Nairobi — So, what were investors paying for when they massively subscribed for the Uchumi rights issue in October last year?

Despite the fact that the fundamentals showed the company was in difficulty, investors voted for the company in their thousands. The rights issue, which raised Ksh1.2 billion ($16.66 million), was snapped up by the scrip-starved market in a matter of weeks.

And it was not as if only the small investors, unable to interpret the accounts of the company, were the ones who bought the rights. Sophisticated investors, including foreigners participated in the issue.

Yet all the books showed a negative cashflow position and a negative equity position for the company.

According to an analysis done by stockbrokers Kestrel, sales per square foot had plummeted for four successive years, from Ksh436 ($6.05) per square foot in 2000 to Ksh203 ($2.81) per square foot in 2005.

Gross margins had also dwindled, from 17.3 per cent in 2002 to 15.1 per cent in 2005.

In retrospect, what attracted investors to the rights issue was the franchise model that had been unveiled by the company a few months before the rights issue.

Following the closure of some of the stores in February last year, the board launched a franchising business model that was touted on the grounds that it would give the company a national presence without having to invest too much capital.

Under the model, the company would lend its brand name to independent retailers who would be required to maintain high standards for them to retain the franchise.

At that time, the company said it expected the first seven of its franchised stores to commence business by the end of October 2005.

The board also announced that the company would in subsequent years facilitate the opening of 10 similar stores annually in key locations countrywide.

Still, critical voices warned that the franchise model was overhyped.

In a bulletin to its clients, Kestrel warned, for example, that franchising only worked with "high-margin" branded chains like hotels, fast foods and convenience stores, where the brand name itself helps to sell the product or service.

"What is the value of the Uchumi brand name, and how much will franchisees pay for its use?" asked Kestrel in the bulletin it prepared for its clients. And, considering that the Uchumi business was a low-margin business, how much of the margin were the franchisees willing to share with Uchumi?

Uchumi has now exposed the bubble that the Nairobi Stock Exchange has become.

It would appear that as long as interest rates remain high and opportunities and channels for directing savings remain limited, demand for shares will continue to depend on hype and irrational exuberance.

Uchumi's touted turnaround strategy began in November 2004 when the board recruited John Masterten-Smith as managing director, replacing King'etich Bett, who had acted in that position since June 2004.

In February 2005, the board decided to close 10 loss-making branches across the country, which resulted in the loss of 580 jobs.