will go through all the assets in detail. To keep it short:

-          At the balance sheet level, GP could continue the bond buyback given the gross cash position. With a dollar denominated debt and the majority of the assets in Brazil the balance sheet looks inefficient. All the recent investments have been done outside Brazil and mainly through the listed Swiss arm Spice which somehow helped compensate. The expected cash-in of Magnesita shares (22% of NAV) could be used to call further debt.

-          Spice (26% of NAV) has been the main investment vehicle of GP in the last couple of years since GP took the controlling majority of the listed Swiss vehicle. However, with Spice itself trading at 36% discount to NAV there is an implicit double discount applied to all new investments carried through Spice that prevent value crystallization. Spice had recently announced that it plans to pay a $5m dividend in 2019 that will be raised by $0.5m in 2020 and in 2021. Translating into a 3.25% dividend yield for GP that may further help lower the discount.

-          Centauro’s IPO could unlock significant hidden value. Given the implied valuation discussed by the brokers USD 700-1100m, this asset alone (14% of the reported NAV) would account for more than half the current market cap!

IV - How does the Current NAV look like?

GP Investment has always been very conservative when reporting its holdings that are often accounted for at or below invested capital for the non-listed portion. On the fifth column (Target NAV) I make 3 upward valuations to GP’s reported valuation on Spice, Centauro, and Brz Investimentos that I will justify below. The current NAV can be split into five blocks:

(1)    Listed portfolio (58% of reported NAV)

• Spice (26% of reported NAV): GP Investment holds 58.5% of Spice, a listed Swiss Private Equity vehicle. They have been gradually increasing their position while liquidating the legacy portfolio of Spice and using its cash pile to co-invest alongside GP with a wider scope.  Spice’s current NAV stands at $230m with more than half of it comprised of cash & receivables ($119m).

i.       Legacy portfolio still represents 20% of Spice’s assets. It is mainly consisting of PE funds in emerging market as well as some companies where Spice invested alongside GP like Magnesita and Centauro (discussed below).

ii.      Under GP management, Spice invested in Leon, the UK healthy fast food chain that seems to be doing very well despite the difficult environment for the restaurants market in the UK. Recent like-for-like sales are positive and the company has opened 9 new restaurants in the UK and is progressively expanding in Europe through franchise agreements. GP is well positioned to help Leon foster its internationalization. For the record, the previous GP investment in the restaurant sector was the Brazilian Steak House Fogo de Chao that resulted in an IRR of 24% and a cash on cash return of 3.4x following the successful listing in the US.  

iii.      Spice has also a stake in Rimini Street, a strongly growing (+30%) third party ERP maintenance provider (13% of Spice’s NAV).  Spice owns 5.1% of Rimini Street and co-invested alongside GP (2.5%) using a SPAC structure. This explains why the asset is reported both at Spice & GP level. This is a “special situation” case. I explain in the appendix the whole story behind this acquisition. For the quick picture, Rimini is trading on a fully diluted basis at 10x adjusted Ebitda following the 20% decline since the listing. This is clearly a bargain given: (1) the current 30% growth (2) adjusted Ebitda margin strongly growing and reaching 40% in the latest quarter (3) a higher acceptance of third party maintenance business model.

Without any upward valuation adjustment on Rimini, Spice currently trades on a 37% discount to NAV (of which half is cash).

Update: Spice has recently made 2 new investments that are not yet in the reported figures but look promising. I also discuss them in details in the appendix for relevance.

• Magnesita (22% of reported NAV): I will not elaborate much on this investment since I believe that we are nearing the period where GP could cash-in. Magnesita is the 3rd refractory producer worldwide (5% market share) that merged with its Austrian competitor RHI (9% market share). The new global leader successfully listed in the London Stock Exchange which made share rerate following a better visibility/liquidity and good synergy prospects. GP may use the end of the first lock-up agreement next October to monetize this investment. The new entity is still trading at modest multiples despite the rerating (6.2x EV/Ebitda, 9x PE, 10.5% FCFy in 2019). I consider this investment at current market value.

• BR Properties (6% of reported NAV): One of the main commercial REITs in Brazil with a BRL 7.5bn portfolio mainly comprising of well-located office space in Rio de Janeiro and Sau Paulo. NAV stands at BRL4.7bn while market cap is BRL4.4bn.

According to the financial statements, the assets look conservatively valued in the at 8.5-9% gross cap rate on average. The conclusion from a discussion with a local real estate agent in Sao Paulo is that the portfolio of BR properties is overall well located, with cap rates for this kind of assets currently more in the range of 5.5-6%.

Rents have been depressed by the crisis while vacancy is nearing 25%. With conservative leverage (30% LTV), we are getting exposure to a quality portfolio that could significantly rerate with better macro in Brazil.

(2)    Private portfolio (27% of reported NAV):

•       Centauro (14% of reported NAV) is the largest sporting retailer in Brazil with a 5% physical retail market share and a presence in the 10 main Brazilian cities. The company has invested in an e-commerce proposition that now accounts for 15% of sales and is growing at a double-digit rate along with same store sales. Over the last 5 years, the company did grow an average CAGR of 19% (vs 8% for the sport retail sector in Brazil that is still projected to grow at the same pace). It distributes the main sports brands (Nike, Adidas, Puma...) often with exclusivity, while private labels account for 20% of the mix.

Centauro developed many omni canal synergies under GP’s ownership to enhance customer experience (click and collect, inventory visibility, buy online & return free in store, average delivery time of 1.5 day…). The company has also reduced its cost base, significantly lifting its Ebitda margin from 1.3% to 9.6%. GP’s 10% stake is still reported at 0.8x the invested capital (8.5x EV/EBITDA). I adjust valuation upwards using 1.3x EV Sales multiple that still doesn’t seem very bullish given the growth prospects, thus lifting the current stake from USD47m to USD70m. The company has filed for an IPO that should now be a matter of timing. The best window of opportunity should be in early 2019 following the elections. The company is seeking to raise proceeds in order to refurbish some stores and build new ones under the new format. The new stores, more focused on enhancing customer experience, are displaying 34% increase in turnover. Their progressive roll-out should therefore be supportive of pricing the deal. A key catalyst in my view.

• EBAM (4% of reported NAV) is the largest Brazilian supplier of mineral aggregates in volumes. Performance has been rather sluggish given the macro context. GP has been gradually revising down the valuation. The subsidiary is currently valued at 0.5-0.6x invested capital.
  
  
• Brazilian Hotel Group (6% of reported NAV) is the third largest hotel owner in Brazil. The company was delisted by GP following a takeover in 2014 that valued the whole company at around 8.5x Ebitda or R$1.1bn - USD411m (using 2.6 USD/BRL). Recently, BHG has reached an agreement with Accorhotels to sell management right on 30% of its assets (4.4k rooms) for R$200m, USD60m to Accorhotels. On the basis of this recent deal, the implied valuation for BHG is R$865m - USD220m which look close to current reported total valuation at 6x 2017 EBITDA given that GP’s 8.6% direct stake in BHG is valued at R$73m - USD19m in the current NAV. However, one should consider that this value is very conservative as it is only based on a 20 years management right agreement. The real estate is owned by BHG. The current reported value is 50% that the 2014 takeover value in USD and 20% in BRL.
  
  
• Beleza Natural (3% of reported NAV) is a beauty/hairdressing chain that specializes on the Black Brazilian women.  Under GP ownership, the number of stores went from 13 to 35, but the consumption crisis has put a dent on the growth for the last 3 years obliging GP to implement cost cutting initiatives. Belaza Natural is also opening a first store in New York on July 18. GP’s stake is conservatively reported at 0.6x invested capital.

(3)    Asset Management business & Real Estate Portfolio (8% of reported NAV)

• The Asset Management business (BRZ Investimentos) is currently valued close to zero on the reported NAV ($0.6m), while the company has around R$3.4bn (USD0.9bn) assets under management consisting mainly on pension schemes of long term institutional clients that are mostly invested in credit funds. The company generates USD 1.5m per year net profit on average after tax. Putting a 10x PE multiple would lead to a USD12.5m value for GP’s share (83%);
  
  
• Real Estate Portfolio. The real estate portfolio (mainly residential and mixed use) is valued at 0.6x invested capital.

(4)    Cash Debt & other receivables (8% of reported NAV)

On the latest reported NAV, GP has $100m cash and USD170m perpetual callable bond paying 10% coupon. The company has recently used a portion of its cash to partially call $30m of the note. $140m of the bond is still currently floating. This operation makes sense and will help lower the cost of capital since GP is paying 10% USD Interest on the perpetual note and had no further room to buy back shares given current liquidity. GP has also $95m of other receivables that could be considered as cash proxy (mainly receivables from funds that are to be received with next divestments, money held in escrow accounts for previous divestments, expenses incurred that will shortly be reimbursed, some loans to employees…)

V - Conclusion

All in all, GP Investments is currently trading at 62% discount to NAV. The potential catalysts mentioned above should help lower the discount provided that they materialize. Very often, the discount on this kind of holding companies can be justified with the tax liability that the company might pay when liquidating the NAV or by the management fees that, if compounded over a long period, may constitute a drag on valuation. There is no such issue with GP Investments given that the company is incorporated in the Bermuda with favorable tax treatment while the revenues collected from managing the private equity funds fully cover the management fees, bonuses, and holding expenses.

VI - Appendix: Spice investments (The Rimini case + Bravo Brio & The craftory)

The Rimini Case

Rimini Street is a third-party ERP maintenance provider held by Spice & GP. The business model is quite simple. When software companies such as Oracle or SAP launch a new product, they would usually take care of the maintenance, charging the client a very high margin for the maintenance part. However, as they launch new features and upgrades, they become more interested in selling the new version rather that the 1 or 2-year-old previous one (in order not to cannibalize their original business). Nevertheless, some customers don't see the necessity to overpay for new software while the existing one fully covers their needs. Rimini Street contracts with these customers in order to take care of the maintenance and tailor the ERP to their specific needs at a cost that is 50% lower than what Oracle or SAP would normally charge.

Actually, the SPAC managed to benefit from a special situation. In 2011, the company has been sued by Oracle who claimed that Rimini Street doesn't have the legal right to provide those kind of services + that the company is violating some intellectual property. In 2016, Rimini Street was forced to pay $124m to Oracle as the course recognized the intellectual property infringement case but the court verdict didn't prohibit or restrict Rimini Street from doing their third-party service business (including Oracle customers). That was a kind of validation of the business model.

However, as Rimini Street didn't have the money to pay the fine, they were forced to issue a very expensive debt of $170m with very tight covenant an a very high interest burden (around 15% + many other fees). For this reason, they have been looking for an equity injection to ease the financial structure and agreed to enter this transaction with GIPIAC. Furthermore, doing this kind of transaction with a SPAC allows the company to be listed on the NASDAQ (since the SPAC is listed and would take the name of Rimini Street) and therefore have a better perception of the business giving more credibility to the company following the case with Oracle.

The transaction valued Rimini around 11x adjusted Ebitda and 6.5% Free Cash Flow yield (adjusting for the high interest cost and normalizing taxes). Which looks a bargain given: (1) the current 20-30% growth (2) adjusted Ebitda margin strongly growing and reaching 40% in the latest quarter (3) a higher acceptance of third party maintenance business model.

Following the listing. Rimini has just announced two good news that I perceive as catalysts for potential normalization:

a)       The court reversed certain awards made in Oracle’s favor stating that Rimini “provided third-party support for Oracle’s enterprise software, in lawful competition with Oracle’s direct maintenance services”. Rimini Street is therefore receiving a $50m refund from Oracle.

b)      Rimini Issued a $140m a redeemable convertible preferred stock (still paying a 13% dividend for 3-5 years) that will materially ease the debt burden and the covenant that restricted Rimini to incur additional marketing expenses to fuel growth. Accounting for full dilution (and if Rimini choose not to pay the dividend and convert later the preferred stock into a higher number of ordinary shares), the stock would currently trade less than 10x Ebitda following de 30% decline since the listing.

Bravo Brio Restaurant Group

An "upscale affordable dining" Italian chain with 110 locations across 32 US states. They paid 4.05$/share valuing the company at $100m EV which represent a 35% premium. The company has $60m market cap and $40m net debt. Valuation rations stands at 0.25x sales and 3.7x Ebitda.

The asset has been trading at a depressed level for some time with dreadful reported same store sales variation:

Ebitda margin stands at 5.6%, lower than the 10-12% they used to achieve back in 2007-2014. They target to close 5 locations this year. This is clearly a restructuring case as well-sized restaurant chains tend to display Ebitda margin well above 10%. Spice is expected to leverage its recent experience in the sector with the LEON acquisition last year that seems to develop very well. Furthermore, GP successful track record in the sector with the development of the Brazilian Steak House chain "Fogo de Chao" listed on the Nasdaq in 2015 (24% IRR, 3.4x cash on cash) should help as well.

The craftory

A $300m platform vehicle designed to support challengers’ brands looking to disrupt established consumer goods. This investment is still at commitment stage with limited disclosure (Spice expected to commit $60m). Over the last five years, the organic growth of many major FMCGs like Unilever, Kraft or Reckit, has been flat while they’ve been trying to compensate with mega-mergers fueled by cheap debt, suggesting that these big mammoths find it harder to adapt to changing tastes and behaviours. The idea behind this game is to endorse an anti-corporate / anti-VC model to foster creativity, flexibility and storytelling.

Catalyst

• Centauro's IPO
• Balance sheet optimization
• Spice dividends' increase