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When I interviewed him on Rational Radio this week, former banker turned shareholder activist Dave Woollam explained how he had warned the Tongaat board of directors about their looming crisis. And, for his troubles, was shown the door – politely of course. Less than a year later, in Woollam’s estimation, those worthies are now lurching from one crisis to the next. You can listen to the podcast of our interview by clicking below. And then read the excellent assessment the chartered accountant put together for us. In it Woollam asks some very serious questions – while leaving very little to the imagination. – Alec Hogg
By Dave Woollam*
The recent spate of SENS announcements from Tongaat, culminating in the voluntary suspension of their shares has again put corporate South Africa in the headlines for all the wrong reasons. After a torrid 18 months, Tongaat joins a long list of companies who have seen their share price fall suddenly by more than 50% – caused by a range of factors from allegations of impropriety to governance failure to poor strategic execution. There is no doubt that the economy is proving very difficult and the lack of policy certainty, poor GDP growth, political factionalism and poorly performing SOE’s is weighing heavily on South Africa. However, there are many companies who are performing well despite these and other well-worn excuses that are trotted out in the opening paragraphs of many results announcements.
Tongaat is a curious case. On the one hand, it would be easy forgive those who on the face of it saw the group as performing admirably despite the headwinds it was facing. Afterall, the company received the prestigious Investment Analysts Award in the consumer products category for 11 straight years until 2018 as well the overall best company award in 2015 and 2018. A scan of the media shows interviews and articles that generally put Tongaat in a positive light and showed Peter Staude to be a genuine, humble and highly intelligent individual.
Investec even took the unprecedented move of publicly apologising for the behaviour of one of its errant stockbroking analysts who dared to suggest that it was time for Peter Staude to go. It is therefore not unexpected that there has been such a divided opinion on why Tongaat has suffered such a calamitous fall from grace.
I began looking at Tongaat in some detail in the second half of 2018, and built a detailed 10yr model on the results and other productivity data from the various Integrated Reports, investor presentations and market data. It quickly became apparent to me that the numbers were not supporting the rosy and optimistic picture that the company seemed too keen to portray. I won’t go into any great detail on these findings, as much of it has been churned through the media recently and some of it is still to emerge from the various forensic investigations that are being conducted. I will however highlight a few key points. During the period from 2010 to 2018:
- The company reported cumulative after-tax profits of R9 billion and paid dividends of R2.7 billion. During the same period, borrowings increased by R7.5 billion. A simple mathematical deduction would leave the question – where did the other R14 billion go?
- The group spent R8 billion on Capex (excl. cane roots) with no substantive detail being provided in the AFS and other published reports other than a few unquantified references to a new mill and refinery in Mozambique – estimated at around R800mill. What we do know is that over the last 10yrs, Tongaat has not built any new mills or refineries in SA or Zimbabwe, the company has not materially expanded its farming operations through land acquisitions and mill refurbishment costs and property development Work In Progress are disclosed as current assets. What else could the R8 billion of Capex relate to? A cynic might conclude that a substantial amount of otherwise normal operating expenses were somehow capitalised as fixed assets.
- Biological assets (cane roots and standing cane) increased in value by 173% from R2 billion to R5.6 billion. Sugar prices and cane yields have mostly fallen during the period and whilst hectares harvested have increased, when combined these factors don’t support the significant increase in the valuation of these assets. Standing cane in South Africa is the standout which increased by 582% over the period.
- Land sale debtors as at 31 March 2018 stood at R2.7 billion and represented approx. 2.5 yrs. of property sales. It appears that some of these deals may not have been as conclusive and unconditional as first disclosed and several them are in the process of being unwound. What is more troubling, is that every year from 2015 to 2018, the company confidently forecasted that it expected land sales over the following 5yrs to be between 150ha and 400ha p.a. and talked of nearly 8 000ha still to be developed. In the 4 years from 2016 to 2019, an average of only 73ha p.a. was actually sold and it now appears that a large portion of this was not really “sold”.
- As at 31 March 2018, the group disclosed cash reserves of R2.7 billion and stated that net debt, after deducting these cash reserves, was well within its debt covenants. Why would the group have increased it borrowings (at high interest rates) by R7.5 billion, when its cash reserves increased by R2.6 billion over the same period. The answer lies in the fact that most of the cash (estimated at R2.5 billion) was trapped in Zimbabwe, due to exchange controls, and also valued at the USD/ZAR exchange rate – two important facts that were never disclosed by the company. Since then exchange controls have got worse and the local RTGS currency is trading at somewhere between 6 (the official rate) and 12 (the free market rate).
- Probably the most illuminating graph was the one in which I plotted sugar milled by Tongaat S.A. over the 18yrs from 2001 to 2018. Tongaat has a stated milling capacity of 1 million tons p.a. and in 2001 they milled 977 tons, just shy of full capacity. The following graph shows what happened in the following 18yrs.
In summary, and at the risk of some speculation, this is what I believe transpired at Tongaat over the last 10yrs. The SA sugar operations were facing continually declining fortunes, the Zimbabwe operations, whilst very profitable could not repatriate dividends to SA and the Mozambique expansion plans proved to be much more expensive and took longer than expected. Peter Staude was obsessed with getting the sugar operations (the historical heart of the business) back to their former glory and kept throwing cash at the problem, funded fortuitously by the sale of land into the rapidly expanding Umhlanga and North Coast region. Unfortunately, the sugar businesses failed to recover, Zimbabwe got worse and Mozambique developed problems whilst the goose that was delivering land sale profits stops laying her golden eggs.
What happened next was probably just the natural extension of a man too proud to admit defeat and failure and who with a dominance of character was able to control and persuade all those around him that good times were just around the corner. This is not to diminish the severity of what went wrong and the potential accountability that anyone found to have misled investors should face.
The pressures felt by the sugar industry in SA, the deteriorating situation in Zimbabwe and Mozambique and the decline in developer confidence in KZN are not entirely the fault of Tongaat’s management and the board and are somewhat excusable. However, what is not excusable, is the apparent obfuscation and manipulation of the reported results as well as the unrealistically optimistic forecasts and prospects eagerly offered by the company to its various stakeholders as well as the vast rewards accepted by management for delivering these distorted earnings.
The BEE deal probably best encapsulates the value destruction at Tongaat over the last decade or so. In 2007, Tongaat issued approx. 18% of its shares at a price of approx. R92 per share to two BEE vehicles. The deal valued at R2.3 billion, was funded partially by bank debt and partially by Tongaat. By the time the deal was recently liquidated in April 2019, the shares were worth several hundred million less than the approx. R600 million loan owed to the banks and Tongaat had to write of the balance. Zero benefit accrued to the BEE partners after 12yrs of waiting!
A final observation – during my entire research of every single document ever published by Tongaat in the last 10yrs and every interview on TV and print media, I only ever saw Peter Staude as the frontman or spokesman for the company. Never once did the Chairman offer any public comments, the CFO was strangely hidden in the background, and the other key executives were largely unknown to investors and other stakeholders. There is a similar trend amongst the other fallen angels such as Steinhoff, Resilient, EOH, Brait and Net1 etc.
Whilst we seem to live in the age of the superstar unicorn CEO, with the like of Steve Jobs, Jeff Bezos, Mark Zuckerberg and our very own Elon Musk and Markus Jooste leading the way, we should be very wary of giving too much weight to these charismatic and invincible individuals.
On a positive note, there are many business leaders who are at the helm of their respective companies and are doing an outstanding job as stewards of shareholder capital and these criticisms are in no way meant to be universally applied. Whilst not exhaustive, CEO’s like Sim Tshabalala (Standard Bank), Mike Brown (Nedbank), Mteto Nyati (Altron), Brian Joffe (Bidvest) and David Hurwitz (Transaction Capital) are CEOs that come to mind as being committed to high standards of governance, stakeholder accountability and transparent honest reporting.
One of the essential features of the capitalist system was described as Creative Destruction by economist Joseph Schumpeter in 1942 – the process by which innovation relentlessly displaces the old and obsolete companies who fail to keep up. It allows capital to be redirected to the most productive companies in the economy and this in turn drives economic growth. If this hypothesis is true, should we be surprised or worried when companies fail? After all, isn’t that just the creative destruction process playing out – culling the deadwood so that the strong trees can grow and thrive? I disagree.
Businesses will fail, however in order to lower the overall cost of capital demanded by investors in any market, there needs to be effective additional safeguards and risk mitigation to protect investors from avoidable failure versus inevitable failure. Some might say who cares if Tongaat fails – it’s only a fraction of the market cap of the index – but if this raises the cost of capital of the whole system by 10 or 20bps then it matters a lot. For that reason, we should all be worried about the string of failures in our recent past, many of which seem to have slipped past the various Custodians of Corporate Governance and all the safety measures and systems they are supposed to be managing.
We know full well the toll that mismanagement of the public sector has had on the South African economy in the last decade and the consequential junk rating we have suffered. What is less apparent, in my mind, is the understanding of the collective damage that corporate failures are having on the risk rating (and therefore cost of capital) of our equity markets. The whole ecosystem that supports this huge network of capital providers and listed companies, who are also paid enormously well, need to come together to find solutions that will help reduce the number of avoidable failures. External auditors, boards, regulators and advisors need to realise that they are collectively responsible for the wellbeing of this important marketplace and engine room for economic growth and need to stop trying to point the finger elsewhere when things go wrong.
The airline industry knows this concept full well. Airlines spend a huge amount of money hiring and training competent pilots to fly their planes loaded with passengers. They also know that whilst human error or incompetence may only result in a tiny fraction of these planes crashing, the consequences of these failures is both systemic and catastrophic. For that reason, they add multiple additional layers of failovers and safeguards to further reduce the risk of these human errors or negligence to an even smaller subset. Despite this, every plane crash sends shivers through every airline operators’ spine, as the market and media analyses what went wrong, and places an intense spotlight on the industry – Boeing is a recent relevant example. Our pilots (CEO’s) and co-pilots (CFO’s/COOs) are the first line of defence in protecting investors capital, but this is not enough, and we need to be constantly thinking about how we create further safeguards and risk mitigation to avoid “pilot error or negligence”. If not, our cost of capital will go up, investment opportunities will be less viable, and the economy will decay.
The primary actors in this environment are the boards, external auditors, institutional investors and regulators etc and I don’t think it’s just a case of fine tuning and strengthening the existing processes or adding new layers of regulation. There are in my mind some fundamental impediments that need to be addressed at a deeper level and new solutions found. For example,
- I believe that the exponential increase in the complexity and scale of IFRS has backfired and made AFS almost impossible for the average investor to understand. With so many complex adjustments to the cash earnings it has allowed dishonest management to manipulate earnings through opaque adjustments and journal entries. The complexity of Groups with a multitude of subsidiaries and SPVs has made the understanding of the balance sheet extremely hard. In my opinion, listed companies should be compelled to publish the AFS of every subsidiary in the group as well as the consolidated AFS so that people can draw their own conclusion on the construct of the sum of the parts.
- Board structures and the way board members are appointed needs to be re-examined. Too many boards are still “controlled” by the CEO who through a weak or friendly chairman, can arrange the board to his/her liking. Too many directors sit on too many boards or have fulltime jobs and therefore don’t have time to get much more than a 35000 ft view of the company. At least a few key directors should be more involved in fully understanding the company and its risks and operations, paid more, but also held to account. Shareholders need to take a far greater interest in who is on the board and whether they are skilled enough and exercising their responsibilities properly. We should consider having more representative members on the board – such as employee representatives and shareholder representatives.
- AGMs are too often seen as a bureaucratic nuisance which must be held quickly and without fuss in order to tally up the proxies which are largely sent in beforehand. The AGM is the only forum in which shareholders can openly pose questions to the board and they should be both encouraged and allowed to do so. AGMs should be allowed to run for as long as it takes to satisfy shareholders that they have been heard and more shareholders should attend the AGM to exercise their rights in person. Lastly, I believe, all directors should be made to attend the AGM and should be individually available for questioning by shareholders.
- External auditors still largely approach auditing on a traditional substantive basis by deploying armies of trainees to “tick and bash” the records books. They state that they use a risk-based approach, but I don’t think this is deep enough and, in my experience, largely deals with traditional financial risks such as fair values and provisions etc. Why don’t they approach the audit from an analytical and research approach? By using highly experienced forensic and financial analysts to model and question the financial trends and profit levers, they may see the red flags more easily. More qualitative assessments and critical thinking around the behavioural aspects of the company, its management and governance are likely to raise even more red flags. We need auditors who are more Bloodhound than Labrador.
- Regulators need to stop just adding more and more layers of regulation and begin showing their teeth. During my many years as a CFO of two banks, we spent huge amounts of time and effort reporting on and complying with the Banks Act and it’s regulations, but nothing chilled the spine more than a call from Errol Kruger (the Registrar of Banks at the time) with a “request” to come through to the Reserve Bank now for a meeting with him. These occasional interventions, which were delivered with firm determination, made sure we as Banks towed both the spirit and the letter of the law. Whilst sometimes uncomfortable, I had tremendous respect for him as a regulator and we need more regulators who are going to use their powers decisively, quickly and firmly when companies destabilise the system.
*Dave Woollam is an ex-banker turned professional investor and occasional shareholder activist.
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