Q&A with David Hurwitz, CEO
CHIEF EXECUTIVE OFFICER
TRANSACTION CAPITAL'S DIVERSIFIED PORTFOLIO OF FINANCIAL SERVICES ASSETS COMPRISE WELL ESTABLISHED, AUTONOMOUS AND UNIQUE BUSINESSES GROUPED INTO TWO DISTINCT DIVISIONS – SA TAXI AND TCRS.
Despite the challenging operating environment (detailed in the Chairman's report), the focussed application of the group's strategy over the year has ensured that our portfolio continues to leverage its deep vertical integration and specialism to achieve organic growth.
Our evolving competencies in data and analytics continue to drive profitable growth by improving our risk management capabilities, supporting management decisioning and control, and providing the insights needed to develop and refine our product offerings to defined customer segments.
Underpinned by a maturing understanding of their social relevance, vertical integration enables the divisions to continue to innovate in their respective markets, and identify and develop opportunities that expand our total addressable markets to create greater value for all stakeholders.
Q: HOW DOES THE OWNERSHIP TRANSACTION BETWEEN SANTACO AND SA TAXI DEMONSTRATE THE GROUP'S COMMITMENT TO SHARED VALUE?
For many decades, South Africa's minibus taxi industry has been a core pillar of the South African economy and is responsible for getting millions of South Africans to their destinations every day. However, due to the historical and political realities that shaped the formation of the sector, the industry has often lacked meaningful partnership opportunities with other industry participants or financial institutions.
It is an entirely black-owned industry, comprised solely of SMEs, and it has developed without financial support into the most critical component of the South African integrated public transport system.
At the core of our business model is a commitment to engage deeply in the industries in which we operate by driving broader participation in industry value chains and investing in initiatives that drive sustainability. As a national body that represents the interests of its members, who are individual minibus taxi operators, SANTACO's acquisition of a 25% stake in SA Taxi for R1.7 billion on 19 November 2018 is truly historic and transformational.
The equity transaction is built on a foundation of years of mutual respect and cooperation between SANTACO and SA Taxi. With a shared vision to enhance the sustainability of the minibus taxi industry, the transaction represents an understanding that by working together, we can achieve more.
It is important to note that this is not a black economic empowerment deal, which would only enrich certain individuals or limited groups; rather, it is an equity partnership that will enable the equitable distribution of the value generated in the minibus taxi industry verticals to all minibus taxi industry participants by:
- Providing a better and more affordable offering to minibus taxi operators.
- Providing commuters with safer, more efficient and more reliable means of public transport.
- And ultimately, building a more sustainable minibus taxi industry.
This transaction is the first of its kind, where business and industry have collaborated voluntarily, independently from, but with the support of government, to deliver shared value through meaningful social impact aligned with commercial benefit.
The proportional ownership structure, allocated to SANTACO and a trust representing broad-based provincial structures, will ensure that ownership and associated economic benefits of this investment accrue to all levels of the industry and allow for SANTACO to participate in revenue flows across the verticals in SA Taxi.
Of the future dividend flows accruing to SANTACO, 90% will be applied towards reducing debt, with a 10% trickle flowing directly to the trust from the outset and allocated and administered according to a predetermined charter. This dividend income will support relevant infrastructure and other developmental projects designed to create sustainable value for the industry and commuters. Partnerships with local government will be sought to leverage this investment in infrastructure for greater socio-economic impact.
Thus, the transaction will deliver benefits to commuters, government and the nation in improving the infrastructure and services in the industry, and enhance the industry's sustainability for the benefit of individual taxi operators and associations. From a commercial standpoint, the transaction will provide tangible value to SANTACO, its members and provincial structures, and greater alignment between SANTACO and SA Taxi will support further growth for the group.
More broadly, SA Taxi continues to work closely with SANTACO leadership on other initiatives designed to deliver sustainable benefits to SA Taxi's clients and the industry as a whole. These initiatives include credit life insurance, the Black Elite fuel loyalty programme, skills training and collective engagement with other industry stakeholders.
Q: HOW HAS THE GROUP AND SA TAXI FACILITATED THE TRANSACTION?
The deal is the culmination of several years of engagement between SANTACO and SA Taxi. Group executives and SA Taxi's leadership team have been intensely involved in the process, from the negotiations with SANTACO to approaching funders, structuring the deal and engaging with government and regulators.
Of the R1.7 billion purchase price, approximately R1.2 billion will be funded jointly by Standard Bank of South Africa and Futuregrowth Asset Management, who are SA Taxi's long-standing and largest debt funders. The remaining R521 million will be facilitated by SA Taxi in the form of vendor finance.
Q: WHAT IS THE IMPACT OF THE TRANSACTION ON SA TAXI AND TRANSACTION CAPITAL?
From SA Taxi's perspective, it will achieve greater alignment with SANTACO and the minibus taxi industry, which stands to unlock additional opportunities and broaden its total addressable market from our current client base of about 30 000 to almost all of the approximately 250 000 minibus taxi operators in South Africa.
SA Taxi will use approximately R1 billion of the net proceeds of R1.2 billion to settle interest-bearing external and shareholder debt, which will yield significant earnings benefits. The remaining amount will be retained by SA Taxi to fund growth. SA Taxi's net asset value will increase to about R3 billion (from R1.6 billion at 30 September 2018). Return on equity will remain at approximately 20% due to these accretive earnings benefits.
Going forward, SA Taxi will continue to grow earnings organically at rates similar to prior years. However, the financial benefit of the transaction (improved net interest margins from the lower leverage and interest expenses savings) and the operational benefits of a stronger enhanced relationship with SANTACO are significantly accretive to SA Taxi's earnings over the medium term and are expected to support higher growth rates.
The vendor finance made available by SA Taxi will result in Transaction Capital consolidating 81.4% of SA Taxi's earnings. Although Transaction Capital's proportionate share of SA Taxi's earnings will be smaller, earnings are expected to increase due to the settlement of debt. Seen together with the expected growth in the finance, insurance and retail businesses from greater alignment with the minibus taxi industry, this ground-breaking deal is expected to be earnings accretive to the group over the medium term. Furthermore, Transaction Capital's net asset value per share will increase by approximately 105 cents per share immediately after the implementation of the transaction.
Finally, the group executive office's balance sheet will be debt free and well capitalised after the implementation of the transaction, with approximately R1 billion of excess cash.
The group is cognisant that businesses in South Africa have a broader responsibility to society, beyond statutory or legislative requirements. Transaction Capital's willingness to take on and financially facilitate the SANTACO ownership transaction on a voluntary rather than an obligatory basis, stands as testament to our strategic emphasis on creating shared value, which 1. Transaction Capital and The Empire Family Trust (representing SA Taxi's CEO, Terry Kier). enhances commercial returns and delivers positive social impact.
Q: CONSIDERING THE CHALLENGING OPERATING ENVIRONMENT, HOW IS SA TAXI MANAGING THE ASSOCIATED RISKS?
Serving higher quality taxi operators to create a more sustainable minibus taxi industry
|NEW ORIGINATION VOLUMES BY RISK GRADE (%)|
In the vehicle financing business, demand for new and quality pre-owned vehicles remains strong, especially considering the resilience and growth of the minibus taxi industry as the dominant mode of public transport. However, difficult economic conditions combined with high minibus vehicle prices and escalating fuel costs resulted in a marginal increase in SA Taxi's non-performing loan ratio to 17.7% (from 17.1%). This was offset by the reduced average cost to refurbish repossessed vehicles and higher recoveries on the resale of these vehicles.
Thus, the credit loss ratio only increased to 3.3% (from 3.2%) and remains at the bottom end of the division's risk tolerance of 3% to 4%. The division's focussed loan origination strategies have resulted in higher credit quality, with 75% of loans originated in better risk categories and repeat loans to existing clients increasing to approximately 31% (from 26% a year ago).
As detailed in the Q&A with Terry Kier, SA Taxi CEO, SA Taxi's insurance business is the main driver of non-interest revenue. The division continues to grow its product offering and manage insurance risk effectively, with claims ratios remaining robust.
The business remains focussed on growing the proportion of insurance claims processed via SA Taxi's combined autobody and mechanical refurbishment facility, and reducing the average cost to refurbish insured vehicles. In addition, it continues to invest in information technology, data management and predictive analytics specifically designed to reduce insurance risk, prevent insurable events and reduce the cost of insurance claims.
Despite a weaker Rand causing inflationary pressure on spare parts costs, the average cost to refurbish insured vehicles reduced further in the period, underpinned in part by greater efficiency in SA Taxi's specialised refurbishment facility. SA Taxi established its own parts procurement and distribution, and vehicle salvage operation in March 2018, called Taxi Auto Parts or TAP. Via TAP, SA Taxi is able to import and locally procure quality parts directly at a lower cost, and distribute these to SA Taxi's own refurbishment centre as well as its network of preferred external autobody repairers. Through TAP, SA Taxi is also able to optimise the salvage value of vehicles.
Q: THE CHALLENGING OPERATING ENVIRONMENT IS ALSO A FEATURE FOR TCRS. HOW IS THE DIVISION'S STRATEGY SUPPORTING ITS PERFORMANCE?
Key to TCRS' performance in this environment is its diversified business model, which reduces concentration risk. TCRS is diversified by business activity across collection, transactional and value-added services. Within its most significant business activity, collection services, TCRS acts as both a principal in acquiring and then collecting on NPL portfolios, and as an agent on an outsourced contingency or FFS basis. Its business activities are diversified further across various consumer-related sectors, clients and geographies.
TCRS' defensive business model supports performance in different market conditions. The challenging economic climate in South Africa, and TCRS' data, scale and capital position, favour the acquisition of NPL portfolios from risk averse clients who prefer an immediate recovery against their NPLs. Activity in this sector was higher than in the 2017 financial year, with opportunities to purchase loan portfolios emanating from traditional lenders, credit retailers, municipalities and state-owned enterprises.
Whereas TCRS historically focussed on acquiring portfolios of written-off unsecured retail debt, it has extended its focus to non-performing consumer portfolios in alternative asset classes such as secured loans, debt review portfolios and consumer debt prior to write-off, with the latter typically sold on a private bilateral basis. Investments in our legal collection division are supporting TCRS' ability to grow market share in this sector.
The difficult consumer credit environment since 2016 has resulted in lower levels of consumer credit extension and a consequent contraction in the volumes of contingency matters handed over for collection in South Africa by banks, credit retailers and specialist lenders. Again, through its strategy to diversify geographically, deepen its penetration in its traditional market segments (banks, retailers and specialist lenders) and grow revenue from adjacent sectors (insurance, telecommunications and public sectors), TCRS has grown its contingency and FFS revenue by 19% during the year.
TCRS is continually assessing opportunities for bolt-on acquisitions to enter adjacent sectors and penetrate new product types, cognisant that opportunities for growth remain notwithstanding the challenging market in South Africa.
In the transactional services business, management is exploring progressive fintech and payment technologies to diversify earnings growth and create future opportunities, including the development of an online client portal and technology-based origination system.
In the value-added services business, Road Cover has been fully integrated into the division and performed to expectation. The application of data and analytical skills that underpin TCRS' operations stand to augment Road Cover's offering and presents encouraging growth prospects.
Q: WHAT PROGRESS HAS BEEN MADE IN RECOVERIES CORPORATION IN AUSTRALIA?
Our strategic plans in Australia are on track. Recoveries Corporation has made strong progress in achieving its strategic imperative of driving operational efficiencies by deepening management competence and overlaying TCRS' technology and business information capabilities. With the operational integration substantially completed, the business is expected to yield an enhanced return on future revenues. On a like-for-like basis, Recoveries Corporation's revenue was in line with expectations, supported by a broad client base in the insurance (23%), telecommunications and utilities (12%), banking and commercial (32%), and public (33%) sectors.
Although Recoveries Corporation is still a small component of TCRS, it continues to diversify the division's contingency and FFS revenue. For a relatively small initial investment, the opportunity to gain a deep understanding of the Australian collections industry and participate in emerging opportunities is proving meaningful.
In addition to achieving operational leverage, growth opportunities include bolt-on acquisitions of specialist collectors. Also, TCRS continues to be cautious as it seeks to apply its analytics, pricing expertise and capital raising capabilities to the selective purchase of NPL portfolios in Australia.
Although the debt collection market is highly fragmented, it is estimated that NPL portfolios are acquired annually for an aggregated purchase consideration of AUD600 million, many times larger than the South African market, which gives an indication of the growth opportunity for TCRS in this market.
Q: DATA AND TECHNOLOGY ARE KEY TO THE ABILITY OF TCRS TO GENERATE IN-DEPTH INSIGHTS, ENABLE PRECISE DECISIONING AND ENHANCE EFFICIENCIES. WHAT HAVE BEEN SOME OF THE KEY DEVELOPMENTS AGAINST THIS STRATEGIC OBJECTIVE OVER THE YEAR?
As mentioned above, we are overlaying TCRS' technology and business information capabilities in Recoveries Corporation in Australia. We have built a highly efficient collections business in South Africa, and by leveraging our systems, intellectual capital and balance sheet, we are enhancing the efficiencies of the Australian business in areas like the dialer and right time to call, which stands to improve profitability. In leveraging our capabilities in business intelligence and analytics, we are also enhancing how the workforce and operations are managed.
In South Africa, TCRS continues to fine-tune all aspects of the technology investments we have made in areas that can be considered 'outside of the call'. We are extending investments and focus to 'inside the call' through advanced technologies, including artificial intelligence. With increasing smartphone penetration and data access, along with the reducing cost of data, the division's focus on non-voice channels will enhance how consumers transact with TCRS.
TCRS is also expanding and enriching its master data universe (MDU), which now includes both performing and non-performing credit-active consumers. The business is investigating commercialising the MDU.
TCRS' focus on technology and data analytics has resulted in higher productivity and lower operating costs. On a like-for-like basis, excluding recently acquired businesses, TCRS' cost-to-income ratio improved to 76.8%, compared to 77.3% in the prior year.
Q: TRANSACTION CAPITAL CONTINUED TO DELIVER GOOD GROWTH AND DRIVE EFFICIENCIES ACROSS THE BUSINESS. WHAT ARE ITS PROSPECTS OVER THE MEDIUM TERM?
Despite the adverse environment, Transaction Capital's entrepreneurial management teams continue to invest unrelentingly in innovative strategies that create a diverse and expanded earnings base.
At SA Taxi, these initiatives include broadening its insurance client and product base, reducing the cost of insurance claims and credit losses, and achieving further procurement and operational efficiencies in its autobody and mechanical refurbishment facility. SA Taxi's ownership transaction with SANTACO is expected to support growth in the finance, insurance and retail businesses. It stands to unlock further opportunities to provide allied services within the broader taxi industry and expand SA Taxi's total addressable market. Together with the financial benefits of reduced gearing, these factors are expected to be value accretive to Transaction Capital's earnings over the medium term.
The acquisition of NPL portfolios is the main driver of organic growth at TCRS. Activity in this sector remains buoyant, with future performance underpinned by more than 50% growth this year in the fair value of purchased book debts and estimated remaining collections. TCRS will continue to expand and enrich its database, and invest in new technologies to enhance yields through higher productivity and lower operating costs.
Post the ownership transaction with SANTACO, Transaction Capital's balance sheet will be completely free of debt, with approximately R1 billion of excess capital. This gives us the capacity and flexibility to continue investing in organic and acquisitive growth opportunities that will further entrench our position in our chosen markets.
Through precise implementation of the group's strategy, Transaction Capital will continue to achieve robust organic earnings and dividend growth over the medium term, at least in line with past periods and current performance. Our growth expectations assume that the group's excess capital is not deployed accretively, so further upside potential may become evident.
Over the past few years, SA Taxi and TCRS have adjusted to South Africa's challenging economic conditions to become highly efficient. Although both divisions are strong performers in this low-growth environment, a sustained economic recovery will support their potential to outperform current performance expectations.