In 2017 and early 2018 Denker Capital put together an investment checklist consisting of 82 items, with around 22 relating specifically to due diligence on management.
This gives some indication of the critical role that management plays in an investment decision.
“We are acutely aware of the importance of management to the investment outcome because they are the custodians of share capital and responsible for the allocation of capital to projects as well as the execution of them,” says Ricco Friedrich, portfolio manager of Denker Capital’s Denker SCI Equity Fund.
An investment checklist is for a portfolio manager like a preflight checklist is for a pilot, he says. It’s not just about ticking boxes.
“It is about understanding softer related issues about management – how they got there (were they helicoptered in or did they work their way up?), how they did previously, understanding their leadership style, and delving more deeply into their personality and character. We recognise that management and culture can create a sustainable competitive advantage.
“This forces us to make sure we have considered all those elements before investing,” he says.
Based on the investments Denker has walked away from, it is not one factor on its own but a combination of factors that give potential investors concerns about management.
Should a company’s management and/or its board not perform, the management of fund managers themselves are increasingly being put to the test by investors who expect them to act to protect their interests.
Yet few fund managers are willing to do this.
“We find it ironic that many larger companies are reluctant to take on a fairly active approach to unlocking value for their clients,” says Denker SCI Equity Fund portfolio manager Claude van Cuyck.
“It is important for our clients that we take an active approach to unlocking value, especially when we have taken a view and the investment hasn’t panned out as we expected. This could be due to poor management, poor asset allocation or poor governance – but through an activist approach, investors can engage with the board and management, and can get management changed if it is not doing its job,” he says.
“Through active management we have been able to unlock significant value at companies such as Altron and Adcorp. It is our fiduciary duty to ensure we are doing what we can to improve corporate South Africa and unlock value for our clients. We will happily fight for the rights of our clients. It does take time and it does cost money, and we take these costs onto our own income statements.”
The fund’s investment in Grand Parade has been one of its biggest active engagements. This started in mid-2017 when Denker asked to meet chairman Hassen Adams with a range of concerns including the departure of the CEO, the lack of experience and poor site selection of Burger King stores, high central costs, questionable acquisitions and corporate governance issues.
Since then it has voted against the company’s remuneration policy and called for an extraordinary general meeting to make changes at board level, where it was partly successful.
“Our experience is that with the right motives, hard work and grit – and always acting with integrity – shareholder activism can add significant value to all shareholders and our clients,” Denker says.
“Grand Parade is still unfolding, but we see material upside,” says Friedrich. “We had a choice to exit or look for ways to unlock value, and we believed it wouldn’t be too hard if we could facilitate a change in management.”
While Grand Parade is invested in some great businesses and is trading at a discount to intrinsic value when Denker initially invested, “the lesson we learnt is that it is sometimes hard to gauge, even in the second third or fourth meeting, if this is a management team you want to partner with – be extremely cautious when there is a management team you don’t know well.”
This happens rarely for Van Cuyck and Friedrich who both have decades of experience in the market. “With our years of experience and it being a relatively small market, there isn’t a management team we cannot pick up the phone and speak to, and that network is one of our competitive advantages,” says Friedrich.
“We don’t necessarily want to invest in a business where from the outset we want to be actively involved, but if we believe there is value to be unlocked, we will work with companies like Value Capital Partners or go it alone as we did with Grand Parade.
“Our shareholding is just 2% of the company, and it accounts for less than 1% of our fund, but the improvement in share price since our intervention has been 70%. If we can get one or two of those a year, it does add to the relative performance of the fund.
“Denker’s involvement is a differentiator as large fund managers are not always prepared to roll up their sleeves and help to bring about change.”
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