An "emerging" market?

Looking out the window of our co-working office in Cape Town, we stared at an unfinished highway bridge which, as we later learned, was started over 40 years ago. This road to nowhere seemed to us the perfect symbol of the only “emerging” market in the world that failed to grow its GDP per capita over the past decade.

On our first day in the country, a rainy Saturday, we sat in the dark at the Apartheid Museum for hours waiting for the lights to come back on. The employees explained that “load shedding” happens daily so that different parts of the country can take turns using electricity because of operational deficiencies at the state-owned utility company. Aside from inconveniences this caused us – such as increased traffic jams from non-working stop lights – several companies cited this as a major inhibitor to productivity.

Three days later, we listened to the country’s president speak in the same square where Nelson Mandela addressed the people upon his release exactly 30 years earlier. In his speech, the president committed to destroy one of the most fundamental institutions – property rights – by expropriating land without compensation from white owners and giving it back to the natives. While many people believe this is nothing more than political rhetoric meant to secure populist support, the fact that such a possibility is entertained undermines people’s willingness to invest in assets which could simply be seized.

It’s a disgrace to Mandela’s legacy that his political party has been plagued with severe corruption. After years of being marginalized, leaders of the anti-apartheid political movement have been extracting value for themselves instead of strengthening inclusive institutions. For example, after ruling for nine years the previous president was forced to resign on substantial allegations of fraud, racketeering, and money laundering. Perhaps it’s difficult to support a family of four (official) wives and over 20 children on a politician’s salary without side gigs. Some were hopeful that the new president who took office two years ago could turn things around, but he has struggled to make any meaningful impact so far.

What’s worse is that there is no credible opposition party which could take the lead. Towards the end of our first week in South Africa, we witnessed a spectacular train wreck as a minority far-left party took the State of the Nation address hostage for nearly two hours before leaving in protest and finally permitting the president of the country to speak. Among their demands were expulsion of the last apartheid-era president in attendance who had claimed the week before that apartheid was not a crime against humanity, and the removal of the minister of public enterprises responsible for the utility failure. While their disruptive tactics were hostile and aggressive, they nonetheless raised awareness of – and symbolized – the dire state of the nation.

Many of these problems stem from decades of institutionalized racism which only ended 25 years ago. Measures to remedy this history have largely failed, and racism is still very strong. We heard many stories of – and personally witnessed – hidden and explicit racial discrimination, both direct and reverse, in public, the workplace and government. Observing this situation in what has become the most unequal country in the world marked a stark contrast for us given that we manage a fund based in Finland, one of the most equal countries in the world.

South Africa’s unemployment rate has steadily increased over the past decade to a staggering 30% today (and nearly 60% for youth), essentially the highest of any country in the world. And keep in mind that this figure doesn’t factor in discouraged workers who have given up looking for work, so the actual situation must be even worse than these numbers indicate.

Of the nine emerging markets we’ve lived in over the past nine months, we felt the least safe in South Africa. We couldn’t have cellphones in our hands without passersby warning us to keep them in our pockets, Uber drivers would recheck at every intersection that the doors were locked and shared stories about violence they had personally experienced, and security guards told us to wait inside for our car and insisted on escorting us the 10 meters to the street. The situation seemed to have deteriorated since our previous two trips over the past three years.

Of hundreds of people we met in South Africa, no one was optimistic about the country’s future. One very experienced CEO who grew up in Zambia said that from his observations it’s more likely that existing institutions will keep deteriorating than that the rest of the country will improve. Many CEOs said they want their kids to leave the country and cited skilled emigration as one of the major human capital risks to their business. This brain drain may well be the final nail in the coffin for any hopes that this country ever emerges.

Scrappy brothers thriving in a difficult environment

Given this dismal situation, if we were macro investors, we would simply have no interest in South Africa. However, as bottom-up investors we travel the globe in search of great businesses at low valuations, and the fact that very few investors are looking at South Africa is actually good for us. After meeting nearly a hundred companies during our month in South Africa, we managed to find one that delivers promising results in spite of the depressing external environment.

This defensive business, set up as a real estate investment trust, is a self-storage asset owner which should continue growing despite likely future domestic economic issues, as the business is driven by life-changing events such as marriage, separation, having a child, doing renovations, starting a small business, or expanding a business. These life-changing events can be positive or negative, and continue to happen whether the economy is expanding or contracting. The company’s partial exposure to another underpenetrated market outside of South Africa provides an additional hedge against currency devaluation which, we believe, is likely.

The company’s founders, who serve as the CEO and CFO, are two young brothers who grew up in a working-class family. After six months of mailing letters, they convinced the state-owned utility company to sell them an uninhabitable lot sitting under power lines for $200,000, which they scrambled to scrape together. They then innovatively applied the condominium model of pre-selling a portion of the units to come up with a down payment for the loan to build a $4 million self-storage facility, which turned out to be a success.

After researching the industry in other countries and personally visiting every one of the 100 South African self-storage facilities they found in the yellow pages, they became convinced of the huge opportunity in this nascent market and have grown the business to 66 properties over the past 13 years. The competitive siblings, who run ultra-marathons, now dominate the market, and continue to consistently expand the number of properties in high-quality locations. Additionally, they have built a core competency in digital marketing in order to generate inquiries which they believe to be the crux of the business, and they deliver a 10% dividend yield to shareholders.