🔒 PREMIUM: David Shapiro: Unpacking Steinhoff; Naspers in New York; and prospects for 2018

LONDON — In this episode of The Old Firm, David Shapiro and I draw on our decades of engagement with Steinhoff CEO Markus Jooste in an attempt to understand the biggest corporate scandal to hit South African markets; and discuss the prospects of concrete gains after Naspers reached out yesterday to US investors with its inaugural New York investor day. Also in focus is the ANC elective conference – and its impact on investment prospects for 2018. – Alec Hogg

It’s time for the Old Firm, David Shapiro is in Johannesburg. Dave, I know the weather is much better over there than it’s been here recently but certainly the corporate environment, not so warm in SA right now.
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No, you know Alec, I think we’ve been absolutely shaken by the collapse of Steinhoff. I don’t think one understands the size of Steinhoff and the kind of way that it actually dominated the local economy. I know it wasn’t as big as British American Tobacco, or Naspers, or Richemont or companies of that nature but still, this was a small company a few years ago. I can’t remember when it started in the 90s.

In 1997, yes.

It was built up into huge businesses, with tentacles around the world, all over and I think, to a large extent, people loved this business. Markus was a very charismatic character. He had a lot of personality. I personally, loved to listen to him on the radio or watch him on TV. He just had that way of putting things across, which was so expressive. I think that it’s had a major impact and it comes at a time when we’re already reeling from political issues. We’ve been on the FT last week, in The Economist, a lot of worries about what’s going to happen on the weekend so, I think it has really shattered business confidence here. Also, remember this ties in with the other discussions we’ve had, with McKinsey, with KPMG, and issues like that. I think this has just, really…Everybody has taken a step back and not quite sure how to digest it and how to process it all.

We went to visit Steinhoff, (you and I), if you recall. It was a few years after they had listed. They listed in 1998. It was the old GommaGomma that then became this Steinhoff company. Then they bought and had a huge win in the early 2000s, with a big part of SABMiller, as they were divesting. It was called Afcol, which was a furniture manufacturing business. They put a bid in at R19.25, I remember it so well, and Pat Cornick bought it for R19.50. Then a year later Pat Cornick went bust and they picked it up for R4, and that was the start of Steinhoff. I remember we went there and we tried to understand the business model. It seemed to make a hell of a lot of sense whereas today, people are looking at it and saying, ‘well, what was their business model – what were they doing?’

David Shapiro

You know what the original business model was, and that Markus or Claas Daun, or was it Bruno Steinhoff, brought it across from Germany, where he used to source cheap furniture in Eastern Germany, and sell it into Western Germany. Their model was pretty much the same, and this is what I always liked about Markus was that the idea was to manufacture furniture in emerging countries, where the costs were much lower, and then sell the product in developed countries, such as Europe, and so on. It was a wonderful model and I think for a long time he stuck to that strategy – sourcing in China, sourcing in SA, and selling into richer countries where furniture prices were high. He bought Conforama, which was I think a very good buy, and so on. I think up to that point, and I’m not sure where he started to go ‘wrong.’ It was pretty good and it made a lot of sense. I think he also started to accumulate a lot of deals on the side and that’s where I started to get a bit nervous. Finding him more opportunistic rather than sticking to the original strategy. Whatever came he kind of took, and then of course, when he finally tied up with Wiese, I think a lot of people thought that Wiese is a successful man. Two wonderful companies in Shoprite, a brilliant business in Pep, maybe they’re going to make things happen.

The whole thing with Markus’ outlet in Europe – they were going to bring Pep into Europe. I know they already had established themselves there but they were going to grow it dramatically. That was the broad model, which seemed to make sense but the detail was very difficult to unravel, the way they were getting there and then recently, the deal that he did in Poundland and Mattress Firm, I think just also started to cause concerns but overall, his strategy was fine. That’s the way that I pick it up.

Also, I did talk to him about these international deals that he was doing and it’s interesting to note, nobody remembers it now of course, but there were two deals they walked away from. One that Sainsbury’s got, and another one with Darty in France that they felt that was too expensive. That’s what he said anyway but of course Mattress Firm, which was incidentally bought from a South African or a guy who came originally from Durban, and went to the USA and had built this amazing business. Maybe that was the end of the rainbow or it certainly was, as far as they’re concerned but from what you can read, David, and there’s been hedge fund reports that have been widely circulated and well interpreted around the web. What actually happened here? Where did it all go wrong?

I think the pattern is too many acquisitions, too fast, with too much debt, and I think that’s a flag. That’s where things start to go awry and we don’t know. I’m going to cast your mind back to Lieberman, back in the late 80s, when he went on a similar acquisition trail and it’s the same kind of pattern. You start to believe in yourself, you over believe, you think you can do anything. You start to maybe drop the ball with the due diligence and accumulate too much debt and then as soon as the businesses start to let you down slightly, you find that your gearing is going the wrong way and you’re no longer covering your debt easily. I would imagine that’s the…There are a lot of other businesses that have come under quite a bit of pressure. Not through fraud or not through irregular transactions. I’m just looking at Famous Brands, for example, the same kind of pattern. Taste and those kinds of things. When you expand too fast to absorb the businesses there’s always going to be something that goes wrong.

What we don’t know is what he did and how he manipulated the accounts or valuations that led to his surrender or his resignation. No one is quite sure where the problems are and whether this will lead to the demise of Steinhoff or whether they’ll come out okay because Alec, when you look at some of the operating businesses, especially in SA, there are still very good operations. If you unbundle Kap or you unbundle Steinhoff Retail these are seriously followed operating businesses. We just don’t know what’s out on the other side and we don’t know the debt against it, so this is difficult.

So the big problem in this is that it appears as though the figures were massaged and massaged to borrow or to give an optimistic view to the people who lent money to the company. When you do that you have all kinds of liabilities or potential liabilities. I saw the ShareHolders Association of Europe, which is based in the Netherlands, is looking to sue Steinhoff for €21bn. I don’t know if that’s just a number sucked out of the air or how strong these people are or whether they’ve been successful. They’re talking about a class action against Steinhoff because the figures were fudged. It does appear, if you recall, and it’s strange to think about it, it was only last Monday, David where they once again reaffirmed. The board reaffirmed that the numbers were accurate. They dismissed aggressively, as they had done for the past few months, allegations of impropriety and they said that the figures would be released on Wednesday morning and that the unaudited financial year end figures would be released, and the audited results would be some time in the future. Well, then Wednesday morning came and of course, that was the shock where the board said some new things had come to pass. So up until Monday, as far as the board of directors were concerned, they were backing management after a board meeting, which must have been on Tuesday, they decided that management wasn’t, well, as they put it, ‘new information came through, which showed accounting anomalies,’ or however they described it, which we in normal layman’s terms see as, crooking the books.

Recently departed Steinhoff CEO Markus Jooste

Exactly, Alec, a lot of things come up and there were areas that have always concerned me. I’ve always jokingly said, in the media or in the press, that accountancy is a fraud. I always say it because companies can release ten different numbers. You do a lot of journal entries and you can get a lot of troubles or get rid of a lot of troubles. All that you have to do is pass one entry and your problems are gone. Have a look at the number of different earnings numbers we get, diluted and non-diluted, and so on, headline figures, etc., so it’s very confusing. What it does show you is that you can, and one doesn’t want to use the word manipulate but in other words, you can massage numbers. I’m always wary of accountancy. Who else does it is Charlie Munger, and ask him his view on accountants, so a very similar view. I’m cautious of some of the numbers that are published and the way that we’re able to fool the public outwardly, with these numbers so you’ve always got to look at the cashbook. The cashbook never lies, money that goes in and out, and that’s the one issue.

Yes, but the problem with that Dave, just to stop there for a minute. The cashbook was fine. The cash was very close to, and I think that’s where the other big flag is waving because if you look at it, and that’s the first thing we look at. What is the cash flow? Is that aligned with the profits that are being generated? If it’s too low, well what’s happened to the debtor’s book? These are basic things that one understands from analysing a company’s income statement and balance sheet. But what appears to have happened is that that cash flow was itself being manipulated. In other words, they were raising money in other ways and not disclosing how the money was raised, pushing that through as normal operating cash flow and that is fraud.

Right, yes. That’s cooking the books to a point where you’re never going to find it. So who do we rely on finding it and the answer of course, was the board of directors. Those are your gatekeepers, your auditors, and your non-executive directors, or even your directors – those are the gatekeepers and those are the people that we, as investors or outsiders, rely on to watch over what’s happening in the company. Alec, you know, and you’ve been in business for a long time. The last thing you ever want to do is accept a directorship. It’s a massive burden or onus. It’s an onerous task now to be a director because there’s no difference in the company between being a non-executive director and a director. You both have the same duties and responsibilities. A non-executive and an executive – those are the King Codes. That’s defined by the King Code but generally, if I’m a director – I’m a director, and that means that I’ve got to know exactly what is happening in the company, and it’s more than just attending three or four board meetings. You’ve got to be vigilant. You’ve got to ask questions. How much gossip do you pick up by just going to the canteen and talking around the coffee machines, etc?

Scuttlebutts, yes.

You need directors to have that.

It was Phil Fisher who spoke about scuttlebutt and the value of that, and I think we need to listen to that advice very carefully.

Exactly, and that’s almost 100 years’ old. When did Phil Fisher write, was it in the 40s? I don’t know when he wrote, in the 30s and in the 40s but absolutely right. You ask other people about the businesses and what worries us is if you look at the composition of a board, Markus Jooste could not have put a higher quality board together if he wanted to. It was top quality people – Johan van Zyl admittedly, only came on a year ago, before that he had Pep.

Theunie Lategan, he’s got him on there from FNB.

Sorry, Jannie Mouton. I mean look at them, have a look at them.

Yes, Jannie stepped off about a year ago, Dave, but he had Theunie Lategan, a very senior guy at FirstRand, and Steve Booysen, an ex-CEO of Absa. You’re not talking about mugs. I mean, Len Konar, we know was a professor of accountancy so if anybody understands accounting it’s got to be Len, and he was the head of the audit committee, and so on, and so forth. You’re right, if you can’t trust these guys then who can you trust?

Exactly, and that’s my worry. One has got to be openly critical – what did they do? If ever you’ve sat through a deal, every time you sit down around the table to negotiate a deal you’re not on your own. There’s two or three chaps to your left and two or three chaps to your right – that’s your team. Across the table are other people as well. You’ve got the opposition, and they’ve got six or seven people so there’s always people. There’s documentation that flows backwards and forwards, and so on. Now, Johan van Zyl, Theunie Lategan, and all these chaps have been through that before. They know what’s involved in a deal. Now, we would have imagined that every time a deal came across the Steinhoff board table that they had the ability to know what to look for in those deals. I think this is where the disappointment is starting to emerge. They’re now going to investigate it and put out a statement. They’ve got a committee that’s going to investigate it. We’re saying that you should never have investigated it but you should have prevented it that’s why you were there.

But it wasn’t the deals, Dave. It wasn’t per say, the deals because if you look at those deals, on paper they weren’t bad transactions. It was what they were telling the marketplace and presumably, those directors were told or they were given information that they believed. Short of going into the bookkeeper’s office and going and having a look at what the transactions are. What do you do? I had that instance at Moneyweb. We had a financial director who stole money and literally, what he did was he created fictitious transactions so he would pay the accounts. Supposedly to our creditors but they were going into his bank account and he took a few million from us, and from a little company that was a very difficult situation. I must admit, I was an executive at the time and I was off at the farm during that period but still, it was very difficult when someone is dishonest and does that. Even if you’re checking up on them, how do you know, as those directors, how would they have known without seeing the journal entries themselves, which you don’t as a director. You’ve got to believe that management is giving you the accurate information.

Well, I suppose we can hold back judgement until such time as we understand what he did, what Markus did. The problem is that I’m not sure that whatever Markus did, I cannot believe he did it on his own. There must have been collusion along the line that allowed him to massage the numbers and manipulate the numbers, create perhaps fictitious entries and that. I think we have to find out what happened. What also astonishes me at the moment, as well is that we have a company trading on the markets where we know that the CEO has resigned because of accounting irregularities and that the auditors are holding back on signing the accounts. Yet, days go by now, we’ve gone now and this is the eighth day that we’re trading without any information. From my point of view, I think it’s unfair on the regulators because there’s a good chance that you’re going to lose everything. If the company is going to have a court case them, or a class action you could lose everything. So the stock exchange has got to start insisting on some kind of information on an ongoing basis, and the company has got to provide us with that. You can’t leave it open-ended, allowing speculators to come in and people to make up their own minds or when this is going to be. There’s no other company on the JSE that’s trading under those conditions.

Sygnia Group CEO Magda Wierzycka

David, the next big milestone is on Tuesday, when the presentation is made to the banks in London because that’s really what it’s about. I was talking to Magda Wierzycka on Monday night and she’s been following this closely. She made the point that the banks actually own Steinhoff right now so, if you’re a shareholder and you’re trading in the shares just be aware that you might be diluted to heck, if the banks decide to pull in their money or they decide to convert, as they might have to, their debt to equity. But on that, on Tuesday, do you think that what’s going through the Steinhoff executive’s heads is, let’s get something together that the banks will believe? Let’s not communicate until we can do a deal with the banks because up until that point, up until the time that the banks, who are owed €21bn – Dave, that boggles the mind, but up until that point they don’t really have a business anymore because the banks will just take over everything because it’s security for their loans.

But you see, whatever you said now should be disclosed as well. I think they should give us ongoing information about what it’s all about. What they’ve discovered where the problems might be, and so on because as long as it’s listed you’re going to speculate. I think underneath it they’ll be able to save a lot of businesses. The problem is just what the extent of the true debt is and I think that’s worrying everybody. I don’t think the businesses, and a lot of the underlying businesses – I know that there were huge amounts of goodwill on the balance sheets, massive amounts. I think some of them might be justified, to a point. There might be levels that are justified but I’m hoping that they’re able to save the business and this doesn’t come to nothing.

Alec, I think one of the big issues of why we are hoping this is that we’re running out of places to invest in on the JSE, when a company like Steinhoff vanishes. We lost SAB two years ago, or 18 months ago. It was a big loss to the stock exchange. I know we’ve got the ABInBev bet here in place but it hasn’t quite captured the imagination that Breweries used to have. We’re losing Steinhoff, a lot of their underlying businesses are taking strain so we’re running out of shareholdings and it’s hard to put a decent portfolio together in SA, it’s very difficult.

Well, you’ve still got Naspers and I was watching the presentations yesterday in New York. Bob van Dijk took the top team to New York and gave a full day of presentations. He had a full house it seemed, or certainly there were dozens of investment analysts from Wall Street there and it was interesting what they were arguing about. Just to put it in context, David, and I would love to get your insights. He says that the stock should trade at a discount of 20% to its underlying assets. Now, remembering that its asset in Tencent, in the Chinese company, is actually worth $136bn. That’s what Naspers’ shares in Tencent are worth, if they were to sell them today. Naspers itself, its market cap of $113 so, there’s a difference there, if you like, of $23bn, just gone or vanished, which Naspers’ shareholders should own. Then you’ve still got PayU, OLX, Delivery Hero, MakeMyTrip, and the rest of the companies that we know quite well, MultiChoice and so on. So all of that you’re getting thrown into the pot for free so, clearly, the job for the Naspers team who say that they’re trading at a 38% discount to their value of their company. The job for them is to reduce that discount, that 38% discount. He was asked, how are you going to do that? And it’s through share buy-backs, it’s through additional listings from Naspers’ underlying companies and additional listings for the company itself, so Naspers shares. They did talk about an ADR (American Depository Receipt) program in America. You know that market well. If they start expanding the ADR program in America and in London, they spoke about, if they can do that and make those instruments more liquid – first of all, is it possible? Secondly, would that not address the discount?

Bob Van Dijk, chief executive officer of Naspers Ltd., gestures as he speaks during an interview at the Media 24 Ltd. office in Cape Town, South Africa. Photographer: Halden Krog/Bloomberg

First of all, the underlying businesses are very good. Don’t brush them aside or ignore them. I think there’s some very good ones, in the ones that you’ve mentioned that are growing and starting to make a difference to their cashflow and contribute to the fact that they’re completely overwhelmed and swamped by the value of Tencent so he has to do something and it’s a pity. Can you imagine if you’re working for those businesses and you know that your contribution is having absolutely no impact on the share price? So yes, the other thing is that the ADR, and I watch this every day. Every day one of the things that I open and watch very closely is the value of trade on a daily basis. If I look today, as I’m talking to you now, there hasn’t been much trade today, about R13bn, but Naspers makes up 25% of that R13bn. Now, this is with Steinhoff, which is in the news, which is only trading at about 4% of the market so understand how important Naspers is for us but the other thing is that, and I haven’t got the numbers in front of me but I would imagine that of that 24%, a lot of it is foreigners coming in and taking their share here as a proxy for Tencent, as a cheap proxy to get into Tencent. It’s easier to deal in our market than maybe to deal in the Hong Kong market as well so I think we’ve got a very big following from foreigners already in this market and already buying the shares.

ADR can only help us but I think what they’ve got to do is keep pushing the message that it’s not only Tencent. That there is this discount and that there are some other very good operating businesses underneath that are adding to the cash flow and giving them more fire power to actually expand those businesses. I like the group. I know that it’s been under pressure and I know that there’s been a lot said about it but I can’t discount what Koos Bekker has built up, even with Bob van Dijk coming through now, and where they’re heading. I’ve no doubt if they pursue this that they will hit something big along the way.

Well, to get another Tencent is probably inconceivable. They’ve invested $30m and it’s now worth $136bn but let me give you some of the other investments that they’ve made, which they were highlighting yesterday. OLX – they’ve put $3.2bn into, and it’s worth $7.8bn. Now, if that had been a separately listed company we’d be very impressed. PayU – they’ve put in $600m, which is now worth $1.2bn, and these are analysts’ valuations of these businesses. Delivery Hero – they’ve put $1.4bn into it, and that was only in the last few months. It’s now listed and worth $2.5bn. Then MakeMyTrip – they put $0.6bn into it, and it’s now worth $1.3bn. So you’ve gone from $600m to $1.300m. Those are very serious returns that have been achieved outside of Tencent but as you say, because Tencent is so big, $136bn, those others together get to about $12bn – $136bn is 10% of the rest of them.

Yes but I promise you if those were separately listed businesses on the JSE, I think their values would be considerably more. Not only would they bring a bigger selection for us to participate in growing the importance of technology in the world. I think they’d attract massive outside interests and, as you say, if you want to put a discount there, which is like a holding company discount. Also, if they had to sell Tencent they’d have to pay capital gains tax, and the usual arguments but if they had to unwind those companies and list them separately, even separately and not even in bulk, I think you’d get wonderful followings here because each one of those that you’ve mentioned is a very special little business. I’m just sorry that they’re not here. I’m just sorry that we can’t participate directly in some of those businesses and we have to go looking offshore for similar kinds.

Read also: Koos Bekker to Naspers’ shareholders: You’re richer because of Tencent

They’re certainly thinking about it, David so they’re on a mission to reduce that 38% discount and that’s got to be good news, if you’re a shareholder.

Listen, I’m up to my eyeballs in Naspers so you’re talking to the converted. I think it’s a great company and all credit to Koos for having spotted it. He’s made mistakes and he’s the first to admit that he’s made mistakes. One thing he does do when he makes a mistake he’s out of it. He doesn’t hang around but this is a winner, as you say, it’s never going to be repeated again but don’t discount Tencent itself. A super business.

A fantastic business. That one we’ve actually got in our Global Portfolio, but just to dwell on mistakes and to maybe close off with that. They also highlighted a number of those. There’s a company called BuscaPe, I don’t know if you remember that one. That they lost $149m on. Gadu-Gadu they lost $111m on. Then there’s one called Net Rental that they lost $88m on. Markafoni they lost $66m and they say from the other investments that they made around the world they dropped $437m so, add it all together – $851m. When you start translating that into ZAR – they’ve made a lot of bets but their argument is that they’ve actually written off 10% of their $8.5bn that they’ve invested into Net Properties, and now they’re generating 77% of their revenues from Internet Properties. Well, the strategy has worked, even excluding Tencent, which of course, makes it a stratospheric success.

That’s what’s great about him. That is what I think is very good about Koos Bekker is that he’s quite prepared to take those risks and write off the ones that don’t work but look at what happens when they do work. It’s a marvellous business.

Well, David, it’s been a marvellous year chatting with you. I think very tough for investors pretty much across the board unless you were invested in offshore tech stocks, which those who were there have had a wonderful run. We’re looking at 2018, just to close off with. Your thoughts on the ANC elective conference and how that’s going to affect investment markets next year say, with each of the candidates, a Cyril win and a Nkosazana win.

ANC Presidential hopefuls Cyril Ramaphosa and Nkosazana Dlamini-Zuma

Well, I think we want Cyril to win. Simply that he gives us a better option than Nkosazana. Whether he’s going to have the power to make a big difference, I’m not sure. Structurally, there are so many issues that we have to address here and whether he’s going to have the power within the ANC to actually do what he says he’s going to do, I think it’s a very difficult task but at least we’ll be on a better footing than we are at the moment. I don’t want to be pessimistic on SA. I don’t want to be too negative but I think there’s a tough road ahead and to get growth going again is going to require a huge effort. You’re going to have to change attitudes here. I cynically say that if Cyril comes in it doesn’t mean that 10-year-olds are suddenly going to be able to read or that the ladies sitting in the Home Affairs offices is going to suddenly start working for a salary and her pension, instead of trying to take backhands. I think we’ve got to change those attitudes but at least we can start pointing in the right direction to address that. From my point of view and from an investment point of view, I still think that we’re going to be outplayed by the global market. I still think we’ve got a good year coming there. There’s a lot of obstacles that we have to negotiate but I think generally, we’re in a much better position globally this year. Growth is starting to pickup and I think it will start to translate into confidence and better business profits. I am hopeful for equity markets next year but don’t expect the 20% that we saw in the S&P this year. I can live with 10%. I can live with 7%.

David Shapiro, and he is with Sasfin, where he is the deputy-chairman of Sasfin Securities and a member of the Old Firm.

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