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More twists than the Sani Pass

The saga at Sovereign Foods needs an elegant solution.

This article was originally published in the latest edition of the Moneyweb Investor digi-mag. To view the original, and the rest of the publication, please click here

I’m all for shareholder activism. Too often management whose interests are not aligned with shareholders’ ride roughshod over the rights of shareholders.

For this reason the efforts of shareholder activists like Theo Botha, Chris Logan and Albie Cilliers must be applauded. It is horrifically difficult to take a stand as a small shareholder and see it through to the end. It requires the tenacity of a Jack Russell, the thick skin of a rhino, the time of the elderly and when it gets legal, lots of cash.

Most institutional investors prefer to engage with management teams behind the scenes. But smaller investors do not always have that kind of access or clout.

Locally activists have been particularly vocal about issues such as executive remuneration and the inadequate disclosure of pay policies. Some companies have no problem hiking directors’ pay regardless of the company’s poor performance or the fact that they are involved in a round of retrenchments or cost cutting.

Last year Asief Mohamed, CEO of Aeon Investment Management, whose clients hold shares in Sovereign Foods, took issue with the company’s R24 million cash and share bonus to six members of the exco team which amounted to 18% of Sovereign’s 2015 profits before tax. Part of the bonus was enabled by a change in the company’s short-term incentive plan targets, which was made without informing shareholders.

Mohamed drafted a letter to the board of directors and institutional shareholders, which can be read here, taking issue with the bonus scheme, share options, and what seemed to be excessive fees paid to non-executive directors.

The board appears to have listened. (Their response can be read here.) While management will not pay back the bonuses (which the JSE investigated and found to be legitimate), they will commit and reinvest about R17 million back into the company as part of a black empowerment scheme which is central to a number of changes that the board believes will address shareholder concerns.

These include abandoning the long-term and short-term incentive schemes, aligning management and shareholder interests by ensuring management has skin in the game, reducing the fees of non-executive directors, returning capital to shareholders through a 10% share buy-back scheme and locking in management for a seven year period.

The changes are not perfect. For instance some investors have criticised the BEE deal for not being broad-based enough. The changes are also cumbersome in that each change is dependent on the one before it and as such have been packaged as one transaction, forcing shareholders to vote for an all or nothing package.

However for 85% of shareholders the changes were good enough and in January they voted in favour of the resolutions. These shareholders believe that management, which has been in place for five years, is doing a credible job of restoring a previously poorly-managed company for growth. And while the current share-price of R6.65 may be languishing between two previous rights offers (R8.50 and R4.75) the share has not performed badly when compared to its bigger competitor Astral over a five-year period (albeit off a low base). 

 

Total return 1 yr

Total return 3 yrs

Total return 5 yrs

Astral

-32%

+35%

+12%

Quantum Food

-27%

NA

NA

Sovereign

18%

+48%

+29%

Source: Aeon Investment Management

This is where I think there is a very fine line between positive shareholder activism and activism that is not constructive. A minority of shareholders continues to believe that management is simply ‘feathering its own nest’ and voted against the transaction. Effectively they are holding a company to ransom.

It is important at this juncture to spell out that 11.9% of shares in issue were voted against the transaction in January. Of these shares, Kevin James, CEO of unlisted competitor Country Bird, held 8.1%. (This stake has since increased to 10%.) Thus the shares held by arguably ‘legitimate’ dissenting shareholders equate to no more than 3.8% of Sovereign shares.

In terms of the Companies Act shareholders who object to a ‘fundamental transaction’ such as that proposed by Sovereign can exercise what are called appraisal rights. In other words the company is obliged to buy their shares from them at fair value. What that fair value is, is a matter of some disagreement.

However regardless of what the fair value price is, having to buy back 11.9% of its shares on top of the 10% share buy-back proposal was not expected, and is a bridge too far for a company whose market capitalisation is R506 million.

As a result Sovereign changed the terms of the proposal such that it would buy back just 5%, rather than the planned 10% of its shares.

From here the story has more twists and turns in it than the Sani Pass, with the battle reaching the courts on two occasions. In the first case Sovereign turned to the Competiton Tribunal for support against what it claimed was hostile intentions on the part of Country Bird. They lost (ultimately because the competitor did not in fact acquire the shares necessary to achieve negative control). In the second case management found itself in court because Country Bird, later joined by activist Albie Cilliers, brought applications to stop shareholders from voting on the revised proposal.

The case is precedent setting because section 163 of the Companies Act (which refers to appraisal rights) has been invoked for the first time. The judge ruled that the shareholder meeting (planned for Tuesday March 29) could not go ahead. However she adjourned the rest of her judgement. Effectively this means that the proposed transaction is now in limbo.

With hindsight the Sovereign board may have acted differently. That said, while investors large and small have the right to take management on over the way they are running the company, so too has management a right to defend the company from what appears to be hostile shareholders whose long term intentions are not necessarily in the best interests of the company.

An elegant solution seems a little way off.

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