Mr Price vs … everyone

There’s little doubt, had Mr Price made that fateful December announcement 10 years earlier, it would have been greeted with much delight by the South African investment community.  

But too much stuff – and all of it bad – has happened in the intervening years for almost anyone, bar Mr Price’s board and its management, to feel anything but dread about its R9.7bn purchase of German-based retailer NKD Group. 

The provision since of additional information about NKD has done nothing to quell worries that Mr Price is set to join the list of corporate casualties whose hubristic management were convinced they could conquer far-flung markets.  

And here’s the real killer for angry shareholders: chances are (based on much historical evidence) that whatever happens with a Mr Price-owned NKD, its executives will emerge from the deal considerably richer. 

In the latest, excoriating, review of the almost-completed NKD deal, Zwelakhe Mnguni, chief investment officer of Benguela Global Fund Managers, describes the “graveyard of offshore expansions” by South African retailers.  

“In every instance where a South African acquirer purchased a mature asset in a low-growth competitive market (UK/EU/Aus), often from private equity or distressed sellers, the result was significant shareholder value destruction.” 

Benguela joins 36ONE’s Cy Jacobs and Mergence Investment Managers’ Peter Takaendesa in trying to force a change of management heart; in Benguela’s case it has approached the JSE directly – and been rebuffed – in an effort to have the deal put to a shareholder vote. 

Shareholder approval 

The JSE, you see, has rejected Benguela’s request that the NKD deal be seen as part of an interconnected transaction dating back a few years and including the acquisition of Yuppiechef, Power Fashion and Studio 88. The combined value of these deals would be well above the 30% of market capitalisation used to define a Category 1 transaction. Crucially, a Category 1 transaction requires shareholder approval.  

(How frustrating for Benguela then that the slump in the share price since the deal was announced in early December means at one stage the cost of just NKD was close to 25% of Mr Price’s market capitalisation.)  

The extent of the opposition to the transaction – at one stage the share price was down 24% after the announcement – may have stunned Mr Price management, but it is hardly surprising given the retail sector’s recent history. By one count the past 10 years have witnessed the destruction of an eye-watering R220bn of shareholder value. 

Mnguni believes the destruction is down to three core factors.  

First, there’s management hubris with South African retail executives believing their superior efficiency can rescue structurally broken businesses in highly competitive foreign jurisdictions. Think Woolworths and David Jones (2014); Famous Brands and GBK (2016); Truworths and Office (2015).  

Then there’s woeful oversight, where boards consistently fail to question the motivations of the seller, particularly when the seller is a private equity (PE) firm. These PE firms, says Mnguni, are “short-term optimisers” whose objective is to “dress up” an asset for exit, “often by starving it of maintenance capex to boost reported free cash flow”. 

In this category we have Steinhoff (from 2007-2016); Brait and New Look (2015); and Spar Group and Poland (2019). 

Perverse management incentives  

And, third, there’s the flawed remuneration model, which sees executives perversely rewarded for “closing the deal” rather than ensuring the quality of the asset or its eventual return on invested capital.  

“Short-term incentives weighted to headline earnings per share (HEPS) and/or turnover encourage acquisitions that mechanically increase these metrics in the short term, thereby triggering massive payouts before the long-term capital destruction is realised at the expense of shareholders in subsequent periods,” argues Mnguni. 

Among the biggest gainers of these implosions was Markus Jooste, whose 2016 remuneration of R126m included R25m for closing acquisitions. Then there was Woolworths’ Ian Moir, who received R191m over the five years David Jones was bleeding value, says Mnguni. 

Truworths’ Michael Mark received R206m over the 10 years following the acquisition of Office (UK) despite the R6.9bn write-down needed. While Moir is long gone, Mark is still in charge. 

You get the picture? 

“On the information [Mr Price has] provided so far it’s difficult to see how this will be any different from the other blunders,” says Takaendesa, and then, dubiously: “Maybe there’s some hidden gem they haven’t revealed yet.” 

It’s worth noting this is the first deal under CEO Mark Blair that analysts have opposed. “The market doesn’t have a problem with deals per se, it’s the jurisdiction,” says Takaendesa, who believes there are still opportunities in South Africa.  

If Mr Price really believes there aren’t, then it should return the money to shareholders who can do their own offshore investing, he says. 

Similarly, says Benguela’s head of research Victor Seanie: “We are not opposed to deals; we are opposed to value-destructive deals such as NKD.” 

Other people’s money  

Most times, the CEO of a listed company is gambling with other people’s money. From a personal financial perspective, thanks to the traditional structure of executive remuneration, it’s a bet he or she can’t lose. It’s only the shareholders who lose. And, as Mnguni reminds us, shareholders of South African retailers have lost big time over the past 10 years. 

While Benguela Global Fund Managers is reserving a full deep dive until after its engagement with management, Mnguni warns the “preliminary indicators regarding the NKD acquisition are chillingly familiar”.  

Indeed, it does appear the transaction ticks all three boxes.  

No doubt NKD has had a tough four years and is not expected to be earnings accretive in year one. Yet Mr Price executives argue it will be a good long-term earnings contributor. 

As for board oversight, particularly important given the seller is a PE firm, the so-called independent chair Nigel Payne has been a director since 2007, which can only add to shareholder concerns. 

And, what should we make of the fact the deal was tipped off at the first analysts’ presentation after co-founder Stewart Cohen had stepped off the board? Cohen, along with Laurie Chiappini, founded the group back in 1985.

An uncertain, resource-strapped start became a phenomenal growth streak; while the retailer did a few deals outside South Africa, these tended to be comparatively small and were all wound down – due to disappointing performances – by 2019.

Such was the conservative nature of its founders, who favoured organic growth, that for most of its history Mr Price management had to endure analysts’ complaints about its lazy balance sheet. 

(Currency was unable to contact Cohen for a comment on a deal that will see a lazy balance sheet of R3bn cash end up with debt of R4bn.) 

Benefit of the doubt

Alec Abraham, senior equity analyst at Sasfin, appears to be the only analyst prepared to give Mr Price management the benefit of the doubt on the basis of their track record rather than the sector. 

However, he agrees that on the currently known information and financials, it doesn’t look attractive. “Mark [Blair] insists it’s the information not yet disclosed that makes it so enticing.” What Abraham is keen to know is whether Mr Price found NKD or whether its private equity owners found Mr Price. 

Benguela has now appealed to the Financial Services Tribunal. If this is unsuccessful there’s not much else shareholders can do to protect themselves from another potentially value-destroying deal.  

Companies, after all, are ultimately controlled by their boards of directors, who are in turn responsible for appointing management.  

If at least 10% of the shareholders get together, they could call for a meeting and, if they can secure at least 50% of the votes, they can fire the directors.  But that’s a long, drawn-out and inevitably fractious process. And it’s  too late for the NKD deal.

It may or may not be complicated by the fact that apart from the Public Investment Corporation, with 17.6%, Ninety One with 14% and (as of yesterday) Allan Gray with 10%, the shareholding is quite scattered. 

There’s not even much shareholders can do to ensure the group’s remuneration policy doesn’t provide for generous bonuses before there’s any sign of contribution from NKD. Votes on remuneration are merely advisory. 

Still, it’s worth noting Benguela’s point on the duty of care and skill required of a director. 

“We remind the board that under Section 77(2) [of the Companies Act], directors may be held personally liable for any loss, damages, or costs sustained by the company as a consequence of breaching these duties.” 

The only other option: sell the shares. 

ALSO READ:

• Mr Price faces shareholder revolt over R9.6bn NKD purchase
• Dreadful déjà vu as Mr Price goes large
• The trouble with Truworths

_{Top image: Mr Price CEO Mark Blair and chair Nigel Payne. Picture: mrpricegroup.com.}