This article by MOI Global instructor Scott Miller is excerpted from a letter of Greenhaven Road Capital, based in Greenwich, Connecticut.
If an operator can turn a profit during very challenging times, it portends well for performance when the environment improves. Investors like to think about peak and trough earnings for cyclical industries. Earnings during boom times are often afforded a low P/E multiple because they are considered unsustainable. Similarly, during trough or recession times, a higher P/E may be applied because it is highly likely that earnings will rise with an improvement in the economy. A low P/E ratio on depressed trough earnings can be an interesting investment set-up because we may see revenue growth, earnings growth, and multiple expansion (a higher P/E). In short, this combination can lead to an investment that returns multiples of the original investment.
In the past two letters, I have mentioned building a position in a South African company that fits this description. It is certainly not the proverbial “best of times” in South Africa. Unemployment is hovering around 30%, the country has wrestled with government corruption, there are rolling power outages, and there are a host of apartheid-linked legacy inequality issues. The economy is bouncing in and out of recession. Consumer confidence is low and interest rates are comparatively high. None of this is a favorable backdrop for housing, yet Balwin Properties (BWN.JO) has endured, and actually prospered. If I were going to pick a place in the world to operate a home builder, it would not be South Africa. However, if I could only buy one home builder, it might be Balwin Properties.
In the “worst of times” description above, I left out the fact that South Africa has a housing shortage of about 3 million homes, 700,000 of which fall into Balwin’s core product category. Demand is reinforced by urbanization as well as a growing middle class. Balwin Properties caters to this rising middle class by developing multi-family, sectional title housing, primarily in the form of one-, two-, and three-bedroom four-story walk-up apartments with prices ranging from $40,000 to $150,000 USD: the entry to mid-market segment. Their developments are located in high-density, high-growth urban nodes across key metropolitan areas such as Cape Town, Johannesburg, Pretoria, and Durban.
While the Balwin properties vary in terms of size, they all have lifestyle centers, housing amenities like gym/fitness spaces, one or two restaurants, spa/wellness areas, children’s play areas, swimming pools, mini sports fields, and spaces for gathering. The Blyde development in Pretoria even boasts Africa’s first Crystal Lagoons lagoon for swimming, kayaking, and paddle-boarding. Apartments have the exact same finishes (dishwashers, faucets, cabinets, etc.), which allows Balwin to benefit from scale. Still, the quality is surprisingly high. Doors are thick, brand names are used, and they are well laid out. The projects are developed in phases. On average, a development sells 25 apartments per month, and a new phase of development will not be started until it is largely pre-sold.
Property development is not a “great business.” It is cyclical, there are low barriers to entry, and it is capitalintensive. Balwin does receive some benefits from its scale in purchasing, advertising and sales, and a small “brand” premium, but ultimately, I believe that this is a better investment than business. Insiders own in excess of 50% of the shares and the company is led by an owner-operator. Given the economic headwinds in South Africa and tightness in the mortgage market, it is probable that these are not peak earnings. We acquired our shares at a P/E multiple of less than 3x and a 50% discount to tangible book value, which largely constitutes land holdings at cost and developments under construction. There is a realistic path to a multi-bagger.
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Disclaimer: This document, which is being provided on a confidential basis, shall not constitute an offer to sell or the solicitation of any offer to buy which may only be made at the time a qualified offeree receives a confidential private placement memorandum (“PPM”), which contains important information (including investment objective, policies, risk factors, fees, tax implications and relevant qualifications), and only in those jurisdictions where permitted by law. In the case of any inconsistency between the descriptions or terms in this document and the PPM, the PPM shall control. These securities shall not be offered or sold in any jurisdiction in which such offer, solicitation or sale would be unlawful until the requirements of the laws of such jurisdiction have been satisfied. This document is not intended for public use or distribution. While all the information prepared in this document is believed to be accurate, MVM Funds LLC and Greenhaven Road Capital Partners Fund GP LLC make no express warranty as to the completeness or accuracy, nor can it accept responsibility for errors, appearing in the document. An investment in the fund/partnership is speculative and involves a high degree of risk. Opportunities for withdrawal/redemption and transferability of interests are restricted, so investors may not have access to capital when it is needed. There is no secondary market for the interests and none is expected to develop. The portfolio is under the sole investment authority of the general partner/investment manager. A portion of the underlying trades executed may take place on non-U.S. exchanges. Leverage may be employed in the portfolio, which can make investment performance volatile. An investor should not make an investment, unless it is prepared to lose all or a substantial portion of its investment. The fees and expenses charged in connection with this investment may be higher than the fees and expenses of other investment alternatives and may offset profits. There is no guarantee that the investment objective will be achieved. Moreover, the past performance of the investment team should not be construed as an indicator of future performance. Any projections, market outlooks or estimates in this document are forward-looking statements and are based upon certain assumptions. Other events which were not taken into account may occur and may significantly affect the returns or performance of the fund/partnership. Any projections, outlooks or assumptions should not be construed to be indicative of the actual events which will occur. The enclosed material is confidential and not to be reproduced or redistributed in whole or in part without the prior written consent of MVM Funds LLC and Greenhaven Road Capital Partners Fund GP LLC. The information in this material is only current as of the date indicated, and may be superseded by subsequent market events or for other reasons. Statements concerning financial market trends are based on current market conditions, which will fluctuate. Any statements of opinion constitute only current opinions of MVM Funds LLC and Greenhaven Road Capital Partners Fund GP LLC, which are subject to change and which MVM Funds LLC and Greenhaven Road Capital Partners Fund GP LLC do not undertake to update. Due to, among other things, the volatile nature of the markets, and an investment in the fund/partnership may only be suitable for certain investors. Parties should independently investigate any investment strategy or manager, and should consult with qualified investment, legal and tax professionals before making any investment. The fund/partnership is not registered under the Investment Company Act of 1940, as amended, in reliance on an exemption thereunder. Interests in the fund/partnership have not been registered under the securities act of 1933, as amended, or the securities laws of any state and are being offered and sold in reliance on exemptions from the registration requirements of said act and laws.
About The Author: Scott Miller
Scott Miller is the Founder of Greenhaven Road Capital, a boutique investment partnership that seeks out off the beaten path investments, modeled after the early Buffett partnerships. The firm is built on the belief that a focused investment manager can outperform an index by limiting fund capacity and by concentrating exposure on a few great ideas over a long time horizon. Experience as an owner-operator of businesses influence Greenhaven’s approach towards partially-owning companies rather than merely picking stocks. Prior to founding Greenhaven Road, Scott co-founded Acelero Learning, serving in a variety of roles over a decade from CFO to CTO, to Chief Strategy Officer to his current role of Board Member. Acelero Learning has grown from three people in an office “cube” in New York City to 1,100 employees serving 5,000 children across four states. Additionally, Scott managed a manufacturing business, with responsibility for hiring, firing, planning inventory, negotiating with suppliers and acquiring customers at a reasonable cost. Scott holds an MBA and a Masters in Education from Stanford University.
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