Discovery rights issue details

The long awaited Discovery Rights issue announcement came yesterday. I suppose not too long awaited, the company only announced this on the 24th of February, for some market types that is too long ago to remember. OK, so give me the lowdown, give me the skinny! Urban dictionary will help you to understand those terms and a whole lot of others that you wished you hadn't looked at.

For every 100 shares that you hold of Discovery by the close of trade Friday, you will have the ability to acquire 9.38641 for 90 Rand a share in the rights issue. How would that work practically then? Say now that you have 250 shares, apply the above ratio and you would get to 23.466 shares at 90 Rand. Obviously there cannot be fractions of shares, it is 1 or nothing. The release does not say anything about rounding, I am pretty sure that it is either up or down. In this case then, your 23 shares at 90 Rand, in order to follow your rights, would mean that you would be in for 2112 Rand. The position right now, if you own 250 shares in our hypothetical case, at the opening price today, is worth 32000 Rand. The share price closed at 128 Rand exactly last evening.

Dates? What are those? When do you have to have the money in your account? The sooner the better as always, there is a little bit of time. The circular goes out Monday the 16th of March, the rights start trading on Friday the 27th of March, the rights issue closes the following Thursday (the 2nd of April) at noon. The following Tuesday, the 7th of April, the shares are issued against cash in your account, i.e. the cash flows out of your account and into the coffers of the company. Easy enough to understand, right? You basically have two weeks to come up with the money and our recommendation is that you must follow your rights. You must not do nothing however, the rights will have a modest price to them. Expect the share price of Discovery on Monday, which will trade ex the rights, to fall between 6-8 percent if my math is correct.

Last thing to know, and possibly the most important thing as a long term shareholder, what is it that the money is being used for? The company will be issuing 55,555,556 new shares at 90 Rand, a total of five billion Rand. 1.35 billion Rand will be used to increase their overall stake in DiscoveryCard to 74.99 percent, valuing the whole DiscoveryCard at 2.7 billion Rand. The whole business has net advances of 3.4 billion Rand as at 31 December 2014, and it recorded pre tax profits of 300 million. That means that they paid 9 times pre tax profits, Discovery has a tax rate of 28 percent. You can do the math. They only have 250 thousand card holders.

Why do they want to own this business? As they say, initially when they started in this business (in 2004) "The business model was constructed with Discovery receiving the revenue required to fund the integrated behavioural incentives and Discovery sharing in 20% of the underlying DiscoveryCard profit." And then now, "The DiscoveryCard customer base is a profitable and unique asset, and sits in the mid-income, mass affluent and affluent segment of the credit card market, which constitutes 93% of the industry's profit pool." Their 250 thousand customers are basically the most profitable, in the sweet spot.

The key here is that Discovery are not looking to become a bank, they make it clear that this card will continue to operate on the FirstRand banking licence (FirstRand own 25.01 percent of this venture), to learn more about their customers spending habits and customise their full suite of products accordingly. I suppose if you know (for instance) that someone spent 1000 Rand at the bottle store on Friday and then went on a drive about later in that evening, you might want to start charging them a little more for life insurance, not so? Equally, the points based system for rewards for good behaviour and a portion of your premiums back in the coming years, that is more important, don't you think? I certainly do. Good behaviour is rewarded rather than naughty behaviour being punished, i.e. you know when you are being bad, you however love being told you are doing well.

This is not something huge and mind-blowing. This is less than 5 percent of their market cap, including them sinking another 800 million Rand into DiscoveryCard, "which will likely be required to develop and enhance this financial services platform." So, 2 billion Rand we know where that is going to go, remembering that in the original release, the first reason for raising cash was further capital required for the "Prudential" business: In the context of the UK, the rationale behind the acquisition of The Prudential Assurance Company Limited's ("Prudential") remaining 25% shareholding in the UK joint venture was to pursue strong, profitable growth and further opportunities. In particular, VitalityLife presents a strong case for further investment, given the success of the Vitality-integrated life insurance product, the scale and reach of the distribution and wellness network, and attractive returns on new business. Historically, new business was funded through the Prudential structure. Going forward, to maintain the rate of growth, additional capital is required.

So, follow your rights, we will contact you all about the rights issue and the timing shortly. Good company that continues to make good inroads disrupting core markets, there is a strong and energetic team at the helm, we continue to also recommend this company as a buy.