Bateleur Flexible Prescient Fund—2017 Half year report back

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Bateleur Flexible Prescient Fund (“the fund”) – 2017 1st half report back to investors

The fund returned a net 3.7% for the first half of 2017. As comparisons, the JSE All Share Index

appreciated 3.4% over the same period (inclusive of dividends reinvested), a basket of government

bonds (ALBI) gained 4.0% and cash (STeFI) returned 3.4%.

Returns were positive across both domestic and foreign holdings, domestic equity holdings delivered

returns of 2.5% and foreign equity holdings 1.2%. These returns were achieved with an average cash

holding of 19% over the period.

The macro environment in SA remains challenging, evidenced in business and consumer confidence

rooted at multi-year lows. With GDP growth close to zero, corporates linked to the domestic economy

are struggling to deliver earnings growth. Although there has been some softening in valuations

(through P/E multiple contraction), the ratings of domestic facing equities (most notably in the

consumer space) remain too high given the anaemic growth prospects.

The international picture is somewhat healthier, with 2017 global GDP growth anticipated to be the

highest in several years at 3.5%*, led by an improvement in Europe, steady growth in China and a

recovery in emerging markets. This has provided a supportive environment for corporate earnings and

global equity market valuations, with the MSCI World Index appreciating 10.7% in USD over the first half

of calendar 2017.

The majority of the fund’s returns have come from companies exposed to the global economy. Top

contributors over the period include Naspers, Tencent, British American Tobacco, Mondi, Shoprite,

Adcock Ingram, Paypal, Bidcorp and Sirius. With the exception of Shoprite and Adcock - both of which

are stock specific opportunities, the remaining contributors all have an international focus.

New holding – Assore

The fund generally avoids cyclical businesses as earnings are difficult to predict, capital intensity is high

and free cash flow generation can be poor. However, opportunities may infrequently arise where the

valuation of a cyclical company is sufficiently compelling to warrant an investment by the fund. A recent

example is bulk commodity miner Assore.

Assore’s primary asset is a 50% stake in Assmang, an unlisted miner that it jointly controls with African

Rainbow Minerals (ARM). Assmang is the largest high grade manganese producer and second largest

iron ore producer in SA. Assore additionally markets the output from Assmang, and outside of the joint

venture, owns 100% of the Dwarsrivier chrome mine.

The company was founded in 1928 by Guido Sacco and listed on the JSE in 1950. It is currently still

majority owned and controlled by the Sacco family.

This family control has enabled Assore to invest for the long term as opposed to having a short term

mind-set. Capital allocation decisions have been astute with the tangible NAV per share increasing by a

compound annual growth rate (CAGR) of 23% over the past twenty years (chart 1).

* Source: IMF World Economic Update – July 2017

2 The family has also run the business conservatively – always maintaining a healthy net cash position on

the balance sheet. This proved especially shrewd in the commodity downturn of 2014/2015 where many

of its larger peers were carrying too much leverage and were forced to postpone dividends, sell assets or

raise new equity capital.

With its strong balance sheet intact during the downturn, Assore was able to acquire the remaining 50%

of Dwarsrivier Chrome that it did not own, at an attractive price. In Assore’s most recent results,

Dwarsrivier contributed R421m to earnings – implying a one year payback on the investment. It was also

able to proceed with expansionary capital projects in both iron ore and manganese, which are now

benefitting the company, in the up cycle.

The current iron ore price is close to $70 per tonne, while the average for calendar 2017 year to date is

marginally ahead of this at $72. Despite several commodity analysts and major producers predicting a

sharp correction in the price, this has not yet materialised. Assore’s cash cost of producing iron ore is

$38 per tonne (chart 2), which highlights the enormous profits the business is currently generating.

Chart 1: Assore - TNAV per share over time (R) Chart 2: Iron ore producers cost curve

Source: RenCap, Bateleur, Assore financials

We estimate that Assore trades on a P/E multiple of less than 5 times and a free cash flow yield in excess

of 15%, which compares favourably to its listed peer group (chart 3). At current spot prices, net cash on

the balance sheet is forecast to exceed R6bn by year end, in excess of 20% of group market

capitalisation. In the absence of a material decline in bulk commodity prices, we expect Assore to return

excess cash to shareholders either via reducing the dividend cover or alternatively paying a special

dividend.

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Spot price: $70/t

Assore has grown tangible NAV per share by 23% CAGR over the past 20 years

Assore’s all in cash cost of producing iron ore is $38 per tonne, versus current spot of $70 per tonne

3 Chart 3: Select miner valuations (P/E times) Chart 4: Assore - Free cash flow over time (Rbn)

Source: Factset, Bateleur, Assore financials

The family control, strong balance sheet, limited expansionary capital expenditure requirements, and

attractive valuation (from both an earnings and dividend view) – provide a sufficient margin of safety for

investing in the company despite the inherent volatility in iron ore and manganese prices.

Offshore holding – PayPal

The fund has been invested in PayPal over several years, initially when it was part of EBay, and more

recently as a standalone entity after it separated from EBay.

PayPal is the world’s largest open digital payments platform that enables digital and mobile payments

on behalf of both consumers and merchants.

The two sided technology platform enables consumers to safely exchange funds with merchants using a

variety of funding sources, which may include a bank account, a PayPal account balance, a PayPal Credit

account, a credit and debit card or other stored value products such as coupons and gift cards.

The PayPal platform additionally offers merchants an end-to-end payments solution that provides

authorisation and settlement capabilities, as well as instant access to funds. PayPal also assists

merchants in connecting with their customers and managing risk.

Outside of its core business, PayPal owns technology applications (through Venmo and Xoom) that

enable friends and family to transfer funds to each other, anywhere in the world, in a safe manner.

PayPal’s success has been driven by 1) first mover advantage, 2) its independence (no longer affiliated or

owned by any major merchant) and 3) strong execution by the management team.

Founded in 1998 (Elon Musk and Pieter Thiel were two of the co-founders) and with the benefit of first

mover advantage, PayPal has built significant scale through the network effect. The company currently

has 193m active consumer accounts and 17m merchant accounts (including 75 of US top 100 merchants

– charts 5 and 6). These customer numbers dwarf its nearest competitors, and more importantly are still

growing at a healthy pace (currently at an organic growth rate of 12% per annum).

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Cumulative FCF Rbn (RHS)Average 12M FWD P/E for the peer group on spot prices 7.7x

4 Chart 5: PayPal - active users and TPV* ($bn) Chart 6: PayPal – share of top 500 merchants

Source: Morgan Stanley, PayPal financials *TPV – Total payment volume ($bn)

Under EBay, PayPal was viewed as a competitive threat by many merchants. Since the unbundling, the

company has actively marketed itself as an independent platform, preferring to partner with banks, card

providers and merchants as opposed to competing with them.

Over the past eighteen months strategic partnerships have been signed with Visa, MasterCard,

American Express, Wells Fargo, Citibank, Bank of America, JP Morgan Chase, Apple, Google, Samsung,

Facebook, Alibaba and Baidu, amongst others. The one major name missing from this list is Amazon,

which would be a major coup if on-boarded.

PayPal is led by Dan Shulman who was appointed on the separation from EBay in July 2015. Although he

has not been in the position long, Mr Shulman has executed extremely well via: 1) partnering with key

banks, card providers and merchants, 2) growing customer volumes, 3) enhancing and simplifying the

technology platform, and 4) keeping costs in check.

PayPal’s operating and financial performance has been impressive since it separately listed. Like many

platform companies with scale, the company operates a capital light business model and generates

significant free cash flow - net cash on the balance sheet currently exceeds $6bn.

Chart 7: Global consumer transactions by payment Chart 8: Payments addressable market

Source: PayPal Presentation – May 2016

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Active Customer Accounts (m) (RHS)

TPV (bn) (LHS)

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Google Wallet

Chase Pay

Amex Checkout

MasterPass

Shoprunner

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Pay With Amazon

PayPal

All merchants

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All other payment types Cash

Global consumer transactions still dominated by cash

Online/ mobile ($1.3t)

Offline retail ($21t)

Digital money ($90t)

Total addressable market:digital commerce and money ($100t +)

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Revenue growth of 20% is forecast for financial 2017, with earnings growth of 23%. Operating profit

margins at 21% are reasonable for a technology company but certainly not excessive. Most importantly,

the growth prospects for the business remain upbeat, driven by the continued digitisation of money, the

mass adoption of mobile devices (smartphones) and the increased volume expected from the recent

partnership deals (charts 7 and 8).

PayPal’s share price has performed strongly in 2017, where it is up 52% YTD in USD – partly discounting

the strong growth outlook. Although we anticipate a period of consolidation following the latest rally,

we retain a holding in the stock.

Business update:

It has been thirteen years since Bateleur was founded in May 2004. We believe it is appropriate to

update investors of some changes that have taken place as the business has steadily evolved and grown.

From a single long short hedge fund that launched in January 2005 with R11m in assets under

management (AUM), the business has expanded to R8.6bn across four different equity focussed

products, namely the Bateleur long short hedge fund, the Bateleur market neutral hedge fund, the

Bateleur flexible fund, and the Bateleur equity fund. With the exception of the equity fund (that is a fully

invested equity fund), all products have a capital preservation focus – the cornerstone of the company’s

investment philosophy.

Chart 9: Bateleur - Assets by strategy (Rbn) Chart 10: Bateleur – AUM over time (Rbn)

Source: Bateleur

The business has recruited selectively since inception. From a staff complement of one in January 2005,

there are now twelve employees in the business, seven in investments and five in operations. The

current staffing is appropriate to manage assets in excess of current AUM, but we have no interest in

chasing asset growth.

Although additional analysts (above our current complement) enable increased stock coverage, they

also reduce the flexibility and nimbleness of the investment decision making process. More analysts

•R3.7bn•R1.1bn

•R1.4bn•R2.4bn

Long Short Hedge Fund

Flexible Fund

Equity Mandates

Market Neutral

Fund

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6 require additional structure, process and management time, and negatively detract from the

entrepreneurial team culture.

Through a research process that has been enhanced and refined over several years, we now cover 162

companies listed on the JSE with detailed models on 111 of these. All analysts and portfolio managers

are generalists as opposed to industry specialists. This encourages comparisons across industries and

removes a sector bias from only focussing on select industries. We are also steadily increasing our direct

coverage of international companies as the hedge funds and flexible fund are all mandated to invest

globally.

From following purely a bottom up fundamental research approach in 2005, we now also spend a

meaningful amount of time on top down macro. This assists us in the asset allocation decisions on the

capital preservation funds, and within the equity component, what sectors to focus on or avoid.

Although macro-economic forecasting is difficult, and often turns out differently to expectations, to

simply ignore it would be naive, especially as several asset classes are closely linked to global interest

rates and monetary policy.

In terms of skills development and bringing new talent into the business, we have been running a

bursary program in conjunction with UCT over the past three years supporting Business Science Finance

students that display potential but have financial funding needs.

Suitable graduates from the bursary program are then invited to join the Bateleur Academy for an initial

two year employment period. Here they are exposed to all areas of the business, undergo external and

internal training programs and are funded to sit the CFA exams.

We currently provide bursaries to three students at UCT and have three individuals signed up for the

Bateleur Academy program.

The culture at Bateleur remains vital. We have no desire to be a mainstream asset management firm or

an asset accumulator. We also don’t believe we can be all things to all people and therefore don’t offer

a diverse range of products outside our core area of equity competence.

The company is 100% owner managed and is not conflicted or influenced by outside shareholders. As

key employees prove their worth to the business over time, they are offered an opportunity to acquire

equity in the business. There are currently four shareholders in the business, which will increase further

during 2017.

Performance across our product suite is strong, with all funds comfortably outperforming their

benchmarks and the JSE All-Share Index (total return) since inception at lower levels of risk as shown

below.

7 Table 1: Bateleur - Fund returns since inception

Investment Strategy Inception Returns*

(CAGR)

JSE TR

(CAGR)

Outperformance

(CAGR)

Fund

volatility**

JSE

volatility**

Long Short Fund Jan 2005 17.6% 15.2% 2.4% 6.9 18.0

Market Neutral Fund July 2008 11.5% 9.2% 2.3% 3.6 17.3

Flexible Fund July 2010 16.6% 13.4% 3.2% 7.3 14.6

Equity Fund*** June 2012 16.5% 11.9% 4.6% 14.8 16.4

* Net of all fees

** 30 day volatility

*** Track record of longest running segregated mandate, net of management fees only

Source: Bateleur, Bloomberg

We would like to take this opportunity to thank all our investors, and in particular those clients that

supported us in the early days and remain investors.

We remain confident in our ability to meet the fund’s investment objectives.

Kevin Williams James Easterbrook

Fund Manager Head: Distribution

Bateleur Capital (Pty) Ltd

Authorised financial services provider FSP no 18123 — SG109 Ground Floor, South WingGreat Westerford Building240 Main Road, Rondebosch7735 — T +27 (0)21 681 5060 F +27 (0)21 681 5066 —

bateleur capital 2016

Collective Investment Schemes in Securities (CIS) should be considered as medium to long-term investments. The value may go up as well as down and past performance is not necessarily a guide to future performance. CIS’s are traded at the ruling price and can engage in scrip lending and borrowing. A schedule of fees, charges and maximum commissions is available on request from the Manager. There is no guarantee in respect of capital or returns in a portfolio. A CIS may be closed to new investors in order for it to be managed more efficiently in accordance with its mandate. CIS prices are calculated on a net asset basis, which is the total value of all the assets in the portfolio including any income accruals and less any permissible deductions (brokerage, STT, VAT, auditor’s fees, bank charges, trustee and custodian fees and the annual management fee) from the portfolio divided by the number of participatory interests (units) in issue. All documents, notifications of deposit, investment, redemption and switch applica-tions must be received by the Manager by or before 13:00 (SA), to be transacted at the net asset value price for that day. Where all required documentation is not received before the stated cut off time the Manager shall not be obliged to transact at the net asset value price as agreed to. Fluctuations and movements in exchange rates may also cause the value of underlying international investments to go up or down. Forward pricing is used. The Fund’s Total Expense Ratio (TER) reflects the percentage of the average Net Asset Value (NAV) of the portfolio that was incurred as charges, levies and fees related to the management of the portfolio. A higher TER does not necessarily imply a poor return, nor does a low TER imply a good return. The current TER cannot be regarded as an indication of future TER’s. During the phase in period TER’s do not include information gathered over a full year. A Money Market portfolio is not a bank deposit account and the price is targeted at a constant value. The total return is made up of interest received and any gain or loss made on any particular instrument; and in most cases the return will have the effect of increasing or decreasing the daily yield, but in the case of abnormal losses it can have the effect of reducing the capital value of the portfolio. The yield is calculated as a weighted average yield of each underlying instrument in the portfolio. Excessive withdrawals from the portfolio may place the portfolio under liquidity pressures and a process of ring-fencing of withdrawal instructions and managed pay-outs over time may be followed A Fund of Funds is a portfolio that invests in portfolios of collective investment schemes, which levy their own charges, which could result in a higher fee structure for these portfolios. A Feeder Fund is a portfolio that invests in a single portfolio of a collective investment scheme which levies its own charges and which could result in a higher fee structure for the feeder fund. The Manager retains full legal responsibility for any third-party-named portfolio. Where for-eign securities are included in a portfolio there may be potential constraints on liquidity and the repatriation of funds, macroeconomic risks, political risks, foreign exchange risks, tax risks, settlement risks; and potential limitations on the availability of market information. The investor acknowledges the inherent risk associated with the selected investments and that there are no guarantees. Prescient is a member of the Association for Savings and Investments SA. Bateleur Capital Pty Ltd, an AFSP; is the investment manager of the Funds.Prescient Management Company (RF) Limited, Prescient House, Westlake Business Park, Otto Close, Westlake, Cape Town, 7966

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