Bond note devaluation and the return of Old Mutual’s Implied Rate

Old Mutual is trading three times higher on the Zimbabwe Stock Exchange compared to its primary listing on London Stock exchange (LSE), indicating that local assets are overvalued as punters seek to maximise value in Zimbabwe’s currency chaos.

Old Mutual has a primary listing on the London Stock Exchange (LSE) and secondary listings in South Africa (on the Johannesburg Securities Exchange – JSE), Malawi Stock Exchange (MSE), Namibian Stock Exchange (NSX) and Zimbabwe.

Old Mutual shares are fungible, which allows the trading of its shares on the Zimbabwe register in the other markets. In June last year, the Reserve Bank of Zimbabwe increased the fungibility limit of Old Mutual shares from 40 percent to 49 percent.

All things being equal, the concept of “one price’ would imply that the same Old Mutual share listed on the ZSE should price the same with other listings, for example on LSE and JSE .

“Given that the economy operates well, Old Mutual shares should be almost equal across all stock exchanges, with no arbitrage opportunities. For instance if you compare Old Mutual share price on LSE and JSE, you will see that there is no arbitrage opportunity” said an analyst.

However, this has not been the case in Zimbabwe, since the introduction of the surrogate currency, bond notes, last year — Old Mutual started to trade at a premium relative to its price on other stock exchanges.

Old Mutual closed at 783 cents on the ZSE on Friday, while trading at 263.32 cents and 263.61 cents on the LSE and JSE, respectively, during the day.

This discrepancy of a cross listed share gives room for the simultaneous buying and selling of the shares, in different markets in order to take advantage of differing prices for the same share. For instance on Thursday one could buy the Old Mutual share from either LSE or JSE and sell it 198 percent higher (treble) on the ZSE.Chart

For a year, Old Mutual on the ZSE has been trading above other Old Mutual shares listed on the LSE and JSE starting from 15 September last year (according to the prevailing exchange rate) when it traded at 270 cents relative to 258,45 cents on LSE and 267,79 cents on JSE. Going forward it continued to trade significantly higher on ZSE relative to other exchanges, especially starting from the month of October as depicted on the chart. This correspond to the period in which the central bank indicated that it would go ahead with injecting bond notes into the economy.

At the height of Zimbabwe’s hyperinflation, which ended in February 2009 when the country dollarised, the bulk of transactions between the fast-devaluing Zimbabwe dollar and other currencies, primarily the US dollar, were calculated using an Old Mutual Implied Rate.This market-driven rate used the price of the Old Mutual share on the LSE against the corresponding price on the ZSE.

Overvalued assets

Analysts said they are using the Old Mutual implied rate as a gross indicator to measure how Zimbabwe assets are overvalued,

“The Old Mutual implied rate is telling us that Zimbabwe assets are very overvalued , we are a putting a premium because of currency risk. So if we want to see the real value of our assets, we can use that implied rate to deflate their nominal value,” an analyst said.

Another analyst said they are using the Old Mutual implied rate to discount the prices of a shares in Zimbabwe to ascertain their prices in real terms.They believe that the share prices quoted on the ZSE are in nominal value, as such, applying the implied rate will give a fair value in real terms.

“Some are using it for valuations for example one can use it to find the real value of our market capitalisation at $10 billion,” said an analyst.

Analysts said the huge difference between the multiple-listed Old Mutual on the Zimbabwe Stock Exchange, London Stock Exchange and Johannesburg Stock Exchange indicates that bond notes are losing value against the greenback, despite being officially pegged at par with the US dollar.

Critics lay the blame on excessive issuance of treasury bills (TBs) by the Zimbabwe government which has led to the creation of phony money through the RTGS system.

“The implied rate points that something is wrong. It tells us the rate at which the government is fueling money supply growth, because what the share price is telling us is that someone is willing to buy it at that ridiculous price irrespective of its fungibility,” said an analyst.

“When you compare with other efficient markets, such huge premium which gives arbitrage opportunity, indicates that there are serious economic problems and in our case it’s coupled with inflationary expectations,” he said.

However, analysts cautioned against too much reliance on the implied rate because of the ongoing bull run on the ZSE, saying there is high demand for Old Mutual’s quality shares against low supply, which, based on market fundamentals, would lead to a higher price. This is also because the company’s financial performance is impressive relative to other counters that are listed on the local bourse.

Old Mutual’s high share price also reflects the underlying macro-economic woes besetting the economy at large, they add.

“Of course the implied rate has its own weaknesses since the stock market rally has gone out of control, with no proper fundamentals being observed,” an analyst said.

Foreign investors, on the other hand, are reluctant to take advantage of the arbitrage opportunity presented by the huge premium owing to delays in getting their proceeds as the country struggles to make foreign payments due to low nostro account balances.

Amid Zimbabwe’s worsening banknote shortage, the US dollar itself has two different values — physical dollars are trading at a premium of up to 50 percent on electronic transfers.

Physical bond notes on the other hand, attract a premium of up to 35 percent on mobile or electronic transfers.

With the central bank intent on injecting more bond notes into circulation, fears of runaway inflation are real. Zimbabwe has recorded the first, and to date only, episode of hyperinflation in the 21st century and could record the second too, in the same generation.