In this part two of a two-article series, analyst Ted Black continues his examination of Pharmaceutical giant Aspen Pharmacare and the possible cause of a steady plunge in asset productivity. Black is a specialist on dissecting company reports, with a focus on Return on Assets Managed. – Claire Badenhorst
Is it time to light an ATO Fire under Aspen Managers’ ASSEtS?
By Ted Black*
From 2002, Aspen grew its asset base year-on-year at an average rate of 31%. Organic growth is vastly different from one through acquisitions. Imagine putting on weight that fast! Your bodily system would soon pack up.
It’s the same for a business. Managing effectively is hard enough as it is. Growing at such a rate makes it far tougher and largely explains why so many firms who do it, end up being weakened and ultimately broken up.
As the late Dr. Peter Drucker urged, instead of looking at numbers first, start by asking, “What’s the business purpose of buying this company?” and “How will it strengthen us?”
The various types of acquisition will firstly be a “hands-off” investment. Secondly, one to invest in and manage. Another is to buy to integrate into your existing operation and manage. Lastly, there is diversification. The aim is to build on strength, not shore up weakness. They all carry their own type of risks with the last – diversifying – being the highest risk of all.
On the face of it, Stephen Saad and his team seem to “invest and manage” and “integrate and manage” what he called a “bolt-on”.
As to Drucker’s final point, always consider “Opportunity-cost”. You must factor it into expectations for performance after the deal is done. The answer to the question, “What’s the best alternative to this investment?” (BATTI) gives a cost-of-capital hurdle that in turn creates a ROAM hurdle for management. The result is an economic profit or loss. It should be the final one in a Profit and Loss statement but never is. Because of price premiums paid and the difficulty of integrating them, it’s why most mergers and acquisitions in time cause a collapse in value.
Given these guidelines and Drucker’s last caveat, how has Aspen performed? If a shareholder were to ask the BATTI question, it would be reasonable to expect a 20% return for equity. If we use that expectation and deduct it from operating cash profit after tax, here is the picture comparing the result with ROAM:
The green bars are the cumulative profit generated from 2002. The first annual economic loss was made in 2010 when ROAM was at 13,1%. As you can see, since then, the downward cumulative loss trend gets steeper by the year. It’ll become ever harder to reverse if Saad and his financial team don’t educate and alert operating management and allow them to keep adding assets– tangible and intangible – faster than sales.
It doesn’t seem from the recent interviews that there is a clear, compensating market strategy in place. If there is, then it should be clarified to shareholders. If they do have one and understand what fundamentally drives the value of a firm – are all “incentivised” with share options – as so many analysts foolishly advocate as the way to improve performance – then why has the value of equity steadily declined over the years from more than R8 in 2006 to less than R1 today?
It takes quite a long time for capital markets to react as you can see if you look at Aspen’s ROAM and market cap trend. When the fall comes, it’s sudden.
During the four years from 2016, market cap plunged by 72%. Up to 2016, there was a negative correlation between ROAM, the share price, and market cap. Growth in sales, assets and profit drove up the share price, not productivity.
So what’s to be done?
You make change with one number, not many of them. Start with one that’s simple to understand – not simple to do, but simple to understand. Not CFROI or EVA or RONA – all good measures but complex. Have a simple, sales-driven, ROAM one. It’s a measure that the financial function can use to educate people company-wide. All people need is simple arithmetic to use it.
Read also:
- Aspen: why profits and margins are only half the story – Ted Black
- Ted Black: Government handling of Covid-19 has imposed unnecessary poverty on millions
- Boardroom ignorance: How maximising shareholder value destroys wealth – Ted Black
Isn’t it high time then for Stephen Saad to get the brains of his key operating managers out of bed … and to light an ATO fire under their ASSEtS?
From now on, put a charge for assets into the operating income statement that reflects an owner’s equity cost as a percent of the assets being managed. Do that and they’ll see what’s happened to the ROS% … negative since 2014.
Add assets with care and fear; unless they can rigorously prove otherwise, more is worse. When adding assets, put strategic effects front of mind – not cost reduction effects. Lastly, have a compensating, closely monitored, rolling quarterly, market strategy in place – not a budget – to offset the added assets.
The hidden potential in there will be huge. It is in all firms if you get the dead hand of bureaucracy off people’s throats and focus on the 10% of effective people who get results in every enterprise everywhere. They lift everyone if you harness brains to focus on the right thing.
- Ted Black is a mentor and coach, he uses the ROAM financial model and a 100-Day Action Project method to pinpoint and convert fuzzy problems and opportunities into high-precision, team-driven projects. Their aim is personal growth; to jack up learning fast, and to measure with tangible results. They are management on a small scale – the rule is less talk, more action. Black has written and co-authored several books that include “Who Moved My Share Price?” published by Jonathan Ball.