magic markets ep197: GNU follow-through – are businesses changing?

The GNU-phoria in South Africa is now a few months old. Loadshedding is becoming a distant (albeit still painful) memory. Sentiment has clearly turned positive, but is this making a difference in day-to-day business decisions around capital allocation decisions?

Every day, the team at Westbrooke is having discussions with private business operators and investors. Dino Zuccollo and Jonti Osher joined Moe and Ghost on Magic Markets for this important discussion. .

This podcast is for informational purposes only and is not financial or investment advice. Please speak to your personal financial advisor.

The Finance Ghost: Welcome to episode 197 of Magic Markets. I’m sitting in a very, very, very windy Cape Town. Everyone on the show today is sitting somewhere a little bit different, hopefully not being blown away. Moe, you’re all the way up in Canada as always. It’s a holiday there today, so thanks for making the time to do this – and it’s because we have such esteemed guests and we’re very happy to welcome them back to Magic Markets. We’ve learned so much from the team at Westbrooke over the past couple of years, and it’s always great to check in with them on what’s happening out there in the world of alternative investments and private deals and all the rest.

Dino Zuccollo and Jonti Osher joining us today – thank you guys both very much. But before we welcome you formally, Moe thanks for joining on I think you said Thanksgiving. I can barely keep track of South African public holidays, so it’s hard enough to keep track of yours as well.

Mohammed Nalla: Yeah, Ghost, the downside of living up here is that I tend to work on Canadian holidays because South Africa is working. And when you guys are enjoying a nice holiday down in South Africa, well, I tend to work as well because Canada is not on holiday. So that’s the downside of living up here. And again, just so you know, a shout out in terms of my level of commitment to Magic Markets and the team that we’re about to welcome from Westbrooke, Dino and Jonti, today is not just a holiday – it’s also my wife’s birthday! So I can tell you the fact that I’m working and doing this podcast rather than taking her out for a nice fancy lunch that might not go down as well as the show might go down, but it’s testament to what we are discussing today because I’m really excited about the topic we’re jumping into.

I’ll tell you why. As a South African sitting abroad, I read a lot of the headlines around this government of national unity and all of the optimism that South Africa is now feeling. And it’s very different to the South Africa that I left, call it five years ago thereabouts, where there was a lot of negativity. And so what we want to really get into today is let’s look at that, let’s see if there’s any substance behind that. What does this GNU mean for investors? What’s it meaning for businesses on the ground? And this is very important because it’s going to inform whether we actually see a sustained uptick in terms of the investment climate in South Africa. What does that look like and what does that mean for consumers and just the overall risk appetite?

So with that as the primer, welcome to Magic Markets Dino and Jonti from Westbrooke.

Dino Zuccollo: Thanks very much guys. It’s a pleasure to be here and happy birthday Mrs Moe. And Moe, you’re doing a great job of selling Canada by the way. The listeners can’t see the size of the thick jacket that you’re wearing, inside your house as well.

The Finance Ghost: Moe likes to put the hard in hard currency. This is basically just a reality for him.

Mohammed Nalla: This show started out as the blue hoodie show, right? So today I decided to go with a black hoodie. The weather certainly turning, it’s now fall so everything’s nice and orange outside. But on that basis, yes, it’s getting colder. And I can tell you it’s not cold by Canadian standards, but by South African standards it’s about eleven degrees outside right now. So not too bad. But yeah, it’s going to get a lot worse. So if we record one of these closer towards the tail end of the year, I’m hoping to do that from a nice sunny South Africa.

The Finance Ghost: Speaking of which, let’s dive into that sentiment here. I think Jonti, let’s start with you because you’re speaking to a lot of the borrowers out there. Effectively, you are speaking to the business owners who are looking for capital, who are out there taking risk, making decisions. We read about a business confidence index and how people feel about the place. This should in theory drive them to want to take risk and borrow money and look for growth and all of the wonderful things that grow our GDP. If that is not happening out there, then things are not going to improve for South Africa. So, the million dollar or million rand question to you is: are you seeing some improvements in the past few months? Are South Africans feeling better out there and are they borrowing money?

Jonti Osher: Ghost and Moe, it’s great to be here. I think from that perspective, sentiment is what we’re talking about at the moment. And we’ve definitely seen a shift in sentiment from, call it at the beginning of the year where the businesses we were speaking to, their objectives then were either not invest capital because it’s uncertain, the political environment specifically, and the economic environment, but also not even that – it was how can I get as much capital out of my business to take offshore to hedge me against that?

And that conversation has quickly moved from “How do I get efficient capital now to take advantage of what many people believe is going to be a positive economic cycle driven by a few things?” to taking the positive sentiment and converting that into opportunity. And I think it’s very important from our perspective, we’ve noted the sentiment change, which obviously brings about a lot of discussion, opportunities, ideas. I think what we obviously have to wait for is how that converts into, call it business growth and cash flow. What’s very important there is it actually does take some time for that sentiment to work its way through the system. And for us as capital providers, we can provide capital against cash flow, current cash flow at a cost of capital, or capital against future cash flow – a different risk profile – but it can unlock those future cash flow forecasts that we talk about. And I think we’re in that environment now.

Historically, we were providing funding against historic cash flow, and now we’re moving into an environment that lets us as the capital provider also go on a level of risk with our partners and provide capital to unlock that future cash flow. And that’s a form of hybrid capital that I’m sure we’ll speak about more on the show. But it just shows the sentiment around the risk environment and some of the factors at play that are giving entrepreneurs and sponsors and investment holding companies the confidence to start to deploying capital.

Mohammed Nalla: Jonti, I think that’s fantastic because you’ve almost pre-empted the question I was going to ask, which is the mix of demand that you’re seeing following this government of national unity. Is that really replacement capex, for example, or is that new projects coming on stream? Is it complete greenfields or is it really brownfields types of investment? You’ve partially answered that to a degree, because you’ve said that there is a mix of that coming through, could you maybe indicate just in terms of anecdotally what you’re seeing on the ground, what the proportion of that mix look like? How much of it is actually just playing catch up with years and years of negative sentiment, just replacement capex, let’s put some of this capacity back on stream. And how much of that is new business? How much of that is actual growth that is coming or stemming from let’s call it renewed optimism? I’d like to maybe just get a bit of an understanding of what that mix looks like.

Jonti Osher: Yeah, so it’s a challenging question, Moe, because the types of borrowers we speak to are diverse in what they are.

So on one hand, we provide capital to entrepreneurs who have a business base, but are looking to grow that quite significantly. I think they have been entrepreneurs within the sector over the last few years, so have actually allocated capital and believed in their thesis around what they’re doing as a business. For them, it’s less about replacement capex and more about opportunistic capital. Maybe some acquisitions, because valuations still, from what we’ve seen, haven’t significantly adjusted, or it’s around growing off the base. They already have new product lines, new product offerings, etc.

Then you get call it the more financial investors like investment HoldCos and private equity sponsors. There might be in their underlying portfolios businesses that they’ve withheld capex to be more cash flow generating businesses over the uncertain period and pay dividends, where now the balance sheet is very illiquid. But they do believe it’s the right cycle to invest and they’ll deploy that into more efficient manufacturing, new facilities, higher working capital levels, etc.

So we’re seeing it as both. I think what business confidence does holistically is just increase capital flow requirements across the sector for transactional kind of business that’s taking place. And that transactional business is both replacement and delayed capex, new opportunities as well as acquisition opportunities.

The Finance Ghost: Jonti, it’s so interesting that you say valuations haven’t moved too much, because if you look at the JSE, public equities obviously move instantly and sentiment just went crazy there. I was worried that the local market ran a bit too hard, too fast, and some of those share price gains have already started to wash away in some places, as I think people have realized it’s going to take longer.

So one of the ones I looked at was PPC, for example. On the construction side, that doesn’t magically just become a way more exciting story in a month or two. So that talks directly to your point, which is that, yes, the minds are changing and people are cautiously optimistic about this, but it’s still going to take a while to actually really genuinely filter through.

Dino, you spend a lot of time talking to the investors rather than the borrowers. And obviously, from a Westbrooke perspective, you guys are also ultimately taking risk, because I understand much of your model is investing alongside your investors effectively. So how much has this political landscape changed? The way you’re thinking about the world, the risk you guys are willing to take, the investors that you’re chatting to? Do you think that there’s been quite a strong shift there? Is there almost frustration that it’s taking longer for the assets to become available now that there’s this positive move?

Dino Zuccollo: Yeah. First of all, Ghost, I think the point you made around what you’ve seen in the listed markets, to me, illustrates one of the reasons for an investment into an alternative, which is it’s just a nice way of demonstrating it in the sense that we’ve seen equity valuations move quite sharply in the listed markets recently on the back of optimism and then realism, all of which are things that may or may not have any real a reflection of what the inherent value is of an underlying business, right? And it’s for that reason that you come into a private market asset, because in our world, the value that you derive from an investment is much more closely linked to what the actual value is of that investment.

I definitely think that the game has changed to a certain degree, Ghost. In all of my years at Westbrooke, it’s always been a conversation with high-net-worths around how much money they can get offshore. And then generally some kind of slight at the SARB around how difficult they are in allowing people to get money offshore. Whereas now, for the first time, I think if I think back to sort of June, July, I remember for the first time in pretty much my time at Westbrooke, having conversations with investors around certain of the offshore investments that we were offering, with them saying, no thanks, we’re pretty fully invested offshore. We would like to keep some money to allocate locally, which certainly, to my mind, is a change.

Jonti and I were debating this earlier, which is, which comes first? Does the investor sentiment to invest locally shift before the deals come? Or is it the other way around? I mean, if you look at the Westbrooke case now, you got to be careful to use anecdotal evidence as the rule, right? But we certainly in the South African business have much more capital available from clients to invest than deals we have available. And that’s actually interestingly Ghost a pre-GNU construct.

At the moment we do three things. We’ve got a senior credit fund, then a more pref offering, and then we do some stuff in the Twelve B space which is a tax deductible investment offering, all three of which are running extensive waiting lists.

I think the situation where we find ourselves as a business, and bear in mind again that our access to deal flow is much more constrained than what you might find in a listed equity investment, but we have much more money than we have deals at the moment across the board.

Mohammed Nalla: I think that’s so fascinating because that’s really the flywheel, right? If you’ve got this waiting list of capital, it’s just waiting for the right opportunities. This ties into what Jonti is saying – if that pipeline starts to develop, you then start to really build pretty compelling investment pipeline for your customers at the end of the day.

I want to ask one additional question with regards to the investor side of this entire equation that I’ve seen this time and time again. South Africa goes through these phases of renewed optimism, then what I call capitulation and extrapolation at the same time. You go from the depths of despair to hey, everything’s fantastic. And then you think it’s going to be fantastic for the long term. And unfortunately, you know, the track record’s been poor, it’s reversed. We see that capitulation and extrapolation in the other direction. And so what I’m really trying to get to, and I’ll pose this first to Dino, but I’d like Jonti to come in as well because I think there’s an investor leg and there’s also the business leg as well, is how much of this move in your view, in your estimation in the conversations you’re having, how much of this is tactical? How much of this is going to last maybe a couple of quarters and then reality starts to bite again? And how much of it in your view is actually structural? That for me is the real defining characteristic of whether we turn the page on South Africa – whether those discussions you’re having with your investors structurally change from hey, let’s get money offshore to hey, we might actually be bullish enough to bring some of that offshore money back into South Africa. I think it’s probably premature for those kinds of discussions. But when it becomes structural, you start to see those discussions. Let’s maybe start off with that question to Dino and then Jonti. I’d like to hear your views on that as well.

The Finance Ghost: Basically, Moe just wants to know if he should be booking a return ticket from his pending trip back to South Africa. That’s the TL;DR there: he’s tired of the weather. Should he come home?

Dino Zuccollo: Look, this is a very nuanced question with a very nuanced answer. I think one of the reasons that people globally find South Africa to be as complex an investment jurisdiction as it is, is because so much of our macroeconomic success as a country is predicated on politics. There are investment jurisdictions like America where politics is a huge thing. But arguably America is in attractive investment jurisdiction in either event. Here, it has, I would argue, a much bigger implication on whether or not someone wants to come in.

The angle around politics is probably something that I’m not best equipped to comment on. I suppose the question that I will pose is this, which is that for as long as the politics remains better – and bear in mind, by the way, South Africa went from probably one of the worst places we’ve been in in Q4 last year, Q1 this year with load shedding and government where it was, and just like everything was a disaster, to now being in one of the best places. 1994, people saying oh, we haven’t felt this way since then. And by the way, the Springboks are winning, which makes everybody feel good, too!

So I suppose it’s not that difficult to feel great, given where we’ve come from, right? The question I’ll ask is whether, provided the politics stays as is, does it really matter? Because if sentiment is there, capital flows come. If capital flows come, people get more and more, the asset prices go up, people become more comfortable to invest, and so the flywheel begins to turn. Now, if you look at our ecosystem, while I say that the amount of money that we have available to invest is a lot, in both instances what does change is where that money wants to go.

So as an example, we have not had any confidence in raising money from investors for anything even remotely linked to private equity in South Africa, anything remotely linked to the swear word in our industry called lock-ins, or anything remotely linked to something that doesn’t produce a cash return, because heaven forbid, you need to get your money out tomorrow because there’s a big drama. Whereas now, the money is still there because, remember, a lot of South African investment capital is tied into pension funds and all sorts of different vehicles that you can’t exit. But where that money wants to go, I’ve definitely seen a change. I see Jonti nodding his head, so maybe I’ll let him chip in there.

Jonti Osher: Yeah. I think from our perspective, investing in alternative marketing, especially at Westbrooke, we believe we can unlock asymmetry in both environments, right? In uncertainty and chaos there’s opportunity, that where assets are mispriced and where opportunities are mispriced, that’s what we’ve been focusing on the last few years.

Now, to Dino’s point, that is generally more in a secure, lower down the risk curve / capital stack type of deal. And that also then meets the investors’ requirements of how they want to allocate that capital. I think in the more stable environment where there is business confidence, there’s been GNU and political stability, there’s been no load shedding – and we’re entering a lower interest rate environment – that’s all a recipe for growth. Even if you listen to the GNU, there’s a growth agenda. You kind of put that all in the mix. It still means, we believe we’re going to unlock asymmetric investment opportunities, but now that bucket will be more in hybrid and preferred equity where returns will be higher.

But we believe this sort of environment caters to that. And obviously we’ll partner in line with what we do from a risk philosophy perspective with the right entrepreneurial sponsors and investment holding companies to unlock those opportunities. But to Dino’s point, I think we as capital allocators to the market will shift where that asymmetry is. And a more stable environment means kind of going up the risk curve slightly, but therefore we expect to earn higher returns over the kind of the period that we’re looking at.

The Finance Ghost: It’s when the language changes from an investor perspective, that’s when asset values really start to move, right? When we’re not talking cash payback period anymore, like some kind of high-risk mining transaction, and you’re talking terminal value and growth. The American language, the language of “this thing’s going to work and it’s going to be here forever” – there’s that incredible optimism that drives the way American entrepreneurs think. They just believe so completely in what they’re doing. They believe their country will just keep going.

South Africa has browbeaten investors over the past few years, especially with load shedding – I mean you’re absolutely right, coming into this year, it was, I think, the worst it’s ever been. And now suddenly it just doesn’t happen anymore, which is remarkable actually. Now everyone’s used to the fact that it’s gone. I think if it returns, there will be riots. But, you know, let’s hope it doesn’t.

You’ve got to see that language change, the way people are building their investment models, putting more weighting on terminal values, you know, longer duration cash flows, and then you can start to see asset values start to really go up and then people realise more value. They believe in the next opportunity. And so that flywheel spins, and it just needs to start, right?

Jonti Osher: From our perspective, that provides more efficient capital to the market. In uncertainty, there’s more margin of safety and as you say, less view on risk-share on the upside, where now you could build in a more stable environment, less margin of safety, and more risk sharing, meaning the top of capital is more flexible, more efficient, and can actually unlock opportunities alongside the sentiment. And that’s really what we’re excited about at Westbrooke, is we provide capital across the capital stack, senior, mezz, preferred equity. We can actually facilitate not only the sentiment, but the capital that can unlock it in a more efficient manner, which obviously and I guess part of the podcast is not just to talk about theory, it’s practically what happens. And I think we talk about sentiment, but that’s got to convert into deals and opportunity, and there’s capital to flow, and that’s what we really excited about. It’s changed from this theoretical kind of discussion more to how do we do it and how do entrepreneurs access capital and their opportunities etc. which is obviously very exciting. And it’s probably not a mindset we’ve seen in the South African environment for a very long time.

Mohammed Nalla: Yeah, I think it’s very powerful. You know, the power of capital markets are exactly why we’re having this discussion. And I know we’ve kind of touched on where we sit in the capital stack, how the risk appetite is bounced around the type of capital deployment. But I want to go into a specific sector because again, it was a success story early days.

Private capital was really instrumental in mobilising investment in clean energy, renewables in South Africa. And that arguably has helped us get to the position we’re in today, where load shedding hasn’t really been a story for the last two quarters. Now, the reason I asked this question is I actually want your views in terms of what’s happening in that particular sector, as I know Westbrooke was quite involved. I know a lot of the projects you were doing were on the commercial side of things. But a lot of stories I’ve seen, certainly over the last quarter or two, is that there’s been massive compression in terms of the types of returns you can get in that space. The returns don’t look fantastic anymore. And so naturally, as capital flows there it chokes off the type of growth you’re getting there.

Maybe just a quick comment – Jonti this is probably one for you – a quick comment on what’s happened in that renewable energy space? We saw a couple of large players go into business rescue in South Africa as well. So clearly the economics have moved past that inflection point where it’s not attractive anymore and that capital, as you correctly say, is probably flowing elsewhere. It’s not in aggregate a bad story, but what’s happening specifically in renewables, because there’s still a lot of people out there trying to raise funding? What’s Westbrooke’s position and appetite in that space, just given where the market’s gone? You were in there quite early on and I believe quite successfully as well.

Jonti Osher: Yeah. So Moe, that’s quite a layered question, I guess with many aspects. I think the first point to address, I think part of Westbrooke’s risk philosophy and approach is to view fundamentals and cash flow and how that pans out and not to invest in the “it” sector necessarily, because that’s where all the capital is going. And I think that’s what happened to some extent in the renewable sector. I think returns on paper, the emotion of being in loadshedding and not seeing the end of it led lots of capital providers to maybe overestimate business cases and assumptions in downside scenarios. I think from a Westbrooke perspective, we still focus on that. And that’s why in certain environments we won’t be deploying as much capital because we believe that the case doesn’t require that. And I think where we’ve seen that materialise is more on the residential side of solar, because you guys will know and anyone listening will know when you’re sitting at home and there’s loadshedding and you don’t have a solution, it takes an emotional toll of frustration. That turns on and off quite quickly when there is loadshedding. In the commercial and industrial sector is where we’re focusing on investing in the long-term cash generating projects that produce electricity, and there’s a contractual arrangement for that. Off-take still makes economic sense because the actual fundamentals of that project is that it provides cheaper electricity to the off-taker. It doesn’t necessarily provide a loadshedding solution and that’s the difference here. There’s a business case and economic case for that system. We’ve seen with some of the electricity tariff increases Eskom wants that it’s only going to grow. And the other side of it, given the residential market slowdown, there’s a lot of stock in the sector. The price of systems is effectively coming down. It plays quite well into investing in the types of projects we investing into, but ultimately we’re just investing in long-term cash flows that are to quality end-users, where the economic case for that is there.

Dino Zuccollo: It’s something Moe that a lot of our investors miss – everyone sees loadshedding as this emotional decision, which if it goes away, it means it’s bad for the sector. But when Eskom are asking a 30%+ increase this year, a solar system still makes a lot of commercial sense if you can bake in a inflation-plus-two increase for 20 years for them.

The Finance Ghost: It reminds me of one of my favourite quotes, which is attributed to Bill Gates, though I don’t know if he came up with it, but it’s basically that we overestimate the rate of change and underestimate the extent. I’m paraphrasing it now.

You know, we think solar is going to go a lot faster, but then people forget, exactly as you say, what is the real long-term story here? It’s actually more about costs than just replacing electricity. Hence solar still that place, even if it maybe goes a bit slower because loadshedding has gone away now.

I think we’ve got a couple of minutes left and where I really would like to finish is just understanding – I hear you saying you’ve got a lot of money looking for deals, and that sounds wonderful, there will be people listening to this podcast whose ears hopefully pricked up at the thought, either they have businesses or they have friends who have businesses, or they are advisors. So what do those deals look like? What assets do you wish were walking through the door?

Jonti Osher: Yeah. So it’s less around the type of asset and more around the opportunity and the entrepreneur and sponsor behind it. We obviously pride ourselves on understanding risk and businesses quite well. We will assess any sector opportunity that has the dynamics we look for. And I think what makes us unique as well is that we provide capital across the capital stack. So that allows us to work with the potential borrower in a solution that really makes sense for that opportunity or that requirement for growth.

And we’re still not seeing banks – they are still conservative and generally provide capital in a vanilla way. So we do believe kind of working with the right sponsor and entrepreneur in the mid-market segment, we can unlock deals alongside them that make sense. And we touched on it earlier. I think this hybrid form of capital that we talk about is going to be very useful for this segment, this mid-market segment, because we can lend more capital than a typical lender would and share in the risk upside. It allows us not to have to look only at historical cash flow and say, this is the leverage level that make sense. We could do that and then add another layer of capital to unlock the opportunity, but then share that risk upside with our potential borrower. And it’s great for them because they kind of want to take the risk and now don’t have to dilute as much as they would if they went to raise equity. And another, I think we mentioned it earlier, another key thing is it provides for flexible structuring of security packages and gives more efficient capital. Obviously, for example, we can now structure a facility because of that margin of safety benefit where maybe there’s a roll-up of interest, and that free cash flow that’s generated from not paying the additional interest could be reinvested at a higher ROE or return on capital. So, yeah, from a Westbrooke perspective, we’re very excited to find transactions with partners that we can grow alongside and essentially share in the risk upside and the opportunity.

Mohammed Nalla: Jonti, I think that’s been a fantastic show. Unfortunately, that’s where we’ve got to leave it. I think we’ve touched on a whole bunch of stuff. This GNU might be the theme, but I think what’s really come out of the show for me is that there’s opportunity regardless of where you look. It just depends where you want to play in that value chain.

If you’re someone looking to actually raise funding in your business, reach out to the team at Westbrooke. If you’re an investor interested in alternative assets, reach out to the team at Westbrooke, regardless of which side of that coin you fall. And again, if you’re looking for the team at Westbrooke, it’s https://westbrooke.com/, that’s where you’ll be able to find the team. Both Dino Zuccollo and Jonti Osher, you’ll find their details on there. Reach out. The team is very accessible. They are happy to answer your questions. And again, I would urge you, like I say, if you’re a business looking for funding, reach out to the team. If you’re an investor and you think some of this is interesting, reach out to the team as well.

This is really what we do at Magic Markets. It’s not just about talking about the big themes. It’s about how you can actually operationalise that. Where can you actually go out there and find the opportunities?

Dino, Jonti. It’s been fantastic having you on the show, and I hope we get to do one of these soon again, because I always come out of these shows feeling like there’s so much more we can discuss. I hope that you actually share that sentiment, but this has been fun, and I appreciate it. Thank you so much.

Jonti Osher: Thanks, guys.

Dino Zuccollo: Happy Thanksgiving.