David Shapiro: Justifiable concerns around Discovery’s “aggressive” accounting

On the Rational Radio show this week, SA's favourite market commentator David Shapiro was in top form, sharing his forthright opinions on the three big investment stories of the moment – Discovery's apparent valuation hole; Sasol's massive overspending on its US chemicals plant; and Naspers' pending listing of its global internet assets in Amsterdam. Great value as always. – Alec Hogg.David Shapiro is with us now to talk about markets and issues of daily occurrence. David you were due to meet the Discovery analysts, the elusive Macquarie in the past week. Did you manage to do that?.___STEADY_PAYWALL___.I did. I've got the report. It's highly technical Alec and I'm on a bit of a tirade at the moment. Why I'm like this is, after Steinoff, EOH, after Tongaat etc.. I think there's a demand for clarity and we want transparency. One's got to satisfy oneself that you can buy the company on the numbers that are being produced. I'm going to try to explain it in terms of property rentals. This is the way that one looks at a life book. When you assign a life contract, it goes on for quite a few years, you contribute your premiums on an annual basis or a month-to-month basis. Can you imagine if you've got a company or a property that's got a 40 year lease with Standard Bank. It's safe and therefore each year your premiums are going up which of course increases the value of the property because you've got a 40 year lease with increasing premiums that will go up perhaps even beyond inflation. Compare that with a property of only 10 years, with maybe a fruit shop or something like that where you can't really trust the ongoing premium. Those are the two extremes. So when you look at Sanlam and Old Mutual, they tend to value their contracts on a 10 to 12 year basis – a maximum 20 years, whereas Discovery has stretched beyond that and that's why we're questioning it. In other words we're questioning whether they've got that 40 year lease and whether they will continue to get those premiums on an ongoing basis. I suppose the market would be a lot more comfortable if they toned that down, or analysts would be comfortable if they weren't so aggressive on their accounting..It sounds very strange because in business the whole idea is to be as conservative as possible and the more aggressive you are the more bells start ringing – Steinhoff, Tongaat etc.. This is not good news for Discovery..Well, we don't know the truth. Actuarial science is something which is so complicated and very difficult for accountants and laymen like us to understand. What's good about this is that these analysts have raised the debate. I'm on a pension fund – a fairly large pension fund that doesn't have Discovery, simply because they didn't feel comfortable with the numbers. It's been very much in the institutional domain, but what the public is now asking is "explain your accounts to us in greater detail. In much more simple ways so that we can be satisfied that the value we paying for you is sustainable". I think that's the good good side of this Macquarie report. The truth is probably in the middle somewhere. I think that's what Discovery is going to have to come out with in their results and really address it in easy to understand ways so that you know you can finally make up your mind whether it's cheap or not..Surely there are two things. As an accountant you know that there are certain write off periods that you're allowed to impose, there are certain rules about capitalising costs. These things are specific and clear and you can't really fool – or sometimes you do get auditors who do, but not too often. In this case with insurance, what I'm hearing from you is that there are different rules for different companies and they apply it in a different way. That doesn't sound right..That's exactly the point that Larissa was making. They reckon because of Vitality, maybe because of the quality of their clients, they may be wealthier – a different income set. That they've got greater clarity over the sustainability of these premiums, they're likely to last for 20, 30, 40 years. Whereas, perhaps Old Mutual and Sanlam have a different client base at a lower income level, where 10 or 12 years is the maximum from the history of how long these policies last. So that's where the debate is. You remember Liberty. Liberty used to be the rich man's insurance company. Things have changed and that's the point. Liberty is not what it used to be under the Donald Golden Era. Also the economy's changed. So I think we will all feel a little more comfortable if it could be explained in a much easier way for us. That's what we're looking at. We're not having a go at the company we're trying to satisfy ourselves, so that when we buy these shares for clients, we're not going to get any shocks. That we're not going to trip over our shoelaces or fall into a pothole..Doing your homework basically..That's exactly what we're saying. We need to do that particularly after what we've gone through over the last year. So we are very sensitive at this stage about these kind of issues..I love it. It's trust but verify. And in this case what you've just explained to me now, I have big questions myself about a company that I've trusted but not understood how to verify..That's exactly it. You've articulated exactly the questions we're asking. We're not going at Adrian, there's no jealousy or anger or desire to see these companies fail. We just want to know that we're not going to face – one day, a publication of results where numbers are suddenly down 20 – 30%.Like Sasol?.Sorry I should've brought that in as well. Absolutely right. Same thing. The pain that we've suffered on Sasol. Another one to add to these kind of shocks. These are big companies. Multi billion rand businesses and caps have been hurt, investors have been really battered and bruised and they want a little bit of truth..What did you make of Sasol's announcement on Lake Charles? It seems as though they now finally starting to open up or give us more detail..The results will come out now, though the market seems to have discounted the worst. But I can't say that. It seems to have stabilised around about the R270 level. But you must remember a year ago this was a company or just over a year ago the company was at double the price. So we've seen a huge write off of value in the company and as I've said to you before, some of it is the economy, a lot has to do with the accounting practices. Perhaps managers being overaggressive in trying to expand their businesses. Very much like General Patton. He just wanted to get to Berlin. The only problem is that the logistics behind him – the food trucks and all the other logistics needed to drive an army, couldn't keep up. And we're in that kind of situation. Everybody wants to get to Berlin but you know you haven't got the logistics or you haven't got the infrastructure to allow you to do it. Even the money in many cases – the funds..It's so interesting that a lot of criticism is coming from investment analysts – if you look at the big companies, the biggest of them all on the JSE is Naspers. And yet from where I sit, understanding my industry – the Internet industry and the digital world, they are the last ones that I'd be be questioning, because if you have a look at the network effect of their biggest asset being Tencent. Tencent is effectively an Instagram, Facebook, Google and eBay all pulled into one, in China, which is a bigger market. So, to me, that's a huge asset. Yet they've got criticism. What was the reaction to to the latest moves by them?.Very positive. I think what's very positive is, we're starting to see a business that's now going to be based in Amsterdam. There's quite a bit of criticism now being directed at the Facebook's, Amazon's, Alibaba's and so on. They dictate society, they can actually dictate the way that you act and the way that you conduct your life. But I think with technology now there's so much more room for new businesses. And I think the hope – and I'm reflecting the views that I'm getting from people around me, the hope is that Bob van Dijk being based in Amsterdam, while having Tencent as a big support mechanism, can actually start to grow other businesses and use his entrepreneurial expertise in that area to create another Tencent. I think there's quite a bit of optimism around it. So I'm happy to give it a chance and to see where this goes because it's the only company in South Africa that we can really participate in, in the way that things are going in the world economy, in the way that things are changing..What did you do with your Naspers shares. Did you just hold on to them or did you sell them?.We're going for the deal, we're going to pay a lot of tax to the South African government, which in any case you're going to pay somewhere along the line so you may as well take it upfront here. But are we definitely going for the deal..On that score to close off with Dave, did you get a chance to read Tito's turnaround plan for the year?.It's a cut and paste from the national development plan. Good for him. I like Tito. He's trying. I'll give him support, whether he can get this off the ground – but at least he's got a bit of energy and he understands exactly what's happening. He's not politically moved, he knows what he has to do. I've seen him on many occasions socially or bumped into him and I think maybe we underestimate him. I don't know where you stand on Tito but at least he's giving it a go..Tito and I never spoke to each other for about eight years – because I did criticise his process, not the person. He didn't see it that way, but then through his generosity of spirit, we met and had a cup of tea. He was very generous. He forgave me and we've been we've been cordial ever since. And I'm a big fan..He's trying, he's really giving it a go and he's not moved by politics and he knows what we have to do..But isn't it good to see the National Development Plan which took so much time to compile, so much brainpower to put together, it was driven by Trevor Manuel with the President – Cyril Ramaphosa as the deputy, lots of amazing commissioners looking at the most brutally honest plan that South Africa – or any country I've ever seen on an economic plan. It's been gathering dust for nine years it's been dusted off and your finance ministers picking it up and saying right guys, we got the plan let's apply..Exactly right. And there is a plan. There are elements which we can develop here that can give growth, just get the politics out of it and get the entrepreneurs into it. That's the whole thing. Keep politics away and we can stimulate growth..David Shapiro is the deputy chairman of Sasfin Securities and as always his forthright views.

David Shapiro: Justifiable concerns around Discovery’s “aggressive” accounting

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