Why, counterintuitively, the most lucrative investments are often in countries where doing business is tough…

business-man-climbing-stairs-investment

The reaction from some businesspeople here in Tanzania when I tell them I have set up an investment fund, which currently has about 35% of its assets earmarked for investment in Tanzanian stocks is, “Why on earth would you want to invest here?!” We have trouble getting anything done. The investment climate is a nightmare. 

They will tell you that doing business is hard. The rules and regulations are cumbersome. Taxes are numerous and complex. Put a foot out of line, for example not having the right kind of fire extinguisher in the right location in a safari lodge room, and the fines are astronomical. 

Ambit tax assessments where the government goes for 1/3rd of your sales, never mind what your expenses throughout the year have been, are also a common tactic – so I am told. Delayed payment of VAT refunds by the tax authorities is also an issue, which I became aware of by reading the annual accounts of one of the locally based gold mining companies, publicly listed in London.

I have not heard the government’s side of the story. I also have not read all the rules and regulations and tax laws. I am sure the government has the law on its side. But it certainly seems the law may be unnecessarily cumbersome in certain cases.

However, as a portfolio investor in large, entrenched, publicly-listed companies, this difficulty of doing business actually works in my favour in many ways.

I am not trying to be an entrepreneur. That WOULD be difficult.

I am investing in the companies that DESPITE all the difficulties of doing business here, and the headwinds they may be encountering, are STILL surviving and thriving. Usually that means the biggest blue-chip companies that are still making money hand over fist and running successful businesses, in spite of the obstacles in their way.

These are the survivors. They are the strongest of the strong. It is precisely because the conditions are not easy that these companies are able to earn the outsized returns on invested capital that they do. It means successful competitors are few and far between.

The dominant companies here have stood the test of time. They’ve persevered and succeeded, as their competitors fell by the wayside or gave up in despair.

Most people are simply focused on the wrong things when assessing
the investment case for publicly traded stocks in Tanzania

They seem to look at the business conditions they face, or might face, if they invested in a small start-up company here. That’s not what I’m looking at, at all, other than to validate my thesis that, for new competitors, taking market share from the stalwarts is very difficult.

My aim is to buy a small piece of the very best existing businesses in the country run by the most competent and ethical management teams, and, in essence, be a small minority partner with them where I can. Acquiring small stakes in “wonderful businesses, at fair prices” is what we’re aiming to do.

It is a formula that has worked very well elsewhere in the world, for the likes of Berkshire Hathaway, steered by Warren Buffett for the past 55 years. 

Alas, many of the most successful and prominent companies in Tanzania are privately held, for example the Bakhresa Group and Mohammed Dewji’s METL Group. So, for the few superior businesses we can access via the Dar es Salaam Stock Exchange, we must make the most of the opportunity. 

My African Lions Fund is building a sizable stake in one such company, which has a monopoly on both stock and bond listings and trading in the country, namely the Dar es Salaam Stock Exchange itself. 

There has been a sizeable shareholder exiting, and we’ve been buying up some of what they had to sell. By the time all is said and done, we hope to control over 5% of the company. 

I view the current share price as not just “fair,” but as a steal. The exchange has the monopoly on stock and bond listings in Tanzania. It earns listing fees, transactions fees, and registry fees, as well as income from operating the Central Securities Depository (CSD), which is a fully owned subsidiary.

These are the exchange’s core businesses. They require only a limited amount of capital. The return on capital is correspondingly high. However, the exchange also has a large portfolio of excess cash and fixed interest investments on its balance sheet, which are not really required to run its business. 

This is a legacy of two things: 

    1. The company going public and raising capital that it did not really need at its initial public offering (IPO). 
    2. Greater returns on its investment portfolio and core business activities than it has paid out in dividends over the years. There is a huge amount of “retained earnings” on the balance sheet.

This year, shareholders already approved hiking the dividend payout ratio to 50%, in order that the company could declare a larger than usual dividend. At the company’s annual general meeting (AGM) shareholders duly approved the payment of a TZS 74.46 per share dividend out of the 2019 earnings per share of TZS 148.92. 

Based on the current share price of TZS 880, that places the stock on a historical dividend yield of 8.5% and a historical price to earnings multiple of 5.9 times. 

By contrast, The Australian Securities Exchange trades on more than 30 times earnings and a yield under 3% and the Hong Kong Stock Exchange sells for nearly 50 times earnings and yields less than 2%. Euronext, which operates most of Europe’s stock exchanges and Intercontinental Exchanges (ICE) in the USA each trade on P/Es in the low to mid-20s.

You get the idea. The DSE is trading at a small fraction of its potential future valuation.

Why you can expect more big cash dividend payouts from DSE

As there is no real requirement for all the excess cash and short-term investments on the DSE balance sheet to keep the business running, I expect there is a chance for continued high dividend payouts. 

In fact, I would not be surprised at some stage to see the company declare a sizable “special dividend.” A precedent for this was recently set by another listed company with a cash-rich and lazy balance sheet, Vodacom Tanzania. It recently declared a special dividend of more than TZS 178 from shares that were quoted at TZS 810 per share before the special dividend declaration.

I estimate DSE could easily pay a similar dividend, of up to one quarter of the share price, at least, without affecting its solvency or capital requirements. Even if that doesn’t happen any time soon, the company will continue to earn a near risk-free return in the high single digits from its cash and bond portfolio. 

I think Dar es Salaam Stock Exchange is about as safe a stock as you can get. 

  • It’s a monopoly. 
  • It has zero debt. 
  • It enjoys guaranteed, annuity-like income streams, and 
  • It has the government as a significant minority owner and partner.
DSE-CSDR buiding
The DSE is located in a building owned by the National Housing Commission -- who is also the constructor for the exchange's permanent home. They are using this building free of rent and due to delays in construction of the new building, their rent-free agreement is extended.

There is much to like about DSE. And that’s why we have bought it and intend to hold it as a core position in the African Lions Fund.

The one drawback is the stock is not very “liquid.” That is, it’s not easy to buy and sell significant quantities of it, without disturbing the price. I don’t view that as a major problem. 

We have been fortunate that there has been a seller of sizable amounts of stock around, just as the African Lions Fund began its existence. Though, that said, my timing is actually quite deliberate, to be starting this fund when others are more likely to be selling than buying. It’s playing out just as I expected so far.

As a result, we got a good foothold in DSE shares at what I see as a bargain price. The DSE is also the sort of stock I can foresee almost no reason to ever have to sell, barring some totally unforeseen event, such as the Tanzanian government rolling back all modernization reforms and going back to the socialist ways of 50 years ago. Clearly, I don’t see that ever happening.

Finally, as I have written before, the DSE is a great way for international investors such as us, who cannot directly buy high-yielding Tanzanian government bonds (the market is closed to us for now), to get exposure to the fixed-interest market here in Tanzania.

Until next time,

Good Investing!

Tim Staermose
Founder
Global Value Hunter
& African Lions Fund Ltd.

P.S. There is one other way for non-East African Community (EAC) investors to get exposure to the Tanzanian government bond market. I’ll be writing about that soon. 

P.P.S. My friend Swen Lorenz recently wrote a comprehensive report on the company that operates the Warsaw Stock Exchange. For a comparable analysis of other publicly traded companies that operate stock exchanges around the world, you might like to read it. Swen charges a modest $49 per annum subscription fee. I myself am a subscriber and I make nothing from mentioning his site. But some of you have come to know me via him and you know that his research is worth many times the subscription. 

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