Nampak, Naspers: Investment metrics reveal a poor show – Ted Black

Amateur investors often focus on how a share price is doing, which is natural because that way they will make a return if the stock is gaining value. But shrewd investment professionals delve deeper into the financials. Ted Black, a Return on Assets Managed specialist, has ripped open the books of Nampak and Naspers in order to investigate whether they are really making an economic profit. He highlights that acquisitions are tempting for CEOs, because they drive pay packets, which are often linked to the size of the company. He concludes that for now, the huge success of Naspers still remains dependent on the Tencent acquisition. When it comes to Nampak, its former CEO André de Ruyter – who now heads up power utility Eskom – presided over the destruction of economic profit over the past five years. – Jackie Cameron.Asset productivity (#ATO) & EVA.By Ted Black*.Alec Hogg had two interesting interviews recently – one was with Bob van Dijk of Naspers. The other was with Chris Logan of Opportune Investments who raised the issue of economic profit, or Stern Stewart's "Economic Value Added" EVA measure at Nampak's shareholder meeting. It's a tough one. Few firms beat the hurdle for any length of time..___STEADY_PAYWALL___.Logan asked the Nampak Board why they don't apply it. The response was it would take three years to implement. Yet, the reality is that every year from 1994 to 2014, the firm did generate an economic profit – no mean feat. The cumulative value created over that time must have been around R7bn. Sadly, the last five years wiped it all out..The reason for the collapse is rooted in misguided " maximising shareholder value" ideology. This uses the share price as the prime measure of top management's competence. Apart from a short-term focus, it leads to an over emphasis on growth – especially of the asset base..As CEO pay also links to size, what is he, or she, most likely to do? The quick way to grow, be paid more, and to pump up share prices, is through acquisitions. As most of them fail to meet expectations what's the result?.The chart below shows a close link between the value-of-the firm and asset growth until 2014. After that the capital markets finally woke up and started to severely punish Nampak for a fall in productivity that had begun declining in the late 90s..In the end, the only valid measure of a manager's intent and results is a productivity ratio. Of the three most important ones, the prime driver of economic profit is ATO. It's highlighted in the Return on Assets Managed (ROAM) financial model below.."Owners" expect a return on their cash investment and bankers demand one for cash they lend. Managers can only pay back in full if they generate a high enough return on the total assets entrusted to them. Market strategy drives it, and the ROAM model measures its effectiveness..Measurement starts with the asset base. The first marketing question it asks is, "For every Rand of assets we own, how many Rands of Sales revenue do we generate?" This is the Asset Turnover (ATO) number..The next question is: "For every Rand of Sales Revenue, how many cents profit do we make?" This is the Return on Sales percent (ROS%), or operating margin. Multiply the two numbers and you get the ROAM%..The multiplier is hugely significant but most financial people, and because of that, operating managers, ignore it. Instead, they calculate ROAM as the Profit on Assets percent..The root cause of doing it that way is that very few managers fully understand the costs of high investment intensity (Assets ÷ Sales X 100). For instance, the higher the premium paid for acquisitions, the harder it is to generate returns that beat the cost-of-capital. You counter investment intensity with ATO..As EVA is a cash measure, first look at the Operating Cash Profit margin – the Cash ROS%..There is a gradual, downward trend but apart from 2019, it's still high enough to expect a good ROAM. However, the next exhibit shows what a big, negative impact a low ATO has:.Over the years, Cash ROAM has fallen from a high of 28% to 5,1% with the following effect on the Value of the Firm….During the 1990s, the VOF was almost 2,5 times the value of the asset base. Today it's less than 0,3. Worse still, shareholders once funded 60% of the asset base and a Rand of equity was worth more than R4 in market value. Today, it's worth less than 40 cents with equity funding a much smaller proportion of the asset base..So what to do at Nampak?.In earlier articles in Business Day and on BizNews a couple of years ago about Nampak, I quoted Peter Drucker: "Every enterprise is a learning and teaching institution. Training and development must be built into it on all levels – training and development that never stop.".Operating people make ROAM work – not accountants armed with spreadsheets – so how do you best get them to do it?.Make change with one number, not many of them. Start with a result and focus on a simple goal – simple to understand, not do – one that's critical for the success of the enterprise..Every firm has a critical number. It will differ from time to time as conditions change but once you know what it is, a campaign to improve it will have a big impact on productivity and the value of the firm..As Rory Sutherland says in his fascinating, provocative book: Alchemy – The Surprising Power of Ideas That Don't Make Sense, "The mind of the Alchemist understands that the smallest change in context or meaning can have immense effects on behaviour"..What could happen if Nampak's entire management – operating and resource people – focused their minds on this one, customer and sales-driven number – ATO – for a couple of years or so?.What if HR worked with Finance to use it as an educational tool to teach and show how each person, team and function can contribute to improving this vital ROAM number, and in so doing, strengthen the company?.To kickstart the process, what if the CEO were to put himself into a shareholder's shoes and demand a return of say 20% for his Equity? Add interest charges, and I think you'll find that for Nampak the total Cost-of-Capital works out around 10% of the asset base..What behaviour change would follow if operating management were charged 10% for the assets they manage? If bonus plans became ROAM and ATO focused? If a few critical measures were trended for frequent feedback?.Change for the better is guaranteed because it will break down one of the biggest productivity barriers of all in companies – financial ignorance. You would be focusing on the "Horse" (growing people), and with the "Cart" (the numbers), following behind them. Most managers swap them round and get things back to front..By now you probably think: What about the first interview? Alec Hogg discussed Bob van Dijk's financing and internet strategy with him and in particular the failed Just Eat bid. Then he asked a crunch question about lack of profitability in food delivery – in van Dijk's view a huge, "growth" opportunity. Unsurprisingly, the answer was vague. What could he say?.The failed bid to buy Just Eat clearly pleased shareholders, and it should. Management was about to break a basic, strategic guideline: Do not add low productivity assets to low productivity assets.. Firms keep doing it in the fond hope that gaining market share through acquisitions will lead to higher returns. High market share correlates with high profitability, but is not a sole cause of it..If his offer had been accepted, Just Eat's investment intensity would have risen from 140% to more than 600%. ATO would fall from 0,7 to 0,2 and Cash ROAM to around 2%..Moreover, van Dijk said they would invest even more to keep growing it. If you couple Just Eat to Delivery Hero's negative Cash ROAM, how could the deal make economic sense – even for Takeaway which is losing money and consuming cash?.It highlights that Naspers' fundamental issue, like Nampak's, is high, investment intensity, but on a far bigger scale..And the effect of that?.Using an expectation of say 15% return on equity, cumulative economic value destruction while he has been in charge runs into $ billions. And hasn't he just cashed in a big chunk of share options as reward for the growth in share price?.Koos Bekker's brilliant investment in Tencent – it keeps growing with a big economic profit every year – confirms that Naspers and Prosus eggs are effectively in one basket. Shareholders must just keep on watching that basket and hope that Van Dijk and his team strike lucky somewhere..But remember, more managers fail for having too much money to play with than too little..Ted Black runs workshops, and coaches and mentors using the ROAM model to pinpoint opportunities for measurable, bottom-line, team-driven projects. He is also a freelance writer with several books published. Contact him at jeblack@icon.co.za.

Nampak, Naspers: Investment metrics reveal a poor show – Ted Black

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