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Bedevilled by the fallen angels – Part 1

The case of Steinhoff as we approach the one-year anniversary of its collapse.

We are rapidly reaching the end of the year, and with it comes the anniversary of Steinhoff’s share price collapse due to accounting irregularities. Billions were wiped off the Johannesburg Stock Exchange. This year has shown us the importance of good corporate governance, as a slew of once-popular stocks (and politicians) became fallen angels.

There are few feelings worse than facing clients after incurring large losses in their portfolios. As an asset manager one has a crisis of confidence – did we not conduct our research or do our homework thoroughly enough? We think of laying blame at the feet of others. Maybe even using a technique perfected by US President Donald Trump and Fox News to deflect from one’s own shortcomings, called ‘whataboutism’.

For example, we lost money in Steinhoff but “what about” almost all other portfolio managers, they lost too, even more than us. “What about” Tiger Brands (-44%), Tongaat (-50%) Pioneer (-41%) or Mediclinic (-35%)? We weren’t in those. “What about” Blue Label (-64%), MTN (-39%), Coronation (-35%), or Massmart (-33%)? We dodged those bullets. “What about” the fact that only seven Top 40 companies are in the green this year? “What about” looking on the bright side: you can set off the capital loss against your gains for tax purposes.

The truth is that we make mistakes as asset managers. Yes, we avoided many of this year’s fallen angels, but the first step on the road to recovery is admitting we have a problem. Corporate governance matters. Business managers aren’t automatically ranked good or great if they make profits – they also have to play by the rules. The latter is much harder to measure or quantify, as we’ve found out, by which time it’s too late.

As asset managers, we have to be better at spotting the loser before it takes the next leg down.

I have decided to detail the failures of each of the culprits in a series of short articles that will be carried over the coming days. The companies that have affected our performance this year include Steinhoff, Aspen, EOH, Resilient, Grindrod Shipping and General Electric.

Steinhoff

Before the accounting scandal, Steinhoff had more than 12 000 stores in 30 countries over five continents, employing 130 000 people. It made it onto Bloomberg Intelligence’s annual list of global Top 50 companies. Steinhoff was known locally for brands such as Ackermans, Pep, Tekkie Town, Russells, HiFi Corp, Incredible Connection and Hertz Car Rental. It had amassed a slew of international brands under its umbrella, such as German household retailer Poco and Conforama in France, Spain, Portugal, Italy, Switzerland and Serbia.

Customers browse aisles inside a Pep store, operated by Pepkor, a unit within Steinhoff International. Photographer: Waldo Swiegers/Bloomberg

In the UK, Steinhoff owned Bensons for Beds, Harveys, and homeware discounter Poundland. It also had operations in Hungary and Australia, and even owned Mattress Firm, the US’s biggest mattress retailer (which has since filed for voluntary bankruptcy).

Read:

Steinhoff’s Mattress Firm files for Chapter 11 bankruptcy

Mattress Firm bankruptcy is a corporate nightmare

Markus Jooste, the CEO of Steinhoff, was celebrated as a charismatic genius and a hero. Then, on Tuesday, December 5, Jooste resigned, the veil dropped, and the walls came tumbling down. What was left standing was a fraudster, a bully and a villain who had pulled the wool over so many eyes and cost pensions and investors dearly.

How much was lost?

Steinhoff saw its share price tumble 98% over six months, from an intra-day high of R55.70 on December 4, 2017 to R1.07 on June 4, 2018. The share had, in 2016, reached nearly R97 per share. Today it trades at a little over R2. The collapse in price saw more than R230 billion wiped off Steinhoff’s market value. This was the largest loss of value by a company in South African history.

Fall from grace

Large institutions – including Coronation, Allan Gray, Investec Asset Management, Old Mutual and Sanlam – accounted for about 20% of the total shareholding at the time. The Public Investment Corporation, which manages the assets of the state’s main employee pension fund, owned over 8.4% of Steinhoff’s stock.

What happened?

The collapse was caused by accounting irregularities (flagged by Steinhoff’s auditors Deloitte), exacerbated by the ‘boys club’ corporate culture of the board, which allowed the fraud to escape scrutiny and avoid detection until it was too late.

The genesis of the fallout began two years prior when there were murmurs of fraud – and an investigation by German tax officials.

The irregularities were brought to light in a report by activist short-seller Viceroy Research. According to Viceroy, Steinhoff was obscuring losses in off-balance-sheet entities, and also inflating earnings in those entities.

This was how Steinhoff managed to acquire struggling companies whose performance miraculously appeared to improve after their acquisition.

Benguela Global Fund Managers also questioned how a company that operates in a 28% tax jurisdiction could maintain a 15% tax rate on an annual basis when there was no capital expenditure, which would allow tax deductions, to lower its tax rate.

There were investigations into senior executives for tax evasion, document forgery and fraud, and rampant and dilutive equity raising. There were also allegations that cash flow trends did not correspond with operating profit. 

An investigation by Financial Mail and the Australian Financial Review even reveals that Jooste and his accomplices were front-runners to the Steinhoff group’s purchase of Australian lifestyle and homeware retailer Freedom Group, which stretches back over a decade. 

Read: Steinhoff was born in sin – report

Where do investors currently stand?

Where the trail of skeletons will end is known only by PwC, which has been investigating Steinhoff’s financials. It has the immense task of sifting through millions of documents to produce a highly anticipated report for release in December 2018.

A class action by Dutch Investors’ Association VEB against the embattled retailer was suspended. The action by VEB is the most advanced of three class actions facing Steinhoff and has been put off until April 2019.

The reason for the suspension is to allow time for Steinhoff to avoid damaging insolvency in the interim. This will give management time to restructure the business and make further progress in its investigations and the preparation of its financial statements.

A recent court case has found that South African shareholders cannot sue for what is referred to as ‘reflective’ losses – in other words, a fall in the share price. This is unfortunate news for any Steinhoff shareholder wanting to hold the directors and auditors to account.

As it stands, Steinhoff shareholders will have to wait until the end of the year for the PwC report, and until April next year for the first class action to continue.

There are a host of class actions targeting the people and companies named alongside Steinhoff in the accounting scandal. More information about them can be found here.

Lee Kern is an assistant portfolio manager at Cratos Capital.

The views and opinions shared in this article belong to their author, cannot be construed as financial advice, and do not necessarily mirror the views and opinions of Moneyweb.

COMMENTS   12

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Thank you for this clear and fair article. Whilst never owning Steinhoff, the demise of the company has affected all South Africans in one way or another. Our reputation as a place to do business has been severely tarnished because of the actions of a few greedy individuals, but the biggest lesson is how the behavior of ones President can affect the psyche of its citizens.
One has to wonder if the theft of shareholders and banks money wasn’t motivated by the example set by Zuma and his connections? The robbing of South Africa’s reputation and resources had already begun so perhaps the moral decay that lead to the Steinhoff debacle can be laid at the feet of our leadership at the time.
Just a thought.

Goodness NO! One can’t blame Zuma for THIS! Sure, Zuma is a bad apple but it’s farfetched to suggest Markus Jooste didn’t act independently.
Read some books from the local library on the Steinhoff fraud.

I agree. You cannot possibly blame Jacob Zuma for Steinhoff. For a start he is a rank amateur compared to the Steinhoff gang. Despite their appearance they are little more than thieves well versed in how to manipulate the law to their own advantage. Big business in this country has been corrupt for decades. They simply got away scot free. Protected not only by the laws which they manipulate but also by the very institutions which should prosecute them and fail completely to act against them. The Hawks, the JSE compliance, the FSB and other regulators are a joke. We need a new version of the Scorpions who are capable of investigating and prosecuting white collar crime successfully.

It appears that some trust has been lost in anything run by what is currently termed as the “Stellenbosch mafia”.

Steinhoff’s set-up was crooked from inception and that pre-dated the Zuma-Gupta cabal. In my own view, I feel it is not for Govt to set the tone for moral and ethical behaviour for business – it should be the other way around. Imagine, totally clean and above board businesses (and employees) in itself will stamp out 90% of Govt related corruption as there will be no takers on hints for bribes and no deals engineered around kick-backs, etc, etc.

Clickbait. There is nothing new in this article and neither does it explain how the whole mess happened.

What the Steinhoff fiasco teaches us is that where the systemic environment in which entities operate is marginalised or sub-optimal in any way, investors need to be extra vigilant. In many ways the past 20 years or so, for a number of reasons, has been like a seal clubbing fest, not only for unscrupulous businesses, but also politicians – enter the Guptas, Steinhoff et al. Although there is always opportunity in chaos with tantalising risk-reward propositions, responsible investors must be able to recognise this and be able to analyse investment opportunities accordingly.

Reality however is very different. When greed, a fast buck and herd mentality prevails, the red mist descends and rational behaviour wafts away. This is true from a pick-pocket to an asset manager to the president of a country. In Steinhoffs case the tell-tale signs have been there for a long time but so too was ‘go-with-the-flow’ and ‘don’t rock the boat’. Since everyone was making money, ‘eveyone’ couldn’t all be wrong, right? Wrong.

To my mind the lessons should be to trust only your grandmother – with your attorney present. Do your own simple but thorough research. Don’t get greedy. A buck profit is a buck more than you had yesterday. If the fundamentals dont stack up, step away. Don’t abdicate your finances entirely to someone else. Do the basic sums yourself, on the back of a cigarette box if needs be. Trust your instinct.

“Markus Jooste, the CEO of Steinhoff, was celebrated as a charismatic genius and a hero” – not if you met him, then you knew he was a complete ****

If i’ve ever seen a marketing article to defend ones fund and decisions this is it!

Cratos BCI Equity Fund has now underperformed its benchmark by 24.42% and underperformed the industry average 18.89% over the last 3 years, as per their fund fact sheet 30 September 2018 (p.s i would hate to see the fund fact sheet for the end of October). I would love to know what your holding in Steinhoff was at the time as you point out to other fund managers being the big holders, but with Cratos BCI Equity fund being a serious underperformer.

This is why asset managers are getting a bad name and the reason why everyone else would prefer to rather invest in tracker funds.

They had ~4.4% of their equity fund invested in Steinhoff right before the crash. What a bunch of clowns.

Asset managers failed in their duties to ensure appointment of fit and proper people to the board that is why the board was an OLD boy’s club. The board doesn’t appoint itself!

The grand master here is not Jooste but Christo Wiese. – One needs to correlate Brait and Steinhoff’s acquisition deals for businesses – to see Christo Wiese’s MO at work – He has been at it for the last few decades.

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