Financial Mail - Investors Monthly
Incentive schemes
Unpicking Christo Wiese’s companies
“The underlying presumption was that the share price would, over the medium and long term, move steadily upwards
To describe them, as some analysts do, as a form of indentured labour for executives may be going a bit far considering the devastating effects of that 19th-century near-slavery system and the comparatively cosseted life of today’s average executive.
But the various share-based executive incentive schemes embedded in every company controlled or established by Christo Wiese do share one critical similarity in that they would have had devastating effects on every one of the “incentivised” executives if allowed to run their contracted course. Fortunately for the 21st-century executives they have hapless shareholders to bail them out.
In the past 12 months these schemes have exploded across the Wiese empire like landmines triggered by a retreating enemy. In this instance the enemy is surely hubris. The excessive confidence in individuals and markets that underpinned these ultimately destructive schemes has wreaked havoc and revealed the control-obsessed cynicism with which they were implemented.
Sadly for Wiese they are likely to be considered a key part of his complex legacy; more so than his role in the establishment of a number of impressive businesses.
It is not merely the benefit of hindsight that makes it
difficult to imagine how Wiese was able to persuade his executives to accept the conditions attached to these highly leveraged schemes. Perhaps he was such a powerful and persuasive individual he blinded his executives to the possibility that share prices might not always move upwards.
The essence of the schemes involved lending hefty sums of money to executives, often with Wiese’s assistance, so that they could purchase shares in their company. The shares were held in a trust or specialpurpose vehicle on behalf of the executives and used as collateral for the loan.
As one financier told IM, for the executive just to break even, the share price had to grow by at least the interest rate charged on the loans, which was often quite high.
The critical underlying presumption was that the share price would, over the medium and long term, move steadily upwards. If this does not happen and the share price drops below the level at which the original purchase was struck — for a sustained period — the executives fail to derive any benefit from being a shareholder and face potentially ruinous claims for repayment of the initial loan plus interest.
That is the sort of chilling prospect that focuses the mind and secures deep loyalty — until things start to fall apart.
Brait is the latest such executive landmine to explode. The R1.1bn bill that has been dumped on shareholders relates to a scheme set up in 2011. In terms of that scheme the “investment team” at Brait paid R1.5bn for 18% of Brait at R16.50 a share, which was housed in a company called Fleet. The scheme was initially funded through a R1.2bn loan from Brait but subsequently refinanced by RMB, with Brait providing a guarantee. The executives chipped in the remaining R300m. The R1.2bn Brait-guaranteed loan was to be repaid in December 2020.
In May 2011, when Brait’s high-flying status must have seemed unassailable, 99.4% of shareholders approved the scheme. For the first few years it did look like an easy winner; the share price shot up to a record high of R165 in 2016.
On the way, some of the original investment team cashed out and pocketed enormous gains, and new executives joined the scheme at the prevailing share price. Since reaching the R165 high the share has slumped to a low of R22 and with the 2020 repayment date looming, the board decided action had to be taken.
It said it would bring forward the repayment date by 18 months, write off what the executives owed and buy back the Brait shares held in Fleet. The cost of this bailout is R2bn. Because they had essentially agreed to the debt — and the assumed repayment — back in 2011, this time around the Brait shareholders had no say.
In an ironic display of the asymmetry of executive incentive schemes, the board justified the bailout on the grounds that otherwise the executives who remained would have worked for nothing. Essentially the message being sent was, executives must be generously rewarded regardless of what happens in the market.
As the financier points out, the symmetry argument is totally flawed. “Shareholders generally don’t buy their shares with debt and are therefore less vulnerable to price fluctuations in the short and medium term. However, these incentive schemes are highly leveraged, which means the payoff and risk profile is very different from ordinary shareholders.”
Making matters just a little worse for Brait shareholders was chair Chris Seabrooke’s comment that a new incentive scheme would be needed to replace the failed one.
Wiese’s involvement in the Brait incentive scheme was not quite as hands-on as the one involving former NBS executive Paul Leaf-Wright, who was able to borrow R30m from Origin, a
private bank in the FirstRand group, thanks to a guarantee from Wiese around the time that Wiese-controlled BoE was set to merge with NBS.
Wiese, who was keen to hold on to Leaf-Wright, allegedly told the high-flying executive that if anything went wrong Wiese would go after him and take everything but his house. Leaf-Wright bought the shares in April 1998 at what turned out to be the height of the bull run. During the next three years, as BoE acquired NBS and was in turn acquired by Nedcor, all sorts of financial gymnastics were undertaken to protect Leaf-Wright from his Origin debt as well as the prospect of Wiese, who by 2000 was no longer involved with BoE, coming after him.
Another BoE-related casualty of Wiese-styled incentive schemes was Michiel le Roux. He was MD of subsidiary Boland Bank before joining PSG to set up Capitec, but wasn’t as lucky as most of the other Wiese executives. He had a high-profile falling-out with Wiese and lost a court battle around his incentive scheme.
In 1999 changes to the Companies Act allowed companies to repurchase their own shares, making life easier for boards that wanted to bail out their executives. The Wiese-controlled Pepkor was one of the early users of this legislative change, which had been intended to accommodate BEE deals. In 2002 it bought back 7.6-million shares from a number of executive incentive schemes, saying the share price had fallen so low that the scheme was acting as a disincentive.
So last year’s Steinhoff-related Pepkor executive bailout was not the first, although it was the costliest. In July 2018 Pepkor informed angry shareholders of a previously little-known R440m liability relating to provisions for losses on the executive incentive scheme that was set to dent the soon-to-be released earnings figure.
It seems shareholders were unaware that when Pepkor had been sold into Steinhoff in 2015, the deal included the assumption of Pepkor’s guarantee for the management incentive loans. The loans had been used to acquire Pepkor shares that were converted into Steinhoff shares after the 2015 deal. The December 2017 collapse of Steinhoff triggered the guarantee when it became apparent the executives would not be able to use their shares to pay back the loans.
Wiese seemed unfazed by last year’s criticism, telling one journalist: “For me, first prize is to have top executives exposed as much as possible to the fortunes of the company. It makes me relaxed that my management and my shareholders are on the same side of the fence. We swim together, we sink together” — an explanation that comes nowhere close to the reality of the schemes.
Requiring executives to take a leveraged position in the company’s shares sounds like a good plan, in theory. Particularly when things are going well and you’re involved with a winner like Wiese. However, if you don’t have much appetite for gambling (which is essentially what borrowing to buy shares is) and things (beyond your control) aren’t going swimmingly, then leveraged executives will be a liability.
Ask Invicta shareholders. This industrial supplies group, controlled by Wiese, was censured by the JSE in 2015 after one of its subsidiaries repurchased 1.8-million Invicta shares from two directors without shareholder approval. It seems the heavily leveraged executives were involuntarily closed out of their positions by financial institutions because of share price weakness. The Invicta subsidiary stepped in to protect them.
Shoprite has not been without controversy. In September 2017, three months before the day on which Steinhoff’s fate was sealed, Shoprite shareholders voted to repurchase R1.7bn in shares from former CEO Whitey Basson. It seems Basson, who had driven the grocery retail group’s decadeslong growth, was unhappy about a Shoprite-Steinhoff tieup, and had decided to exit the company. He triggered a littleknown put option granted to him 14 years earlier allowing him to sell his 8.68-million shares back to the company.
As Invicta and the earlier Pepkor scheme prove, it didn’t require something cataclysmic like Steinhoff to highlight the folly of these high-stakes gambles. Most of them do not stand up to scrutiny and it’s not impossible that the underlying loans could be deemed reckless in terms of the National Credit Act. Banks usually require at least four times asset to debt cover and have in place covenants and margin calls if loan terms are breached.
Was it rank arrogance that made the executives believe these were deals that were too good to miss? Of course, Wiese-related companies weren’t the only ones to push highly geared share-based incentive schemes. Recall how Resilient used to lend its employees up to 20 times gross remuneration to buy shares in the company.
All in all you have to wonder what were the members of the risk committees and remuneration committees thinking when they gave their approval to these schemes. They are not only totally inappropriate in terms of incentivising executives — given that they are wholly dependent on share price movements, which are beyond the control of executives — but they also create huge risk for the company. We are reminded of that risk every time a company informs its shareholders it has to rescue executives from an ill-considered scheme. Recall what Pepkor and Brait have told us about the need to hold onto the executives, at any cost.
At the very least every member of the implicated committees should be voted off the board at the next AGM.
“In the past year these schemes have exploded across the Wiese empire like landmines triggered by a retreating enemy