Does the Old Mutt require euthanasia or just a de-flea?

Of particular concern to shareholders must be the acquisition frenzy that this company has embarked on over the past ten years.

One can only imagine that Scotsman, John Fairbairn who founded The Mutual Life Assurance Society of the Cape of Good Hope in 1845 with no initial capital and only policyholder support must be turning in his grave when his beloved Old Mutual reports to the market on the unfolding of its business fortunes each quarter.
 
I can think of few blue chip companies on the JSE that have gone more strategically awry than Old Mutual since listing in 1999.  One only has to look at the current share price of 900c to fully appreciate the market's assessment of consecutive CEO strategies starting with Mike Levett's tenure from 1985 to that of Jim Sutcliffe in 2001 and now Julian Roberts who has only recently taken over the reigns and cannot carry anywhere near the same blame.  However, he did become Group FD in 2000 and was thus very involved in the unfolding of their corporate strategy.  Listing at 1125c and initially enjoying a market capitalization of £3.9 billion or ZAR 36.8 billion, Old Mutual now has a market capitalization of ZAR 49.7 billion or £3.1 billion, this being nine years after listing.  In comparison, at the time Old Mutual listed, Standard Bank's market capitalization in rands was ZAR 28.7 billion or £2.87 billion and is now ZAR 113 billion and £7 billion.  This speaks volumes to a successful as against a failed strategy.
 
Of particular concern to shareholders must be the acquisition frenzy that this company has embarked on over the past ten years.  Looking back since 1999, I count no less than 35 major corporate deals that Old Mutual has undertaken and by far the majority of these deals are acquisitions with the odd disposal here and there.  Just adding up these large acquisitions and disposals and one quickly reaches a total amount spent in excess of £2.5 billion  since 1999 and with the exception of Nedbank's acquisition of BOE and various transactions around Mutual and Federal, most deals were offshore of nature. 
 
This global spending spree has meant that Old Mutual today carries its fair share of offshore debt and what is unfortunate and disheartening is that various acquisitions have subsequently been exited and it is unquestionable that certain of these acquisitions have been value destroying.  The area of private client stock broking and private client management, which includes the acquisitions of the Gerrard Group, Albert E Sharp and Capel-Cure Myers between 1997 and 2000, was particularly error-filled.  Many market commentators also believe that Old Mutual overpaid for their US acquisition, United Asset Managers in 2000 - they paid $2.2 billion and then later surprised the market with a revelation that certain of the original vendors of these various asset management companies within the UAM stable enjoyed revenue sharing agreements that needed to be 'bought-out'. 
 
Subsequent deals which of late have proven particularly damaging to Old Mutual's fortunes include Fidelity Guaranty Life for $635million in September 2001 and the Bermuda business in April 2003.  These two businesses have been capital nemeses for Old Mutual and have lately required constant recapitalizations. Considering the South African business has remained a gem within the entire Old Mutual stable and pumped cash flow that has supported the valuation, one can hardly blame shareholders for wondering what the rationale for all the offshore acquisitions has been.  Whilst it is easy to blame management for everything, we caution this position as extreme market conditions have placed some of these acquisitions and the business as a whole under abnormal levels of stress that even the most competent of management teams could not have predicted.
 
It was only last week that the market pushed Old Mutual's share price below 800c and according to our view of the value residing within this company, the South African businesses are worth more than 900c and the entire group more than 1500c.  This implies that the market has actually been applying a negative value to all the acquisitions made since listing.  

Viewed simply, one could then argue that for shareholders it would be better for Old Mutual to walk away from their offshore businesses and in a world where one assumes no negative come-backs to the domestic business, the stock would enjoy an immediate re-rating.

Unfortunately, this assumption is flawed as this approach would seriously blemish Mutual's image and create a panic for existing policyholders.
 
Yesterday Old Mutual produced its 3rd quarter trading update informing shareholders on the business's progress and the general investment and insurance environment.  Our assessment is that overall it was a good update with a reasonably positive 'feel-good factor' that would buoy the share. As far as capital adequacy or solvency is concerned the statement was definitely positive and gave little hint of any serious liquidity constraints within Mutual.  This will hopefully dilute the market's fears of an imminent rights issue at highly depressed prices.
 
Two negative points in the update include the worrying Bermuda business, which we hoped Old Mutual would find a smart way to exit but it remains in the fold. To Mutual's credit, they have conjured up a way to reduce the risk they face in this business and its poorly constructed products, but the jury is out as to whether their plan will succeed.  Also, the US Life or fixed annuity business is undergoing a strategic review and being refocused on profitable product lines which is encouraging, however, here too, we were hoping for an exit plan.  We will concede that this is hardly an easy environment to sell any underperforming financial services business and management would also derive more value by fixing it first before selling it.  
 
Whilst Julian Roberts now finds himself in the difficult position of keeping an unwieldy group afloat during horrid market conditions, one should not lose sight of the fact that the market has driven the share price to levels which definitely does not reflect the intrinsic value which is locked-up inside this conglomerate structure.  Roberts is actually, in our opinion, in an enviable long-term position in that only a few basic issues need to be addressed and management are already working on these, before a major re-rating of this company will unfold.  Naturally, market conditions will also need to improve.
 
Alphen believes that Mr. Roberts is moving in the correct direction to improve the lot of Old Mutual shareholders.  Active restructuring, simplifying the Group, exiting non-performing business units and actively communicating with the investment community will in our view go a long way to release the true value within this company.

Adrian Clayton
CEO of Alphen Asset Management, Adrian is also responsible for managing the PSG Alphen Flexible Fund and is the analyst for the Financial Sector.

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