Stephen Saad and Gus Attridge, CEO and deputy CEO of Aspen respectively, did not look like men under pressure at the Aspen interim results presentation on Friday. Instead, they appeared remarkably upbeat – as they do. That is because they believe that while Aspen is at an ‘inflection’ point, it is just a matter of time until cash flow generation improves, debt comes under control and the company can once again start making acquisitions.
However, that is easier said than done. The results, as warned, were bad. In constant currency terms, revenue growth was flat, Ebitda (earnings before interest, taxes, depreciation, and amortisation) margins were down 0.3% and worse in reported terms at -1.2%. Normalised headline earnings per share were down -6%, operating cash flows reduced by 45% as working capital increased by R2 billion, and inventories increased by R1 billion.
While management explained that tying up cash in stock is better than being out of stock (agreed), this remains a big red flag as it means that sales have either dried up or they lost control of their supply chain (both).
Dangerous position to be in
Adding to the misery, the relationship between debt and equity has inflected. Debt is now greater than the market value of equity. “This is a dangerous financial position to be in,” says Zwelakhe Mnguni, CIO at Benguela Global Fund Managers. “If one was to do a rights issue to settle some or all of the debt, the dilution would be massive to current shareholders. A one-month delay in the regulatory approvals of the infant milk formula sale would definitely push Aspen in that direction.”
Moreover, Aspen’s bankers will be breathing down management’s collective necks after the firm breached its debt covenants (this was fixed by temporarily adjusting the ceiling upwards).
Investors responded by dumping Aspen shares. The price fell from R141 to R70 overnight, finally settling at about R100.
It may be that management, once again, underestimated investor concerns about Aspen’s double challenge of low growth and high debt. In September, when the company released its full-year results, unimpressed shareholders responded by dumping shares, causing them to fall from R270 to R190 within two days.
“There is no doubt the debt is a factor in the rerating,” acknowledged Attridge. “We have guided for slower growth and what we are seeing is a change in the type of investors we attract – from growth to value. Value investors are more patient, and we believe they will be rewarded.”
There is no doubting what this management team has achieved. They have single-handedly reduced the cost of antiretroviral drugs in SA, while investing in jobs, growth and world-class manufacturing, all the while taking a small pharma company global. However one has to ask whether they are, at this point, too emotionally invested in the business to make the objective decisions necessary to pull it right?
There are some troubling signs …
Mnguni notes that Aspen’s current mess could be slotted into the book ‘How The Mighty Fall’ by US business management guru Jim Collins. Collins identifies five stages that precede a company’s collapse or forced breakup:
Stage 1: Hubris born of success
Aspen was built from humble beginnings, following its 1998 JSE listing (it reversed into Medhold) and 1999 acquisition of SA Druggists. Following good support by shareholders, management (Saad and Attridge) grew bolder in 2003 when they adopted a generics-focused business strategy. They grew even bolder when they extended their generics strategy into other emerging markets. “Indeed, their great success gave them the hubris to go into developed markets,” says Mnguni.
As the tide of success rolled in, Aspen highlighted the “quality of management” as one of its competitive edges. With the following attributes listed in the company’s Factsheets:
➜ Skilled, experienced and diverse management teams.
➜ Proven track record of delivering shareholder returns.
➜ Demonstrated capacity to complete value-enhancing transactions.
➜ Strong alignment of shareholders’ and executives’ interests.
These are the typical examples of the hubris that started swirling around the Aspen team.
Stage 2: Undisciplined pursuit of more
Aspen grew headline earnings per share at an annualised rate of 22% per annum over the 15 years to 2016 while the market only managed to deliver 11% per annum over the same period. The acquisitions looked good on paper and changed both the product mix (generics vs branded) and regional mix (emerging vs developed markets). However, the acquisitions from 2008 onwards brought about an insidious dilution in shareholder value.
Management’s attitude to shareholder concerns about declining returns on equity, declining returns on invested capital and a lack of organic growth was one of ‘trust us’: “We’ve done it successfully so many times.” While the metrics said otherwise, it was hard not to believe, particularly as both Saad and Attridge are heavily financially invested in the business.
The share price rallied to record highs and revenues doubled between 2013 and 2017 as they went from one acquisition to the other.
Benguela flagged the risks, as the product mix (generics vs branded) and regional mix (emerging vs developed markets) changed, in this Moneyweb article in 2017.
The empire-building pursuit of growth significantly diluted Aspen’s returns and added massive debt. It would seem that they operated under a mistaken perspective that, in the words of Jim Collins, “Big is great”.
In 2018, as the cash flows dried up and the debt increased, they were forced to sell the highly profitable and stable Infant Milk Formula business, despite years of arguing that it was strategic. “That was the desperation for cash talking,” says Mnguni.
Stage 3: Denial of risk and peril
Having listened to the presentation last week, one wonders whether it could be that Aspen is at Stage 3, headed for Stage 4?
“The denials on the precariousness of the situation is mind-numbing,” says Mnguni. “I believe it is these denials that sent the share price tumbling.”
Stage 4: Grasping for salvation
Salvation apparently lies in partnerships in developed markets. In the US Aspen has reached an understanding with a third party to supply women’s health products into the US market. And in Europe, the company is in discussions with a potential partner to market its thrombosis and anaesthetic drugs (in which, excluding the US, it is the global number 1 and number 2 market leader respectively).
“If US women’s health products help drive growth in the developed markets back into positive territory I’ll eat my fedora,” says Mnguni. “The US is a highly regulated market and driving down the price of drugs is a major priority.”
Stage 5: Capitulation to irrelevance or death
At this point, in Collins’s book, the rubber has long since hit the road.
Personally, I would like to see these two executives pull the business back from the brink.
Others are not convinced that they can. The only person prepared to be quoted on the subject was Mnguni. “I expect Aspen to be broken up into two to three pieces in future (no more than three years). In my opinion, the empire building was in vain and we are about to revert back to the basics.”