Old Mutual untying knots ahead of complex demerger and new listings

Regulatory environments overseas and market demand for more focused funds are driving forces for change

On the eve of Old Mutual’s full-year results announcement on Thursday, UK financial services giant Prudential said it planned to split into two separately listed firms, one housing its UK businesses and the other its fast-growing emerging markets and US businesses.

Sound familiar? “Imitation is the greatest form of flattery,” was Old Mutual chairman Patrick O’ Sullivan’s response.

If all goes according to plan, Old Mutual’s results will have been the group’s last as a London-listed plc before it splits into two separate companies, each of which will list in its own right in coming months, undoing a head office structure that was created almost two decades ago when the group demutualised and listed in London in 1999.

One, Quilter, houses the group’s UK wealth management business and will have its primary listing in London with a secondary listing in Johannesburg. The other, Old Mutual Ltd (OML), houses the group’s South African and emerging markets businesses, including its 54% of Nedbank, most of which will be distributed to OML shareholders later in 2018. OML is coming home to a primary listing in Johannesburg, with a secondary listing in London.

Prudential’s demerger is no doubt a response to its own idiosyncratic needs and those of its shareholders, just as Old Mutual’s is, but both also reflect the way the world is changing for financial services groups globally.

One big trend is regulatory. In the wake of the financial crisis, regulation has become ever tighter and more country-specific and regulators, particularly in the UK and Europe, have imposed ever more demanding capital requirements on complex, cross-border conglomerates because of the risks these are seen to entail. That not only makes it complex and cumbersome to manage such groups, but also affects their financial profiles and the returns they can offer their shareholders. In Old Mutual’s case, the UK regulator was the lead regulator, even though the larger part of the group is its South African business. For example, one of its regulatory challenges was that it couldn’t count the surplus capital it was holding in SA as part of the capital of the PLC.

But it was a second trend that was the more important driver for the “managed separation” process Old Mutual embarked on two years ago, and that is the shift in the investment universe over the past decade or two. That shift means many of the natural shareholders that should be holding the group’s businesses in the UK and SA are not, because the PLC is a smorgasbord of emerging market and developed market exposure, which those investors don’t want or aren’t allowed to buy.

When the key MCSI emerging markets index was launched in 1988, it covered just 10 countries and only 1% of the world’s total market capitalisation. Now that’s 24 countries with 10% of the world’s market capitalisation —and there are hundreds of billions of dollars in the global pool of investment capital that tracks the MCSI emerging markets index.

That includes the passive tracker funds as well as the “huggers”, active emerging market fund managers who benchmark their performance against the index.

Sanlam is in the MSCI emerging markets index, even though it’s just a fraction. Old Mutual is not in the index, despite the size and leading market position of its South African and emerging markets businesses, because the group combines emerging markets and developed markets businesses, which means it doesn’t fit the index – and so cannot access that giant global pool of emerging market investment cash. Equally, it lacks access to the UK-focused funds that would be the natural shareholders for its UK wealth business, which can’t then benefit from the high ratings enjoyed by its UK peers.

The aim of the managed separation is that the two companies, and Nedbank, will end up in the hands of their natural shareholders, prompting a rerating that will mean the group’s shareholders end up with more value than they started with.

How much more value will depend, crucially, on how those businesses perform in their own right, and while the managed separation process itself has been enormously complex and difficult, Old Mutual CEO Bruce Hemphill emphasises that the group has been careful to pay attention to improving the quality and performance of its underlying businesses— and Thursday’s strong results demonstrate that.

The group, he says, has “fundamentally transformed” the two businesses, particularly over the past year, under new boards and executive teams. But in the run-up to “exchange day”, when the PLC is at last replaced by the two new listings later in 2018, it’s hard not to ask whether Old Mutual should have gone off to London at all, joining a group of companies, including Anglo American and South African Breweries that made the move at the same time.

Globally and locally, the regulatory environment and the investment universe have changed fundamentally since then, and if a South African company wants to go on an international expansion drive there’s no reason why it shouldn’t do so from a base in Johannesburg or Cape Town. Plenty of South African companies have done that, with greater or lesser degrees of success. Equally, if South African institutional investors want international exposure, they can invest up to 40% of their assets outside SA — or they can simply buy globally diversified companies on the JSE itself.

Cynics say Old Mutual never needed to list in London, even then— the move was just a case of its executives trying to externalise their pensions (just as Christo Wiese tried to do through Steinhoff’s elaborate internationalisation).

The argument from Old Mutual and the government at the time, though, was that the group needed to tap into the much larger pool of capital available in London if it wanted to get its demutualisation done successfully, as well as to gain the freedom offered by a London listing to do international acquisitions. In the event, the group rapidly did a string of acquisitions in the US and UK, which all turned out badly and had to be sold or radically trimmed, losing value for shareholders. Little survives of all those deals. In the UK, Quilter is essentially a new advisory and wealth management business that’s been built up over the past few years and is now bringing in sizeable inflows of new client funds that should make it a desirable new London listing.

At home, Old Mutual Ltd is strong and profitable: CEO Peter Moyo has promised R1bn of cost savings and is relying on organic rather than acquisitive revenue growth, which pleases those analysts who often contrast Old Mutual’s poor track record of acquisitions over the past two decades with Sanlam’s more successful efforts.

Arguably, though, what’s past is past and it’s now for the companies that emerge from the managed separation to prove their worth and show that the whole, exhausting, nit-picking process, which has involved a string of transactions to sell assets, cut debt, put the right capital in the right businesses, refine and refocus the businesses themselves and shrink the London head office, can deliver the promised value for shareholders.

“It has been quite a journey and sometimes involved deeply unglamorous but critical preparation work,” said Old Mutual finance director Ingrid Johnson on Thursday.

Hemphill, who along with Johnson and the rest of the PLC board will step down once the managed separation process is completed, has often said there was no template for a process as complex as this. Perhaps, as Prudential gears up to do its demerger, it will be looking to the Old Mutual template, though, as O Sullivan wryly comments, “they won’t have sight of the full gory details we have lived through”.