The ultimate ‘conman’s plan’
TAKING ADVANTAGE: SELLING TO MARKET
Excitement over Steinhoff fools even the smartest investors in the process.
Recently, one of the foremost racehorse owners in South Africa hit the headlines for all the wrong reasons. It turned out that the company he founded and had built up through multiple acquisitions may actually be a fraud. Investors are struggling to reconcile the company they thought they knew and invested in – Steinhoff – with what they are reading in the newspapers.
Markus Jooste has latterly been described as the ultimate con artist. However, the best conmen understand full well that the trick is to sell what their targets want. What Jooste was selling was many South Africans’ dream – excitement, capital flight, tax arbitrage – all backed up by the MacGuffin of “supply chain excellence”.
This excitement came in the form of a company that made serial acquisitions. Despite decades of evidence that large scale acquisitive activity generally destroys shareholder value, companies that do deals are often regarded as “sexy” by the market.
Over the last decade Steinhoff managed to grow its revenue by 22% p.a., and net profit by 25% p.a. This was achieved through an aggressive acquisition strategy, often paying over the odds for their target companies.
This strategy was funded by massive equity and debt issuance. Its equity base increased from R25 billion in 2008 to R254 billion in 2016, an annual growth rate of 33%. Gross debt also grew rapidly from R17 billion to R129 billion, an annual growth rate of almost 30%. The more debt and equity Steinhoff issued, the more the market applauded and asked for more. Instead of the increased levels of due diligence, it seems the “excitement of the deal” caused the market to suspend its disbelief and relax its underwriting standards.
Research has proven that South Africans are consistently too negative about South Africa – it’s been proven that we believe things to be worse than they actually are in reality. In Ipsos’s Perils of Perception 2017 survey, South Africa ranked as the most needlessly pessimistic nation out of 38 countries. This unnecessary pessimism regarding our local situation may explain why local investors could relax their underwriting standards on offshore investments, empowering unscrupulous salespeople to create products which can be sold quickly and easily, with little regard to future investment prospects.
When Steinhoff’s listing was moved to Europe, Jooste effectively took full advantage of this inherent bias, with investors cheering him on. Of course, the fact that these same investors now want to sue the company for “misrepresentation” is somewhat ironic.
South Africa has also become one of the most heavily taxed countries in the world. Personal income tax rates top out at 45%, while corporates are taxed at a relatively high 28%. CGT is now in excess of 20%. Starting in 2017, dividends have been taxed at 20%. Even VAT was increased to 15%. South Africans increasingly view reducing their tax burden as a national sport. Equally, anyone promoting a tax efficient investment vehicle is likely to get a lot of support from the market. Steinhoff provided tax-efficient investing in spades, with its tax rate averaging around 15% for the 10 years from 2006.
As investors, we need to use the Steinhoff story as a learning opportunity.
1. Accountants, regulators and even fund managers are imposing increasingly Draconian rules and corporate governance standards. The alleged fraud didn’t happen because of a poor regulatory environment, but due to a strong appeal to incentives which caused people to suspend their disbelief. No amount of regulatory intervention will ever be able to eradicate incentive-caused bias.
2. As analysts, it pays to understand not only the numbers that represent the activities of a business, but also the human beings behind the companies. Who are they, what are their reputations, and what are their incentives? These soft issues are as important – if not more important – than the hard numbers.
3. Never ignore the outside view. Our tendency as humans is to favour the inside view. The inside view considers a problem by focusing on the specific situation and making predictions based on that narrow and unique set of inputs. The outside view asks if there are similar situations that provide a statistical basis for making a decision, and if so, what happened?
Piet Viljoen is executive chairman of RECM.