Bursting AST’s Bubble

In most walks of life, optimism is good. Not so in business, where “good news” filters can be terminal. Those at the top need factual information, warts and all. Without it, executives put themselves at risk every time they open their mouths in public.

Then there’s willful misrepresentation. Even if done to “maintain morale” among staff and customers, this could be a criminal offence. Fortunately for South African corporates, the line separating optimism and misrepresentation has never been tested in our courts. But that day must surely be drawing nearer.

Long-suffering AST supporters should bear this in mind while celebrating a doubling in the share price (from 36c to the current 79c) since mid-March. It followed confirmation that another recapitalisation of the business – this time for R160-million – had been secured, laying the foundation for a “merger” with Black-owned Gijima Technologies.

AST’s 64-year-old chief executive John Miller, who previously ran the group’s sales division, has been distributor-in-chief of rosy-tinted spectacles. But his followers are in for an unwelcome surprise when they study the fine print in a 142-page circular to shareholders which details the transaction.

Forget the puffery about it being a win-win merger to establish AST’s empowerment credentials. This is actually a reverse takeover by the 450-person, R250-million a year Gijima Technologies of the 3 000 employee, R2-bn AST. It’s the entrepreneurial fish swallowing the longer-established whale. Disinterested outsiders would describe the transaction as a rescue. Whatever the definition, it’s a highly combustible cocktail that may explode the wrong way.

The deal shows that after years of excessive optimism from management, the technology group’s reluctant funders have finally lost patience. Just 18 months ago they supported Miller’s vaunted turnaround strategy by engineering a R88,75-m rights issue to reduce AST’s debt. Valuations in the new transaction – endorsed as “fair and reasonable” by auditors KPMG – put the entire business’s worth at R65-m, or R23-million less than the fresh capital injected in October 2003. By comparison, in terms of the transaction Gijima is valued at R108-m.

Gijima’s founder William Gumede will end up owning almost 30% of the enlarged entity, comfortably surpassing mining group Kumba (22%) as the biggest single shareholder. Gumede has eight months to buy another 5% from Kumba at 30c per AST share, a handy discount to the 35c at which the rights issue is priced.

After exercising this option, the combined stake of Gijima’s directors rises to 37%. By comparison the combined shareholding of the entire board of AST will be under 2%, with non-executive chairman Hans Smith (ex-Iscor) the biggest at just 1%. So there can be no question who will be making the decisions at the expanded entity. That this reality has not dawned on AST’s executives is apparent in the circular which is devoted mainly to the AST businesses and, rather patronisingly, notes: “As Gijima Technologies’ business is solutions- and project-based, it will likely be integrated into [the] Solutions [division of AST].”

The circular also provides hard evidence that Miller’s self-acclaimed “Business Improvement Programme” (BIP) is a flop. Heralded as the group’s turnaround strategy, the BIP was devised by GEM Consulting, an obscure Australian management consultancy which also happens to be an AST subsidiary. GEM was brought in as an external “expert” after Miller took over in December 2002.

Nine months into his stewardship, Miller was sufficiently emboldened by the BIP’s supposed impact to promise debt would drop R200-m by June 2004. He claimed the full benefit of cost savings would be realised in the financial year to end-June 2005.

Apart from some cash generated through the sale of a dozen “non-core” businesses and the R88,75-m rights issue, little progress had been made by June 2004. Miller’s promise missed the debt target by almost R100-m. Instead of the projected “substantial improvement” in the group’s 733% gearing ratio, by end June 2004 it had climbed to 1 114%.

Even though the cold numbers tell a different story, Miller still chants his BIP mantra at any public opportunity, including the claim that sustainable cost savings are running at an annualised R320-m a year. That is impossible to reconcile at the bottom line where AST is still awash with red ink.

Last week’s unaudited interims to end December reported AST had sustained a net loss of R80-m, a modest R15-m improvement on 2003. More telling, the year-on-year improvement in operating cash flow – after tax and finance charges – was a modest R30-million; a distance from the impact if Miller’s claimed R320-m annual savings were real.

While the benefits of the BIP have been subdued, its price was not with direct costs already topping R75-m. Although much in the circular relates to operational aspects of Miller’s turnaround strategy, the reality is articulated in a single sentence which says of the BIP: “these measures alone are deemed not to be sufficient to restore AST to full financial health in an acceptable period of time to ensure that the company’s competitive positioning is not further eroded.” A single sober sentence that pricks AST’s carefully crafted balloon.

Apart from a turnaround programme that has not delivered, the funders’ decision will also have been influenced by tough questions in their own boardrooms. Management at Kumba Resources now report to new bosses at Anglo American Plc who must be wondering why the iron ore and coal miner lent R41-m to the company which run its outsourced IT function.

Similarly, there will be questions from trustees of the Iscor Pension Fund about the motivation for its loan of R60,75-m to AST. That will raise issues on the judgement of the fund’s outsourced manager, Coris Capital, whose CEO Johan Potgieter is a director of AST, having been appointed to that board in June 2003. Coris, incidentally, also manages the Kumba and AST retirement funds, raising further questions of conflicts of interest.

Without continued funding support from Kumba and the Iscor Pension Fund, AST would long ago have drowned under its debt burden. Indeed, in December 2003 – after the R88,75-m lifeline from mainly the Iscor Pension Fund and Kumba – black-managed Arrivia.kom walked away from a possible takeover of AST after conducting a brief due diligence exercise.

AST’s two loyal rescuers are once again integral in the forthcoming R160-m capital raiser that lays the ground for consummation of the Gijima deal. They lead a lenders’ consortium which has guaranteed R116-m of the rights issue.

Should other shareholders ante up enough cash, the Iscor Pension Fund will have its entire debt repaid, while Kumba is to get back half of its R41-m loan. Standard Bank, the other major funder, will have almost half its R54-m overdraft repaid. At worst, the lenders convert part of their debt into AST shares.

The full R11-m of a debt owed to an entity called Cadtech (Pty) will also be repaid. Shareholders who have stuck with AST since its 1998 listing will grimace at the irony. Cadtech is owned by one Gerrie de Klerk, the former CEO under whose direction AST was driven the brink of extinction. He resigned due to “ill health” just before the reality of the disaster became public. Even after the recent recovery, AST’s share price is 98% down from its peak.

Another irony is that between them, Gijima’s chief executive Gumede, operations director Nhlanhla Mhlongo and financial director Carlos Ferreira earned a combined R1,8-m in the last financial year. That’s considerably less between all three than Miller’s R2,4-m a year, a package that was boosted by R1-million after he was promoted to CEO. It will be interesting to see which way the salaries are adjusted in the new Gijima AST entity.

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