Investigating Investec

A report and valuation on the firm Investec. This is an in-depth financial analysis

Investec is a financial firm that works primarily in the UK and in South Africa. This report seeks to calculate a Cost of Capital for the firm, trying to work out how close its debt ratio is to the optimal debt ratio and how valuable its investments have been. This is the Financing Part of this report.

We will review the firm’s forecasts, and try to see if its growth potential is high or low, and attempt to find out its place in the corporate life cycle.

I am also going to suggest three projects, forecast them myself and check their IRR and NPV. All of this reflects the Investing Part.

Finally, I will go through valuation and check the share price. I will finish by taking a look at management and the firm as a whole.

I would like to add that this is entirely done for my own experience, I do not expect the firm to read this, let alone take my suggestions! But I would like to honestly review the company, and get a feel for its corporate culture and its make-up in a highly competitive environment, as well as reinforce my learning in Corporate Finance and Economics.

This is written impartially, I am not trying to get any results (unless stated otherwise where I try to match calculations to known results) or make the firm seem better than it is.

Thanks to Investec for a unique look with financial analysis.

FINANCING

The Cost Of Equity

Cost of Equity: Risk-Free Rate + Beta x Equity Risk Premium

I am going to use the CAPM model, because the other models are a pain and people only appreciate the CAPM anyway.

The Risk-Free Rate

Based on the core loan group, 47% of the company is based in South Africa, and 53% is in the UK and other countries. For the risk-free rate I will use a rated average using this ratio. It is not entirely accurate, but it is the best breakdown of operations per geography I could find.

For the UK and others, we will use the 30Y UK bond rate minus the historical default spread on country’s with the UK’s rating, which is Aa3. According to data collected by Aswath Damodarum of Stern Business School, the default risk for this rating is about 0.59%.

4.375% - 0.59% = 3.785%

For South Africa, we will use the 30Y T-bond rate minus the historical default spread on country’s with South Africa’s rating, which is Ba2. According to data collected by Aswath Damodarum of Stern Business School this lends a historical default spread of 2.98%. Since South Africa is a very risky business, it has a very high risk-free rate.

12.026% - 2.98% = 9.046%

Now we perform a weighted average to average out a risk-free rate for the financial firm.

3.785%(53%) + 9.046%(47%) = 6.25767%

The Equity Risk Premium

I will calculate an implied equity risk premium by discounting the value of an S&P 500 forecast until it is equal to its value today. That discount value minus the risk-free rate is equal to the implied equity risk premium.

According to PrimeXBT, the S&P’s current value is 5100, and in 1 year it will be 5700. This warrants a growth rate of about 11.76%.

11.75% - 6.25767% = 5.49233%

This is our first implied equity risk premium.

According to FactSet, the S&P earnings will grow by about 12.7%.

12.7% - 6.25767% = 6.44233%

The problem with this method is that it heavily relies on prediction and forecasting, which is a heavily biased method. However, the equity risk premium must reflect investor sentiment, which itself is, of course, heavily influenced by bias.

I will calculate a simple weighted average…

6.44233%(0.5) + 5.49233(0.5) = 5.96733%

Therefore, the equity risk premium is placed at about 5.96733%.

The Beta

Calculating a Bottom-up Beta

We will calculate a bottom-up beta using an average of regression betas from similar companies in investec’s peer group.

Investec has lines of business in the following categories.

Industry - Beta

• Wealth & Investment Activities - 0.50

• Private Banking - 0.48

• Corporate, Investment Banking and Other - 0.47

• Group Investments - 1

Using betas from stern business school we can calculate a weighted average of the beta for the company. We will then lever the beta up using the firm’s debt to equity ratio. I assume a beta of 1 for investments, they consist of holdings in Ninety One, Bud Group Holdings and Burstone Group. Now though this may not reflect individual holdings or stakes, group investments only make up less than 1% of assets or revenues for the firm.

The company does a partial division of its assets, this will be used as a weighted average for our betas.+

Industry - Assets per UK and Other - Assets per South Africa (£ in millions)

• Wealth & Investment Activities - £184 - £187

• Private Banking - £5 326 - £10 087

• Corporate, Investment Banking and Other - £24 417 - £15 999

• Group Investments - £159 - £267

For South African total assets were 26 540. For the UK total assets were 30 086.

UK and Other (to one dp) - 53%

• Wealth & Investment Activities - 0.6%

• Private Banking - 17.7%

• Corporate, Investment Banking and Other - 81.2%

• Group Investments - 0.5%

0.50(0.6%) + 0.48(17.7%) + 0.47(81.2%) + 1(0.5%) = 0.4746

South Africa (to one dp) - 47%

• Wealth & Investment Activities - 0.7%

• Private Banking - 38%

• Corporate, Investment Banking and Other - 60.3%

• Group Investments - 1%

0.50(0.7%) + 0.48(38%) + 0.47(60.3%) + 1(1%) = 0.47931

0.47931(47%) + 0.4746(53%) = 0.4768137

This is the unlevered beta for the company.

Levering Up the Beta

We will now lever it up with the company's Debt to Equity ratio and effective tax rate.

Investec’s effective tax rate was 21.8%.

Total Shareholder Equity = 5 474 242

Total Liabilities = 51 151 485

However, this is a financial institution. Deposits are considerably less risky and insured by the government. Therefore, I have subtracted them from the liabilities. This leaves us with total liabilities of 8 196 904.

Their debt to equity ratio is 8 196 904 / 5 474 242 = 149.735872108%

Levered Beta = Unlevered Beta(1 + ((1-t)(Average D/E)))

0.4768137(1 + ((1-21.8%)(149.735872108%)) = 1.03513132088

1.03513132088 is the levered beta of Investec. This shows a relatively low risk business.

The Cost Of Equity

Expected Return = Risk-free rate + Beta x Equity Risk Premium

Cost of Equity = 6.25767% + 1.03513132088 x 5.96733% = 0.1243464019

The cost of Equity (to two dp) is 12.34%!

Has Investec delivered acceptable returns to its equity investors? In the previous year, their ROE was 14.6. This means, using equity alone, the company has achieved adequate returns. We must calculate a cost of debt and a cost of capital in order to see more clearly what hurdle rate the firm should be compared too.

Since the cost of debt is often cheaper than the cost of equity, it is my assumption that this ROE likely beats the cost of capital. Especially due to the fact that Investec has significantly more debt than equity.

Comparisons

Value Investing estimates the cost of equity to be 9.15%. Their levered beta is 1.33 and risk premium is 6.5%.

The reason why our cost of equity is much higher is due to the fact that we used a more conservative risk-free rate. We used the government bond rates of the underlying countries, coupled with a default spread. This means the cost of equity is higher, but hopefully is a more accurate reflection of risk. Their risk-free rate was 4.5%. In my opinion this does not properly reveal the risk of the South African business of Investec.

That risk-free rate would have placed us closer to their lower estimated cost of equity of 10.6%.

Another difference is our debt to equity ratios. Ours was about 150%. There's was 102%. This resulted in a likely lower beta. Our estimate was based on removing deposits, they may have chosen a more thorough assumption.

Our equity risk premiums were about 100 - 50 basis points apart. We based our assumptions on forecasted ROE, rather than historical returns. This is because historical data is not a forecast, but a measurement of previous firm value.

The Cost Of Debt

Calculating the cost of debt is difficult in financial firms. This is because the debt of a normal firm often holds a lot more risk, whilst financial firms’ debts are often much less risky than they may appear using the CAPM traditionally.

Cost of Debt = Risk-free rate + Default Spread

Since we already have a risk-free rate we can now simply calculate the default spread.

Default Spread

My learning in this area of Corporate Finance has almost entirely been taught by Aswath Damorandom, professor at Stern Business School. Fortunately, he offers a large amount of data, including a ‘synthetic’ rating.

He offers a typical default spread for each bond rating, this is calculated by looking at the chances of insolvency for each rating.

Investec is rated BB globally, which offers a default spread of about 1.83%.

Pre-Tax Cost of Debt

This lends us a pre-tax cost of debt. (This was far quicker than calculating the cost of equity…).

6.25767% + 1.83% = 8.08767%

The pre-tax cost of debt is therefore: 8.09 (2 dp)

After-Tax Cost of Debt

We must now multiply this debt by 1 - marginal tax rate. This should add into the equation the tax benefits of debt.

The marginal tax rate for corporations in the UK is 26.5%. In South Africa it is also about 26.5%. I would have performed a weighted average, but seeing as they are the same we will leave them as they are.

8.08767%(1-26.5%) = 5.94443745%

The after-tax cost of debt is therefore then 5.9% (1 dp)

This was far faster than calculating the cost of equity. This low cost of debt is not strange, debt is often much cheaper than equity. This is related to the relatively low-risk properties of debt as well as its tax deductible properties.

This low rate furthers my impression of the business as low risk. But does that mean its growth potential is slow or negligible? How does the firm deliver to its equity investors as well as its debt investors?

The Market Value of Debt

Before we can calculate the WACC, we must get the weights for debt and equity. Fortunately Equity is not a problem, but we need to get the market weight of debt.

In order to do this, we will get all debt on the firm’s books and perform a calculation.

However, I will not be making this calculation since our counting of debt does not include deposits. The Bank Investec is mostly funded by deposits, and therefore the rest of its debt is traded.

The Cost of Capital

I would like to do a WACC cost of capital by weighting both equity and debt. However, I am only going to include the amount of liabilities that behaves like traditional debt.

Liabilities are 52 446 096. I will subtract deposits by customers and banks, 2 843 008 and 40 438 009 respectively, as well as liabilities to customers under investment contracts, 187 981.

This gives us a total liabilities of 8 932 106. When I levered up the beta I included all liabilities except customer deposits. This is because all these liabilities are still risky to the equity investor, and I wanted them to be included in the beta’s measure of risk.

Equity = 5 668 053 / (5 668 053 + 8 932 106) = 38.8218580359%

Debt = 8 932 106 / (5 668 053 + 8 932 106) = 61.1781419641%

12.43464019%(38.8218580359%) + 5.94443745%(61.1781419641%) = 8.464054744%

This puts the Cost of Capital at about 8.56% (2 dp).

What the Cost of Capital tell us…

The cost of capital is quite low, but still reflects the level of risk Investec takes on as a business. If it were only based in the United Kingdom, the cost of capital would likely fall to about 5%-7%, a large drop from the current risk-free rate would be the main culprit.

This cost of capital is very low but could it be lower?

Is the Cost of Capital Optimal?

The Cost of Capital Approach

This approach asks a simple question, what proportions of debt and equity do I need in order to get the lowest possible cost of capital?

This is a very simple approach, I will simply see what the cost of capital is at different proportions of debt. The Cost of Debt will increase as the default spread increases.

In addition, as debt increases, the levered beta increases to reflect more risk on the equity side. Finally, the tax rate limits the tax deductible nature of debt since a firm cannot deduct more in interest expenses than earnings.

In order to calculate EBIT I will add interest expenses to Profit before taxation. This results in an EBIT of: 3 607 955 (‘000)

822 498 + 2 785 457 = 3 607 955

This means the current interest coverage ratio fro Investec is 1.3 (2 dp)

3 607 955 / 2 785 457 = 1.2952829643

When we cross-reference that to Aswath Damodaran’s historical chance of default, we receive a rating of B- and a default spread of 4.42%.

This is actually in line with many of the ratings for Investec’s business.

I have avoided 100% of either equity or debt. The Implied Spread is the default spread plus the ‘rating spread’. All numbers are to 2dp. We are starting at 10% debt, 90% equity.

10/90 - Beta: 0.52 - Implied Spread: 1.33% - Cost of Capital = 9.35%

20/80 - Beta: 0.57 - Implied Spread: 1.33% - Cost of Capital = 9.08%

30/70 - Beta: 0.64 - Implied Spread: 1.65% - Cost of Capital = 8.88%

40/60 - Beta: 0.73 - Implied Spread: 1.73% - Cost of Capital = 8.65%

50/50 - Beta: 0.85 - Implied Spread: 1.83% - Cost of Capital = 8.45%

60/40 - Beta: 1.04 - Implied Spread: 2.08% - Cost of Capital = 8.33%

70/30 - Beta: 1.35 - Implied Spread: 2.43% - Cost of Capital = 8.60%

80/20 - Beta: 1.97 - Implied Spread: 2.71% - Cost of Capital = 8.95%

90/10 - Beta: 3.83 - Implied Spread: 3.88% - Cost of Capital = 10.13%

You may notice the following data points. Firstly, the optimal is at 60% debt, 40% equity, now as all the data is rounded to 2 decimal places, you can understand how close the cost of capital is around 30-50% debt. Secondly, the data shows a large increase in the after-tax cost of debt at around 70% debt. This is because at this proportion of debt, EBIT is now less than interest expenses. This means that debt costs more as it is not as tax deductible as it was previously.

I would also note that in my analysis, changing the multiple ranges the optimal from 50/50 to 60/40. Still, it's very much in Investec’s favour. I would like to see how this compares to the APV approach.

Key Assumptions

Normally, I would calculate the debt by multiplying the debt ratio to the firm value. Then, interest expenses for the year would simply be the debt multiplied by the risk-free rate and the default spread. However, this is not yielding any risk, the rating has remained the same, regardless of large proportions of debt.

I attribute this to the peculiar market cap of the firm. It is about 8 billion, even though it has an EBIT of almost 4 billion, 6 billion in cash and retained earnings of about 5 billion. It would appear the business itself is having a large negative impact on the value of the firm. This peculiar valuing may be due to a disconnect between the two legal entities, Investec ltd and Investec plc. Investors may struggle to value one in accordance with the other.

Due to this, I compared our interest expenses with our 60/40 debt/equity ratio and created a multiple. I am multiplying the debt by this multiple, because I believe the firm would take on much more debt than its enterprise value suggests.

This is a key assumption, without it, my results would show an optimal cost of capital at very high proportions of debt, as their risk would not be adequately reflected in either approach.

The multiple is 3.91.

I got this multiple through a sensitivity analysis. I changed the value to get the ideal balance between the correct rating for Investec’s 60/40 debt/equity ratio and the correct interest expense at that ratio.

A second important assumption I made is to do with which default spread I should use. I have chosen to use the one for “large non-financial firms.” This is because I removed liabilities typical of a normal financial firm. I don’t believe the default spread for financial firms no longer properly describes the risk of Investec’s debt.

Finally, as I went through my working I was trying to achieve a B- rating for the 60/40 ratio, this would align with many rating agencies. However, its interest coverage ratio was just under. Since the jump from B- to CCC is about a 3% jump in interest rates I chose to use a B-.

The Adjusted Present Value Approach

This approach does not seek to only minimize the cost of capital, the discount rate for all its investments, but also to maximise the value of the firm using debt.

Firm Value = Unlevered Firm Value - Tax Benefits of Debt + Expected Bankruptcy Cost

Expected Bankruptcy Cost = Probability + Cost

We can therefore remove tax benefits and add expected bankruptcy costs to find out an unlevered firm value, then we can use our synthetic ratings calculated during the previous approach to derive a probability of default using historical data.

Bankruptcy costs include direct costs and indirect costs. The direct cost of bankruptcy includes legal fees and other costs, usually 5-10% of a firm’s value. I estimate that because Investec has a large amount of assets and collateral, its direct cost will be about 6%. This is because it will still be hurt in comparison to other firms, but less than most.

In addition, Investec is hurt much more by indirect bankruptcy costs. These include the damage fears of default do to a firm. This is because it is unlikely any wealthy investor would want to deposit money with a bank that may default. They range from 5-30% of firm value. I estimate it to be at about 30%. This is because its entire business relies on trust.

The firm’s market cap is around 4.3 billion in South Africa. Its holding company in the UK is worth around 4.32 billion (The firm has a peculiar business make-up, technically acting as two legal entities for its british and african operations.) The market cap then is 8.62 billion. I will then add 3 607 955 000 in debt and 325 000 in non-controlling interests and 586 103 000 in other securities issued. We then subtract cash of 6 279 088 to get a result of…

8,621,705,100 + 3,607,955,000 + 325,000 + 586,103,000 - 6,279,088 = 12,809,809,012

This is the enterprise value. Bankruptcy costs all together are 36% of this value. The likelihood of default is 4.22% (for the firm’s rating of BB). Bankruptcy costs are therefore…

4.22% x (0.36 x 8,489,809,012) = 128,977,179 (to the nearest integer)

The tax benefits of this current debt is the current debt(3,607,955,000) multiplied by the marginal tax rate of 26.5%.

3,607,955,000 x 26.5% = 956,108,075

The unlevered cost of the business is then the tax benefits subtracted from the enterprise value in addition to the bankruptcy costs…

12,809,809,012 - 956,108,075 + 16,891,697 = 11,870,592,634

We can now lever up this unlevered firm value with different bankruptcy costs and tax benefits.

As I noted before, the market cap of Investec is peculiar, so I connected the debt on my excel spreadsheet for the optimal cost of capital approach done previously. The same debt is therefore used.

The data I used is from Rutherford rede (1). My time horizon for these defaults was 10 years in order to calculate the probability. This is due to a Morgan Stanley paper on the subject suggesting a 10 year time horizon (2). The data is not perfect but gives a good gauge of bankruptcy probabilities.

10/90 - Rating: AAA - Cost of Capital = 9.35% - Firm Value = 13,156,428,885

20/80 - Rating: A+ - Cost of Capital = 9.08% - Firm Value = 14,475,170,419

30/70 - Rating: A - Cost of Capital = 8.88% - Firm Value = 15,802,458,780

40/60 - Rating: BBB - Cost of Capital = 8.65% - Firm Value = 17,179,746,077

50/50 - Rating: BB+ - Cost of Capital = 8.45% - Firm Value = 17,943,371,217

60/40 - Rating: BB - Cost of Capital = 8.32% - Firm Value = 19,270,659,578

70/30 - Rating: B - Cost of Capital = 8.60% - Firm Value = 17,571,230,637

80/20 - Rating: B - Cost of Capital = 8.95% - Firm Value = 16,353,669,637

90/10 - Rating: B- - Cost of Capital = 10.13% - Firm Value = 14,903,005,356

Fortunately for me, the APV and Cost of Capital Approach both yielded the same Optimal. The APV places the optimal at 40% equity and 60% debt. This is likely because of the difference in ratings. At this rating the firm still gets all of the tax benefits of debt, and though its bankruptcy costs are much higher than previous debt ratios, this benefit massively increases firm value.

You may notice I have not run through all of the calculations in this paper, you can find my detailed excel spreadsheet at this link, the Optimal Cost of Capital. I apologise for how messy it is, it's my first time writing publicly like this.

What does the Optimal tell us?

Whether with or without intention, Investec’s debt/equity ratio closely follows the optimal in both approaches. Its cost of capital is near minimisation by a couple basis points and its firm value using APV is roughly equal to maximisation.

Investec has a very good cost of capital, it both acts as a maximisation of firm value and a minimisation of the discount rate used to fund its investments. This gives me a good impression of management.

In the combined results for Investec plc and Investec ltd, one of its strategic actions was a large share buyback in order to ‘optimise capital’. I might assume that this was done to ensure its cost of capital was minimized, as this helps the firm to maximise its value in the long run.

INVESTING

Will Investec continue to deliver a good return?

Using a minimized cost of capital, the firm has delivered good returns. Its ROE of 14.6% is, quite simply, a good investment. But what have those investments consisted of? What do their forecasts look like? What is the firm’s growth potential?

Let’s answer those questions…

How has Investec delivered returns historically?

Since 2023, Investec has delivered revenue growth of about 4%. Its ROE delivered climbed by 90 basis points. The inflation rate in South Africa was about 4.4% and in the UK it was 2.5%.

4.4%(47%) + 2.5%(57%) = 3.493%

This means that revenue growth is more likely due to South African inflation, rather than due to improved operations.

Its 2025 outlook continues on this trend, 14% ROE, and we will cover dividend policy in the last section of this investigation.

Fortunately for me, Investec has placed some strategic actions on its first page. Let’s review them…

The Combination of Investec Wealth & Investment UK and the Rathbones Group

Data for this investment is reflected as a ‘discontinued operation.’ For this reason, some of my estimated cash flows did not include this value.

However, this line item also includes the selling of the Investec Property Fund. This will likely affect how we value this investment.

The firm now manages £107.6 billion compared to £40.7 billion the year before, a roughly 264% increase due to the combination.

Investec holds a 41.25% economic interest in Rathbones. In the second-half of the year the investment produced £31.0 million. Since wealth and investment management is likely to have stable cash flows all year round, I would imagine the annual profit from the investment would be £62 million.

In order to consider whether this investment will provide a good return, I will first compare the values of both the value of II&W UK and the 41.25% economic interest in the Rathbones Group.

I assume a growth rate at the UK inflation rate, and for Rathbones I will simply subtract the forecasted 15 million in synergies from their future costs. Since I assume quarterly revenue is roughly the same, and Investec does not provide quarterly data for each sector, I will divide by four.

The 20yr average inflation rate for the UK was about 2.82%.

My workings can be found here, Comparing Investments. The discount rate for II&W UK is the inflation rate mentioned above. However, since Rathbones is the largest wealth management business in the UK, and its market share is likely to grow due to tariffs blocking out international business, I will give it a 20 basis point larger growth rate of about 3.02%.

I estimated the total value of Investec Wealth and Investment Management to be about £2,375,852,559.42.

The total synergies for Rathbones are estimated to be about £15 million. I will add this to every profit after 2025. They achieved £10 million in synergies so far. I will add this to the 2024 profit.

Instead of using Rathbone’s financials. I have used the profit given to Investec in the second half of the fiscal year. This means that I have set the economic interest to 100%, as Investec’s financials already reflect the economic interest.

I estimated the value to Investec of the combination to be about 2,279,123,385.93

This results in a net loss of about £-96,729,173.49. In hindsight, the economic interest needed in order to get a positive return should have been about 45%. This offers a net gain of about £110,463,861.59.

Is this project good or bad for the firm’s value?

In my opinion, this project is bad for the firm according to our current estimates, it boasts larger revenues and a great market share but does not pay off in the firm’s favour. My research favourably applies the forecasted synergies to the combination’s already larger revenues.

However, this does not fully show the possibility of profit in the project’s future. As Rathbones has a large market share, it could increase its fees, in which case Investec would probably receive a positive return. It may be that Rathbones gets a larger market share due to tariffs on international companies. Each of these more unexpected outcomes will impact Investec, and ensure a positive return in the future of the firm.

If fees were to increase 5%, due to more pricing power for Investec’s clients, which is an increase only twice the average rate of inflation, the firm would receive £ 17,226,995.80 as a positive return.

On the other hand, if market share increases 10%, and costs do not change (idealistic yes) the firm’s return would be £ 131,183,165.10.

What is the chance these investments pay off?

In order for investments to pay off, the company’s growth rate must exceed or match 3.575%. So what is the probability that this happens?

According to another one of Aswath Damodaran’s incredibly useful resources (1), the growth rate for an investment bank in the next five years is expected to be 7.10%. Growth rates for previous years were much higher.

The growth rate for non-bank financial services is 8.04%. The growth rate for both regional and money center banks still exceeds the 3.5% minimum for positive returns.

Still, continuing this growth rate into perpetuity is almost impossible.

The firm must push for higher revenues, prices or market share in the next few years, they likely should have attempted to get more economic interest, though their economic outlook may have appeared to be more positive at the time of the investment.

I think that in the long term, this investment may pay off. Wealth and Investment Management is an incredibly lucrative market, and is one that is set to grow in future years. This allows Investec to strengthen and maintain economic interest in a leading firm in a growing market.

Overall, I believe that whether or not it pays off according to the time value of money, it will be a valuable part of the firm’s portfolio in times of volatile markets and the future business landscape.

Therefore I believe this investment was good for the firm, though may be bad according to the discounted cash flows given.

£300 Million Share Buyback

When I checked the optimal cost of capital, this is likely why Investec closely mirrored it.

Finding out if this investment is good or not is very simple, we just need to compare the amount of money we save each year through tax savings.

Fortunately, we already checked how much the firm value is affected by debt. We just need to calculate the debt/equity ratio before the buyback, and then compare the firm value before and after the buyback to see how valuable the investment was.

In 2023, the firm’s comparable debt was about…

50 767 473 - 39 555 669 - 3 617 524 = 7 594 280

In addition the total equity was about 5 331 665.

Equity = 5 331 665 / (5 331 665 + 7 594 280) = 41.24777724%

Debt = 7 594 280 / (5 331 665 + 7 594 280) = 58.75222276%

The difference here is incredibly small. So what are we missing?

A closer look at ‘optimising capital’

The debt-equity ratio hardly changes in 2022 - 2023 - 2024. So what did this capital optimization actually consist of? And how did Investec ensure that their cost of capital was so close to the optimal in of itself?

I have looked through their results, and little information has been given.

As a firm, if they cannot adequately invest money, shareholders are more than happy to receive some of it back in the form of share buybacks and dividends.

Investec may have used some of its South African cash balances to not only payout its shareholders but also make a nominal impact on capital structure.

However, I still don’t see the effect of this incredibly large buyback. It may have affected the South African firm more than I can see, so I cannot really decide whether this investment is good or not.

However, if this money was not invested, it suggests that no better investment opportunity arrived. It may be that looking forward to the new regulatory economy, Investec wanted to return cash whilst it could, in the form of a buyback as it is unlikely to be expected next year. It is simply a residual cash flow, rather than investing in a more uncertain time period.

Disposing of Property Management to Burstone Group Limited

Investec has a 24.3% shareholding in Burstone Group Limited through the disposal of its property management business.

It was originally priced as a consolidated fund with a NAV of £593 million, 24.3% of £593 million is £144,099,000. I will assume this would be roughly the value of the stake.

The value of the stake is now priced at fair value, at around £61.5 million. This is a significant decrease in value.

I think it would be fair to say, this was a bad investment.

Has Investec’s investments been good?

As far as I can see… no. Investec’s share buyback is really quite neutral, I can’t comment on its effect, but it suggests that they may not have many other good projects, and therefore, returning capital is a good idea.

Their disposal of their property management clearly wasn’t a good investment. However, South Africa’s housing market is quite volatile, and they may have simply been trying to get out of a bad business. Whatever the case, the value they achieved was significantly lower after the agreement than before.

Finally, the combination of Investec Investment and Wealth Management with Rathbones has a negative value according to my forecasts, but it is entirely possible the investment ends up achieving a more favourable revenue growth. It can perhaps increase margins, since it has more pricing power with the largest UK market share, and since the market itself is growing, revenue growth is likely.

The combination gave Investec access to a more favourable market share, and in the long term it may pay off.

2024, in essence, was not a fantastic year for Investec, but we cannot yet see the results of these projects in the future, especially for the combination.

The Future of Investec

Investec has a net income of around 941 040 000. This merits a Free Cash Flow to Equity of about…

Net Income + Depreciation & Amortisation - CapEx - Change in Working capital + Debt Issued - Debt Repaid = FCFE

941 040 + (1 483 + 5 679) - -(209 370) + (1 802 586 - 1 541 194) = 1,418,964

209 370 is everything in ‘Investing Activities’, detailed in Investec’s very condensed cash flow statement. There is very little detail of CapEx or working capital assets. In fact the firm does not really provide any information to divide current assets from non-current, so this should work as a substitute. ‘Debt Issued’ and ‘Debt Repaid’ are put into the same category. It shows the difference between debt in 2024 and 2023. If it is negative, the net effect is debt being repaid, if it is positive the net effect is debt issues.

Therefore…

FCFE = 1,418,964,000

CapEx = 209,370,000

Growth requires reinvestment. The percentage of FCFE in comparison to reinvestment is about 14.76%. This is quite low, we can expect the growth of the firm, accordingly, to remain low if this trend continues.

If we made FCFE into Returnable and Re-investable Cash Flows, by adding CapEx to FCFE, a value of about 1,628,334,000, our percentage of RRCF that is reinvested is lower, at about 12.85%.

However, how much of this cash remains in the business? Could Investec be preparing for later reinvestment? Let’s calculate what percentage of FCFE is returned to shareholders. We already know Investec did a large share buyback at about £300 million. Dividends totaled around £360 million.

(296 712 + 49 076 + 12 599) + (17 408 + 300 000) = 675,795,000

The percentage of FCFE that is returned to shareholders is about 47.63%. This means the remaining FCFE is kept in the cash balance. This is about 45.34%.

This explains why Investec has a cash balance of about 6 billion. It is a cash balance that is possibly about 75% of its market value, including its subsidiary listings in both London and Johannesburg.

It certainly has the ability to invest, but it appears, for whatever reason, the vast majority of FCFE is either returned to shareholders or kept in the firm.

I will now calculate the Reinvestment rate, the rate at which each amount of investment produces returns in the firm. I assume after-tax operating income is ‘Profit after taxation from continuing operations’.

(Net CapEx + Change in non-cash working capital) / After-Tax Operating Income

(209,370,000) / 651,311,000 = 32.146%

32.146% * 14% = 4.5%

This is my expected growth rate. In the next 5 years, I will assume this as the growth rate, part of my valuation for the firm.

However, this is not sustainable forever, it will slowly begin to become normalised, at roughly less than GDP growth.

Right now, this is what I assume will be the future of Investec. Nevertheless, if the firm decided they wanted to continue high growth, they would only need to invest some of their incredibly large cash balance, and they may achieve double-digit growth. It would increase the ROE part of the equation, thus increasing the expected growth rate.

We will look at ‘suggested’ projects later on as I value the ‘control’ of the firm, and see how my own projects may work in the firm’s favour.

VALUATION

How much is Investec Worth?

All my workings are detailed in the following spreadsheet, Valuing Investec.

Year 1 is 2024, the financial details are placed there, and then I assume a simple profit growth rate. All numbers are recorded as free cash flow to equity. These total about 1,418,964,000 in 2024, I am going to assume these will grow at the growth rate. =

When I say 2024, I mean fiscal year 2024, this is because their fiscal year ends in May, rather than at the end of the year. This means, the second fiscal year has technically almost passed. It will be interesting to compare my forecasts to the hard results.

All earnings will be discounted at the cost of equity.

After Year 5, I assume the growth rate will go down by about 0.5% a year. I prefer to understate my valuation than overstate it. It is my opinion already, that looking at Investec’s cash balance is about 75% of its market value, that the firm is largely undervalued.

After Valuation: My Opinion

Whether or not the firm is maturing hardly matters. If I use my original starting expected growth rate of 4.5% I get EPS of £28.62.

The current share price is £4.77.

And this is not including the already large cash balance Investec has, it is almost assumed that all of that is used as CapEx to fuel the low growth of the firm.

Even with the most conservative of estimates, the firm is still undervalued. Will I attempt to get my hands on this stock? Absolutely.

I used a -10% starting growth rate, and it still far surpassed this share price, reaching £ 5.38

Not only because of my valuation but I think I like the firm. I find that the firm is surprisingly unique. Its market cap is medium, and it operates in areas of high risk like South Africa. I was surprised that it operated in a country like that!

It’s peculiar dual listing, where it has two entities, Investec limited and Investec plc, listed on the lse and jse. It makes the market cap at least a little bit more explainable. They also appear to mimic each other, which I found interesting. The share price of Investec limited is often very similar to the share price of Investec plc.

The firm used to have incredible marketing videos, which I saw on youtube, there’s even photos of the Queen holding that familiar zebra on a piece of card.
But since then, the firm is now pushed into difficult macroeconomic tides and possible negative decisions from management. Despite this, I believe that the firm still has the possibility of growth ahead of it.

The Value of Control

I am going to try and change Investec’s growth rate with my own projects. But I also want to take a look at management, therefore, this section will include…

• A look at Management

• Decreasing Dividends and Increasing CapEx

• A new Marketing Campaign.

• Increasing hedges against exchange rates.

A Look at Management

Management of the firm has successfully optimised their capital structure, this means that on any investment, they get a much lower discount rate than they would at any other debt ratio. How big is the effect of this?

With very little debt, the cost of capital becomes about 10%. This is calculated through my optimal cost of capital, however, I increase it a little since the optimal is slightly lower than the actual.

Now, replacing that value reduces the EPS by about £3. It reduces the value of the business from £ 24,471,127,112 to £ 21,866,327,079.29. This is quite a significant loss, over 3 billion of its value.

So, management has roughly created this value through capital optimization.

However, its recent strategic actions have resulted in lower growth forecasts in the coming years. (It doesn’t change the fact that Investec is undervalued in my opinion, I used negative growth rates and it still was multiples above the current EPS.)

Investec’s stock has lost 6.28% year-to-date (all quoted stock prices are as of Friday 2nd May) and it is still 22% higher than its low during April.

This reflects negative investor sentiment about these actions. I agree that they have been largely negative from a firm value perspective.

Management must take better investments in the future, or make sure to be more clear about their purposes. Investors may be willing to risk capital in order to enter new markets as with the Rathbones combination, or to reduce risk by disposing of Investec’s Property Management. As investments, they are very poor, but better explanations may soften losses.

What to do with management?

I don’t believe management has been failing to pick good projects, they may have seemed good with certain parameters, but they should perhaps be more conservative with their estimates, as they may not have made the wrong strategic decisions.

I suggest in the board, an idea I first heard from Professor Damodaran, almost a Devil’s Advocate in the board. Their job is to oppose every strategic decision, and to look at its possible downsides.

This can prevent agency costs for shareholders and reduce consolidation of power in the hands of a single board member or the CEO. It also gives the board the power to see every dimension of a strategic action, and to reject a proposal with enough evidence and reason

Furthermore, anyone whose job it is to estimate the value of a project should receive options to buy shares, this can act as an incentive to value the project conservatively as they benefit more from good projects.

This means decision-makers will be more well-informed with accurate estimates.

Decreasing Dividends and Increasing CapEx

The principle here is simple, in order to achieve higher levels of growth the firm must increase their reinvestment. The easiest way to do this would be to simply make use of the large amount of retained earnings that end up in Investec’s cash balance each year.

However, if we decreased dividends by 20% each year, 60% of FCFE could be used as CapEx. A 14.76% FCFE CapEx ratio warranted a starting growth rate of about 4.5%. If we assume the same reinvestment rate, our starting growth rate will be about 16%. A more conservative estimate would be that this reinvestment is likely to double (perhaps triple) growth.

This still allows for retained earnings to end up in cash balances, or an increased dividend (from the -20% we took earlier.)

This growth rate will greatly increase the value of the business, depending on its effectiveness. It will mean less money will be kept by shareholders (it will mean less cash flows during our second valuation) but the growth should eventually outweigh the extra reinvestment needed.

A New Marketing Campaign

I find Investec’s marketing campaign extremely effective. The idea of a zebra is out of the ordinary, and its brand messaging and peculiar visuals really shares that unique character.

But I want it to be more far-reaching, I want to see it everywhere, these exciting visual effects need to be seen across the UK. This is my suggested project, a huge marketing campaign, fueled entirely through cash.

It’s not creating, not fabricating, just highlighting. People do, generally, like it. Or so I’ve heard.

I think this is what Investec needs to fuel new growth, and to increase market share.

I will assume the marketing campaign will cost a total of 1.5 billion over its life. This may seem like a very large amount of money, that is the point, it is unlikely it would cost this much. Still, it would cover the largest and greatest of campaigns.

Allow me to try my hand at marketing for a moment..

The campaign could focus on uncertainty. It’s everywhere right now, traders fear the volatility of the markets, youths fear the uncertainty of the future job environment, of the new internet world.

Investec should have people ready to take calls with young people about their finances, become more friendly clients, not only to High Net Worth Individuals but to middle income and perhaps even lower income individuals, being a “family” Bank.

Impossible? Absolutely not.

Offer courses and early financial responsibility to younger individuals (backed up by parents of course) and focus on increasing their financial knowledge, perhaps even allow them to access the stock market in some capacity.

This changes the brand image of the bank. It creates the idea that it is more than just a profiteering financial institution, but a community-building friend of the UK. This will increase revenues in the long-term as the bank builds a larger, more loyal customer base.

I will assume conservatively that revenues each year will increase by about 2.75% in the first year, 3.50% annually from years 2-5, 4% annually from years 6-8 and 3.25% from years 9-10. The terminal value will use a 2% growth rate. These values, excepting the terminal value, are added to a base growth rate that I’ve set to the same as Investec’s yearly growth.

You can see my workings here, Marketing Project.

You can see the potential effect of the project in my second valuation, as its cash flows are drawn in and discounted. It has a possible value of 8 billion.

Increasing Hedges

The value of this is easy to calculate, we will look at the costs that exchange rates have had on the business each year, we will then simply assume they are added revenues to the business, they will grow at the rate of inflation.

On the question of cost, I actually don’t know how much the prices are, it massively depends on the amount of currency being hedged, and on which currency is being exchanged for what.

Therefore, I will calculate the upside, only the firm can see the downside.

The cost of exchange is around 15.1%, the amount the value depreciated in the pound-rand exchange.

I will assume this as a percentage of revenues to ordinary shareholders.

The value of hedging against all exchange risk is roughly 5 billion, I won’t be including this in my second valuation since I don’t know its costs. My workings can be found here… Hedging against Currency Risk.

How do these projects affect the value of the firm?

This is a second valuation, with increased CapEx, and my management suggests the firm should take better projects, its expected growth rate is now… 16%. I think this is unrealistic, so I will use half of it. This cannot be kept up in perpetuity, therefore it will contract by about 1% each year, so that the terminal value formula has a growth rate of about 2.5%.

This is less than the inflation rate and the risk-free rate, so I believe it is realistic.

I do a weighted average of the marketing revenue growth and add it to the first value, which inherently increases the growth rate of each revenue afterwards.

My workings are here, Valuing Investec a 2nd Time.

The value of the business with these assumptions is about £ 34,751,782,041.90.

Now, please note that this valuation is based on an incredibly large number of assumptions, just like any forecast I am certainly incorrect. There is almost no chance any project would play out exactly like this.

But still, it gives a decent idea of what the numbers might look like in a different circumstance.

A Simple Check

Valuation can be a very biased process. But when you use conservative data, and value as fairly as possible, and it still comes up hugely in a certain favour, you have to ask questions.

Therefore, I would like to price Investec against its peers. This is not valuation, it is pricing. I will compare Revenue to price, Ebitda to price and net income to price.

Company

Market Cap

Price/Revenue

Price/EBITDA

Price/Net

Close Brothers Group (CBG.L)

~£1.6B

~1.6

~5.3334

~10.6667

Rathbones Group (RAT.L)

~£1.2B

~2.1818

~10

~15

Quilter plc (QLT.L)

~£1.4B

~0.875

~5.6

~8

Investec Bank Plc (LSE)

~£5.75B

~4.95

~3.8333

~9.2310

St. James’s Place (STJ.L)

~£3.5B

~3.8333

~8.75

~14

EBITDA is quickly estimated, proceed with caution when using these numbers. Investec is at the higher end of these prices but nothing unusual or anomalous really, and there is not an instance where Investec's multiple is the highest. Note it does have a larger market cap then its comparables. Data is FY2022

2.273 is the average Price/Revenue and 2.1818 is the median. For Price/EBITDA it is 6.703 and 5.6, respectively. For Price/Net income it is 11.3795 and 10.6667, once again, respectively.

Investec falls generally below the average and median except in Price/Revenue. I far prefer intrinsic valuation but pricing can tell us a lot and there is no reason to reject some of the useful resources both approaches offer us.

Investec is generally below the medians and averages, meaning that it is priced at lower ratios than its peers.

Why might this be?

Investec has a larger market cap, it may be that markets expect Investec to grow marginally in future years as it has already reached maturity. However, this goes against my valuation, since despite giving it a very low growth rate it still showed a higher valuation than the stock price.

It may be because Investec has lower margins. This would explain why Revenue is above average and median but net income and EBITDA are below. However…

Investec

21.6%

— Investec’s

Close Brothers Group

–8.3%

Significantly lower

Rathbones Group

7.3%

Lower

Quilter plc

19%

Slightly lower

St. James’s Place

3.25%

Much lower

Investec’s margins are actually significantly higher… not this data is FY2023

Summary

The cost of equity for the firm consisted of an unlevered beta of 0.4768137, a levered beta of 1.03513132088, a risk-free rate of 6.25767% and an implied equity risk premium of 5.96733%%. This warranted a cost of equity of 12.43464019%.

The cost of debt for the firm used the same risk-free rate, its default spread was about 1.83%. Its pre-tax cost of debt was 8.08767% and the after-tax cost of debt was 5.94443745%.

Using these numbers and a debt ratio of about 60% debt, 40% equity we get a cost of capital of 8.464054744%. This debt ratio matched the optimal closely.

Investec’s projects have not been very good recently, they’re projects have had negative NPVs and are therefore detrimental to the value of the firm. However, it is possible that in the long-term these projects may pay off.

I estimated a growth rate of about 4.5% for Investec, since they do not spend a large amount of free cash on reinvestment. 47.63% of FCFE is returned to shareholders mostly in the form of dividends and about 12% of FCFE + CapEx (or Returnable or Re-investable Cash Flows) is reinvested.

My valuation of Investec valued the stock at about £28.62 per share (including their large cash balance), but I assume that if Investec spends more on CapEx, marketing or improves their projects they could be valued at about £ 40.65 per share. This, roughly £ 12.03 per share, is the value of control.

I would note here that my valuation seems to claim the stock is undervalued. I believe this is true. But such a significant undervaluation is incredibly unusual, I believe it may be partly due to the dual listing of Investec plc and Investec ltd.

They appear to follow one another, and this may mean that the market has a hard time valuing the agreement between the two legally separate firms to share capital. I believe this may have created a stock that is less representative or true firm value, despite moving in response to investor sentiment and management decisions.

Perhaps the market is pricing in

This is done by myself, if there are any issues with my calculations or assumptions, or anything you would like me to clear up, feel free to comment anything. Thankyou very much.

Lesley Espire