LONDON — Futuregrowth’s chief investment officer Andrew Canter has once again shown his mettle. Not one cent of his company’s R180bn portfolio was invested in the disastrous Steinhoff. This is the second massive value destructive event his team has missed, after it sounded the warning long before the last major disaster, Abil. I asked an initially reluctant Canter to explain how he managed to miss the pothole that virtually everyone else in SA’s money management world stepped into. And put what for him is an entirely theoretical question – what would he do if he owned Steinhoff debt or shares. His response was as insightful as ever. – Alec Hogg
On the line now from CT is the chief investment officer of Futuregrowth, Andrew Canter. Andrew, the last time we saw something approaching the debacle of Steinhoff was around the time of African Bank. I remember we spoke a lot at that period of time. Steinhoff, like African Bank, had quite a lot of investable assets out there for a company like yours that invests in fixed interests. Did you own any of the bonds?
___STEADY_PAYWALL___
No, we didn’t and one has to be careful not to sound smug but I’m actually quite proud to say that Futuregrowth has no exposure to Steinhoff at all, in any of our funds.
What did you see that clearly, many others didn’t?
I guess the point is and we’ve always said we’re a responsible investor and we consider ESG governance factors and of course those things can be sometimes quite opaque in the matter of judgement, and over the course of years, and I mean years because we’ve had no exposure to Steinhoff, to my memory at least, for at least seven or eight years. There were already the financial statements that were really difficult to analyse from a lending point of view. The serial acquisitions, that is to say there were acquisitions being done virtually every year and consolidated, which made it almost impossible to do comparables and understand the underlying assets. There were, and people should remember this, at various times in the past seven or eight years allegations about Steinhoff and tax irregularities. Stories that went out and miraculously or strangely disappeared. There was the case where several of the directors of the group were charged with front-running with the Pep acquisition, and that story disappeared. There were many signs actually, if people were paying attention to irregularities and stupor. As a lender we couldn’t get our minds around doing the analysis and understanding the debt and how it was moved between the divisions and we simply said, ‘we’re going to avoid this one.’ Something didn’t smell right to us so, we took on the governance score we said, ‘we just don’t get it,’ and we said, ‘stay wide of it,’ and we did.
The debt is trading at 50-cents on the Dollar on the international markets. What is that telling us? What are investors telling us?
Well, it’s quite a bad sign, although not unexpected. Theoretically, if the debt is trading at below par, below 100-cents on the Rand or 100-cents on the Euro, that implies the company is going to the wall and the debt investors are estimating 50-cents on the Euro recovery. Having said that, I would be really cautious with that statement because nobody has any idea what’s going on right now. To unravel this company or organisation is going to take a long time and it’s going to be messy, and I guess what you’re probably seeing is the bond holders just saying, ‘get rid of it – I don’t want it.’ I don’t want to know the story, I’m not interested. I don’t have the time for this – sell it. I don’t think it’s a rational view to talk about 50-cents on the Euro or 50-cents on the Rand, at this point. I think it’s just a panic sell. People just don’t know what’s going on and they don’t want see it in their portfolios after 31st December, would be my guess.
They say, if you’re going to panic then rather panic first.
Yes, of course. The interesting thing is you start out by saying, it’s trading at 50-cents on the Euro. My guess trading is probably an overstatement. I’ve seen the prices on the JSE bonds today and the shares are actually only a little bit wider on the market, from what I saw, but I was doing trade – nobody is buying and nobody is selling. There’s not going to be anybody that’s going to step in and catch this falling piano, I would guess because nobody knows. Even as a vulture investor you simply can’t take a rational view. The legal mess of the dozens of instruments across dozens of jurisdictions in probably several currencies – it’s just going to be a mess. To try and make sense out of that on short notice for anybody, as a lender, is impossible. You’re hooking this one.
Andrew, if you inherited because you wouldn’t have bought them, but if you had inherited them through an acquisition or some kind of a corporate action, some Steinhoff prefs or bonds, and you were sitting on them now, what would you do with them?
Unfortunately, we’d have to act. We’d have to wade into the lenders. The co-creditors too. We’d be looking at the debt governance. We’d be looking at the legal documents, like in SA we issue debt under a legal framework, called domestic medium term. No programs – we’d be looking at our right to call lender’s meetings. We’d look at whether there’s actually inevitably at fault. Whether the lack of financial statements on time was inevitable. Odds are that none of those seemed to be at fault at this point, until it’s been dismissed. You’d be calling a lender’s meeting. You’d be calling your trustee, if there is one, or you’d be taking action to call for a meeting of the lenders. I wouldn’t delude myself that I could sell these bonds. I wouldn’t just throw an offer on the screen and expect anybody to take me out of this problem. As a fiduciary you’d have to work your way through it and see what recovery you could get.
So that is the likely scenario from here. It’s going to take time and certainly from the debt perspective there isn’t really a market out there to take it off your hands?
I would guess that’s the case.
Steinhoff group and off-balance sheet vehicles are starting to look like a Gupta-empire. I have no sympathy for people who externalized their SA wealth through a sleight of hand listing in Frankfurt. But why risk exposure in a heavily regulated market? Greed over reason perhaps?
— Magda Wierzycka (@Magda_Wierzycka) December 6, 2017
What about the other lenders? What about the banks who would be involved here? Do they have to take a similar approach?
I think maybe one of the things that is different about the debt markets. When you think about shares, your personal share is the exact same share that might be in somebody’s pension fund. It’s exactly the same share that’s sold by the management of the company. A share is a share, is a share. They’re all equal. They all have the same company laws protection. They all speak of a class. Debt instruments are massively different. There might be a bank loan that’s against a specific security of a mortgage bond of a building or another bank loan that’s against removable assets, like vehicles. There’ll be unsecured lenders who have no security to season the first case. A debt restructuring is a much messier thing and this is going to be epic. Even when we saw ABIL go bust. Sure, there’s senior debt and there’s subordinate debt and I don’t know if you remember the fight between those two relatively simple classes of unsecured debt in a single entity in a single jurisdiction. I think there were Swiss bonds as well, but simple. If Steinhoff’s de-structuring is going to be a rat’s nest – you’re really not going to want to be in there. It’s going to be hostile. The lawyers are the only ones who are going to come out of this rich – that’s the headline.
So what’s the damage? Steinhoff loses R134bn in market cap, STAR R22bn, Kap R21bn and PSG R6bn. Total R183bn. Watch out for grumpy old men when you walk the streets of Stellenbosch this December. One of the ugliest stories I’ve lived through after 45 years on the JSE.
— David Shapiro (@davidshapiro61) December 6, 2017
There are lots of small shareholders and clearly, they have to take or might take a different view. If you were able to guide them in anyway, given all the confusion?
I wouldn’t even hazard. I couldn’t, wouldn’t, and won’t. I will even tell you quite frankly as we saw – when we looked at Steinhoff and this goes back years, when we originally did credit some Steinhoff before 2008’ish and we looked at it and we thought that we could get our arms around it and we realised eventually that we couldn’t understand it so, we haven’t done a fundamental analysis since then. We’ve occasionally reviewed it to see if we could get our arms around it. You couldn’t so, I don’t know what’s in there. I don’t know what it’s worth. The comforting thing, in the end is that it’s so messy that maybe the shareholders probably get heavily diluted, lenders probably step-in with a substantial stake, and business goes on. They’re not bad businesses. You can go into the shop and you can buy a sofa or order a bed online – they’ve got a whole bunch of businesses that are operating, with hundreds of thousands of employees. It’s not like ABIL where the doors are going to close because they can’t make loans, for example. As I’ve said, and I need to be careful because actually what I’ve just said is not right now correct. The share is not at zero. The share is still trading with positive value, which implies that the lenders don’t step-in. The shareholders still have a stake in this business, a meaningful stake whereas I don’t know where the market cap is down too, but I think it’s still in the billions, which means if they can find a way to explain what’s happened and where they’re at and they do a rights issue – they will still be diluted for the shareholders but you might still have an operating entity that is independent. The lenders don’t step in, the debt doesn’t default and yes, you’ve taken a bath. You’ve lost over the last couple of years 90% of your value now but you might come out if it with your skin in tack but no responsible person could say that right now – it’s just a scenario.
Andrew, when it comes to people like the auditors. Deloitte have been auditing these accounts for many years now. Presumably, even though you couldn’t get your arms around it, they must have been able to.
I’m going to defer a comment on that. I have an opinion but no reasonable basis. I’m going to let people form their own judgements about this. What was pretty self-prevalent to an intelligent observer I have to question why auditors didn’t ask deeper questions earlier. Alternatively, why they suddenly started asking people questions now, as we sit here in December 2017, for example? Why did it take the German authorities to ask questions to get the auditors to ask questions? I really am not going to go down that road.
Sensibly so, but then if you just have a look at it from a longer-term perspective, what is the best-case scenario from the available evidence that we have to date?
The best-case scenario is that the allegations are panicked. That the allegations or the analogies of fraud and malfeasance are false, and let’s assume that’s probably true. There was probably not fraud, per say. As for the accounting irregularities, were inter-divisional pricing issues and inter-jurisdictional tax issues – there’s a way to find your way through it. That they still are operating, and that story can be told and shows that it’s not as bad as outright fraud. That the business is a growing concern. People don’t lose their jobs and investors don’t get wiped-out, equity investors in the first case, and I think there’s still a reasonable chance. The people behind this, they’re not completely un-credible people. You don’t have a dumb board of directors or the implications of collusion, if this was fraud, are so wide reaching that it’s unbelievable. You just have to believe it was over enthusiastic accounting practices and tax practices that has led to where we are today. If that’s all it is then it’s a good story, by the way. If that’s all it is that it’s over enthusiastic, over the edge accounting tax practices then that means that the shareholders won’t get wiped out and you will still have a going concern in a years’ time.
And the worst-case scenario?
The worst-case scenario is it’s deeper and messier than I’ve described and that the lenders seek to protect security and take over the business and liquidate it and start selling off divisions. I must say, I would guess the appetite for that is…If there’s anything there for the shareholders I’m sure the lenders would prefer to work with the shareholders to keep it as a going concern. Even lenders on their worst day are not really in favour of closing down businesses and firing people.
Andrew, an interesting point in all of this is that although Markus Jooste has left the company the CFO has been retained. He’s been put in, back to his old job, of the group’s CFO. The rest of the executive team is intact. What message, if any, is that sending us?
Well, I guess it tells me that my former scenario that it was really sharp practices rather than malfeasance, is probably the state of play. If I had to read anything into that, or ultimately, they didn’t have a back-up plan – that’s how I’d read it. My guess is that it’s probably the former. That this thing lands as a going concern and that they just got carried away by sharp practices on the accounting side.
So, the probable take on that and taking it one step further, for shareholders or debt holders is just ride it out. Put it in the bottom drawer and hope that in time, the lawyers haven’t taken all the money away, if that’s what’s going to happen.
So Alec you’ve painted me into a corner.
Sorry, I didn’t mean to do that.
No, it’s fine. As long as we have both acknowledged that you’ve painted me into a corner – I will say, if I had shares, that’s probably what I would do. I would put them in the bottom drawer and I would pray, and I will tell you that praying is never a good investment strategy but in this case, that is probably what I would do because there is nothing else you can do, practically speaking.
Andrew Canter is the chief investment officer at Futuregrowth Asset Management.
