The Editor’s Desk: Truth & lies at Tongaat Hulett

Bruised from the Steinhoff debacle, South Africa is facing a fresh corporate scandal with the news that Tongaat Hulett has requested that its shares be temporarily suspended over concerns about the accuracy of the company's published financial statements. While the Tongaat situation seems to be more a matter of poor judgement than intentional misbehaviour, for shareholders, the news is still bad. In this episode, Alec Hogg carefully lays out the details of the drama at Tongaat and explains what comes next for the company and its shareholders. It makes for grim listening. By all accounts, it will be many months before the tangled web of accounting issues is unravelled and shareholders are once again able to trade freely in the counter. – Felicity Duncan.Hello and welcome to this week's episode of The Editor's Desk here on Biznews Radio. I'm Felicity Duncan. And with me is Alec Hogg..___STEADY_PAYWALL___.Now Alec we had some very interesting corporate news this week and I'm talking here obviously about Tongaat Hulett. We saw the Board requesting a temporary suspension of the listing over some questions about the accuracy and fairness and reliability of their published financial results. Now there's been quite a bit of coverage around this but I have found it quite a difficult story to follow and I can't really tell exactly what's going on. And I know you've done a lot of work on this and a lot of research. So could you lay out for us what is happening – why did they request the suspension and how worried should shareholders be?.Yeah it's a heck of a story and my friend Tim Modise who used to work with us on Biznews and then went full time into the broadcasting field asked me to go along to the eNCA on Friday evening for his show and he said he wants to talk about Tongaat. So, I've done a lot of work in preparation for that and it's good that we can unpack it. Just by way of background – it started in 1892, so, for KwaZulu-Natal it's always been the biggest or one of the biggest companies. I think recently Aspen got a little bit bigger than Tongaat, but for the province it's iconic, it employs 31,500 people, operates in South Africa, Mozambique, Zimbabwe and Botswana and I think it's also got some operation in Namibia. It's primarily a sugar company and what it decided to do some years ago was to start converting sugarcane fields into property development. So, that's where the lift off went for Tongaat Hulett – it was a very smart approach. You had all these sugar cane fields to the north of Durban and they then have effectively built what is now Umhlanga, the hub or the new commercial hub of KwaZulu-Natal. And they have a number of estates out there as well that they've converted from sugar cane fields..However, what has happened during all of this process is that it exposed Tongaat to the vagaries of the property market and that's not very easy to get investors excited when you are up one year and down the next. So, over the time, over the past 10 years or so, there's been little things slipping in. Now, this you can only see going back on a 10-year basis on the accounts, but they've started to capitalise more and that means – just for people who aren't accountants – what you can do generally when you are investing in the long-term future of a business, in this case, for instance, growing little sugar cane plants. You have to replace sugar cane every eight years. So, as you're growing the little plants, the investment that you make in them, in growing the new sugar cane, can be what they "capitalised". So, the costs – you don't take them upfront because you're going to get the benefits over eight years. So, you capitalise it. But now the danger here is that this thing can get out of control, because it becomes an easy way to shift costs off your income statement, off your profit and loss account, into capitalising them. And while you're capitalising them, then you growing your asset base, so your asset base looks bigger than it is and your profits look higher than it is. And it gets really dangerous when you start borrowing money as Tongaat Hulett has done. Now, this company's share price in 2015 was at R165 a share. It was suspended, as you said, I think it was on the tenth of June, at R13.21. So, it's a negative 10 – in fact, a negative-20-bagger. The Holy Grail in investing is to get a 10-bagger, get a share that goes up tenfold. This one has gone down 95%..So, what's happened is that over the years as they've been capitalising more and inflating the balance sheet more, they have got out of control and also have been a little over-optimistic every year. The management would be asked what's going to happen next year, for instance, with the sugar production? They've always been saying, we're going to make a million tonnes, a million tonnes from South Africa, and they've never got there. There's always been a problem here and a problem there. And because of a charismatic chief executive in Peter Staude, a really solid, salt-of-the-earth kind of guy, people believed him..And in June last year, an investment analyst at Investec blew the whistle and said there's a problem here. Had we listened to him or those people who own Tongaat Hulett shares, they would have sold the shares at R80 a share rather than the R13 it was suspended at, after he blew the whistle. He said that there was something wrong. A guy I know who's a shareholder in the company went and unpacked the financial results, then went to go and see the… looked at it over a decade, then went to go and see the board of directors, laid out to the board of directors that the cash flow statement and the profit statement don't correlate very well. In other words, something funny is happening here, because your profits are growing or are showing one number, but the cash isn't coming in. So, what's happening? And they pooh-poohed him to begin with..Then there was a new CEO that was appointed and took over at the beginning of this year. An ex-SABMiller guy called John Hudson. He took over on the 1st of February. And before he took over, he started looking into the company for a strategic review, and very shortly after that unpacked things – and I guess new chief executive's brooms do sweep very clean. And he took fright at what he saw. So, you've had investment analysts saying there's a problem here. You had a shareholder telling the board, there's a problem here. And suddenly the board woke up earlier this year, and in particular in March this year, and then started issuing statements. On top of all of this, they have a black economic empowerment scheme, a BEE scheme, which went sour. Then you had a situation that on the 16th of May the company realised that it wasn't going be able to continue meeting its covenants. Now, when you borrow money from the bank, the banks put in certain barriers, if you like, and if you go beyond that barrier, if you say, for instance, your cash flows fall out of bed or if you lose too much money, or you do something that wasn't agreed on at the time – because the banks will only lend you money on the basis that you can repay it and they can get their money back. And if you start breaking those, what they call covenants, then you're in trouble because the banks can come in and pull the loan out immediately and basically bankrupt you. And this is a company that's got around R11bn in debt and it is a company that was generating profit of about R500m a year. So, it's got a lot of debt. They need to generate a lot of profit to pay off that debt. What happened was in May the banks then started panicking and they said that you're breaking the covenants..This was after the new chief executive had started uncovering things that they weren't very happy about. On the 27th of May, the chairman of the audit committee resigned from the board – well, that tells you something as well. And then on the 31st of May, the board really owned up, if you like, fessed up and said the financial statements have not been correct. They were overstated, equity was overstated in the 2018 numbers – that's to March 2018 – by between R3.5bn-4.5bn. That wipes off about 40% of the equity that they stated, that they had in the numbers. And, of course, suddenly you start realising that there is something very, very wrong here. On the 31st of May, they explained that it wasn't just the financial statements that were to March 2018 that weren't right. In fact, the interim results that they gave out to September 2018 were also having to be restated and everything before that, they're going to have to relook at as well..And then on the 10th of June, they suspended the shares until such time as the financial results can be published. And they've said that will not be before the end of October. So if you owned Tongaat Hulett shares, not only have you seen them go down by 95% in the last three years, but now you can't trade in them for the next five months. This is about as serious as it gets..Also read: David Shapiro on Tongaat, was it hit by perfect bad news storm, or malfeasance.It's a terrible situation that shareholders find themselves in and, you know, to me this is now the second corporate scandal around accounting. Now, obviously I'm talking about Steinhoff here, obviously at Steinhoff there was fraud, there was clear malfeasance, there was something going very wrong at the corporate governance level. And you know, we're not saying that the same thing is happening at Tongaat necessarily. But to me, what it does underscore is problems with the reliability of audited numbers. And, again, what is happening in the audit profession? Why are we not seeing auditors picking up on problems like this? So, certainly, as you say, Tongaat was making overly-optimistic assumptions. There was a lot of room for them to be presenting numbers, not necessarily in a malicious way, but presenting numbers that were not accurately reflecting the prospects and situation that the company found themselves in. And the whole purpose of an audit function is to make sure that that doesn't happen. And yet again, we just don't see auditors picking up on this. To me, it's really striking – the last five years or so, I think, have just been a complete indictment of auditing..Ja, Felicity, it goes down to the very basics of it..The auditors are paid by the company. And if you push the company too hard, they will fire you. So, it just doesn't make sense. You can't have a policeman who's policing a particular area of society but being paid by the members of that society. It's just crazy. And this is now finally all coming home to roost. I feel for the guys at Deloitte, because what happened with Steinhoff was not under their watch. There was an audit company in Germany that was colluding with Jooste, who effectively was just writing out fictitious invoices, you know, bolstering the profits by saying, 'Oh we did sales which they never did'. So, that was just pure and simple fraud. In this case, the auditors work for Tongaat Hulett. Deloitte, in both instances. They're then told by Tongaat Hulett's property division, we're going to sell this property, the money is coming in etc. And then it doesn't come in in the next year. Oh, well, it's coming in in the next six months or so. And, the accounting principles, or the treatment of the basics in the financial statements: If you get it wrong in one year and you allow the numbers to be inflated, then next year you're working off that inflated base. Now, as you know, the power of compound interest also works in any kind of number. And before you know where you are, you look back over 10 years – a mistake that might have been done eight years ago in valuation suddenly has become something enormous. And that's exactly what's happened here. The big questions, of course, for Deloitte are, was there fraud? Doesn't look like it. It doesn't look like fictitious invoices were created. But clearly – as happened with Steinhoff – PwC went in, did the forensic investigation, they're doing the same thing now. Deloitte auditors, PwC doing the forensic investigation . So they'll have to check, was there fraud?.Then the second thing they'll have to check is, was there aggressive accounting? Now, we know there was, because they've already admitted that they've overstated their assets by between R3.5bn and R4.5bn as of March 2018. And, in previous years, they say, well we're not so sure about those results either. So, that's the second thing..And the third thing is something that, in amongst all of this, we might be missing and that was a perfect storm has hit this company. They have, on their balance sheet, 95% of the cash that they have on their balance sheet is actually in Zimbabwe and Zimbabwe, and they ain't letting them get that cash out. So, there's more than $200m. So, if you look at the Tongaat balance sheet, the cash looks pretty good. You know, R2.5bn in cash. But actually, that's not cash. It's not even near-cash. It's money that's stuck in Zimbabwe, that you cannot pull out to use anywhere else. Why wasn't that accounted for correctly? There are all these issues. Maybe what management said to the auditors was, well, we can get the money out of Zimbabwe. You know, we've got contacts and whatever. We now know that that isn't actually the case..The other thing was the collapse of the property market in KwaZulu-Natal. The valuations they have on the 25,000 hectares of property that is in the portfolio, is under cane fields, is very different when you have a booming property market to a collapsed property market. You know, they haven't sold a property in Tongaat Hulett since September 2018. Not one property. Now, what does that mean the real valuation of your property is? And it just goes on and on and on. So, this is a very complex situation, but it is another situation where we as financial journalists have to realise, as the investment community needs to as well, that you can't believe the narrative. You've got to go beyond the narrative, because people within companies always are going to look at things more optimistically. They have incentives, in the same way as auditors had the incentive of not getting fired by the companies, the managers have the incentive of their own share options. So, we've got to realise where a person comes from. They might not be wanting to spin and mislead you..But, on the other hand, it's very difficult when you have such a huge vested interest, to be completely open and honest..Ja, a very grim situation all around and one hopes that we get some sort of resolution to it. But, as you say, we're looking to at least October here, which is very, very worrying for shareholders..Now, Alec, on a personal level, you've had a bit of a milestone this week that I want to talk about and that is you have – after a lot of very, very, very hard work – you have finished the Cyril Ramaphosa audiobook. You did it..Felicity, it's been an incredible journey. When I started, when I first read it, Anthony Butler's biography was 10 years old and it was just superb. And I got hold of him afterwards and did an interview with him on the book and said to him, Anthony, you know, it's a magnificent book but you're 10 years out of date and now Ramaphosa is about to become the president of the country – is it not time to update it? And he said, Funny you should say that! Because, obviously, he was working on it and the update was finished earlier this year. They sent me the proofs of the updated book..We negotiated with them for the audio rights, to create an audio book. So, for people who find it difficult to read through 450 pages or want to consume it a little easier or a little quicker. That's what I've done. That's what audio books are about – I have read through the whole book. But, as we well know in our industry, when you make a fluff or you mispronounce or if you put the wrong tones in – or in this case, in particular, you get the names wrong, and there's some very tricky names for a guy with my background – it can be quite challenging..So, it's 22 hours. So, it's a big, big book, but I'm so proud of having completed the project and having done it the hard way. Going through each day, each chapter, editing it, knowing that it's there for posterity. I think it's really good. I'm very proud of the work and you know, we've priced at it R220, which works out to around R10 an hour that you can listen to. You can't get entertainment at that level. And this is more than entertainment. This is a story of South Africa, it is a story of the leader who, as I've often said, the CV – if you look at somebody who's perfect for a particular job, the CV will tell you and the CV of Ramaphosa from the day he was born in what was called Western Native Township, to growing up in Soweto as a Venda, which was like a tiny little group that was looked down on and made fun of by other groupings, to creating a national union of mineworkers, when all the odds were against it, everybody else had tried and no one had been able to create a mineworkers union. Then taking them out on strike, which completely changed the whole way that labour relations developed in South Africa. On to becoming the driving force behind the negotiations process at CODESA, then going into business and being hugely successful in that. And then, against all odds again, becoming president of South Africa. I mean, this guy is remarkable. It's an incredible story. And Anthony Butler has done such a wonderful job in articulating it all. It's the kind of thing I just wish every South African would read and especially those trolls on Twitter and Facebook who come up with the most ridiculous statements about Ramaphosa, not knowing the foggiest about the man, and just making all their assumptions without knowing the facts. He's an extraordinary human being and we are blessed to have him. If you listen to the audio book or read it if you are that way inclined. I think you'll agree.

The Editor’s Desk: Truth & lies at Tongaat Hulett

Related Stories

Meet Tshepo Mahloele – Big Capitec shareholder, ABSIP’s “CEO of the Decade” now accused by Holomisa as kingpin of corrupt network

PREMIUM: Making of a great editor – the George Palmer playbook

Premium – BizNews global portfolio: ASML joins – so does Adobe as Bull takes hold again

Alec Hogg: Helen Zille predicts SA choice will be DA or EFF