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Investment Views

With public sector corruption front of mind, we often overlook the failings of private sector

10 May 2019
Author: Nazmeera MoolaHead of SA Investments

 

While South Africa geared up for the 2019 election, the malfeasance of politicians took centre stage. Most of this centered around individuals in or linked to the governing ANC party, but there were instances that involved the leadership of the EFF too. As the various commissions of enquiry carried out their work, the startling details of the bare-faced theft perpetuated by these individuals has been quite sickening to witness.

However, while the public-sector sleaze is front of mind, the failings of the private sector in South Africa are often forgotten. In 2015, South Africa was ranked 10th in the world for Protecting Minority Investors in the World Bank’s Doing Business survey. In 2019, the ranking had slipped to 23rd.

In the interim there were a host of corporate scandals in South Africa. I’d divide this into four broad categories.

  • Firstly, those companies that aided state corruption – KPMG and McKinsey are the most well-known culprits here. However, the list grows quickly (SAP, Bain, BOSASA...) as there are a host of companies that facilitated public sector corruption in recent years.
  • Secondly, we move onto fraud – the poster child is Steinhoff. The collapse of Steinhoff in December 2017 negatively impacted local savings – by at least R180bn if we only count the proportion of the company owned by South Africans.
  • Thirdly, we have the aggressive interpretation of accounting standards and financial mis-management – in this category we have African Bank, Tongaat, Resilient and Aspen. While category three may not always be illegal, the decisions taken to boost shareholder value in the short term almost always end up destroying shareholder value over the long term.
  • Finally, there are governance issues that do not directly impact financial performance in the short term, but which have long-term ramifications. This is my catch-all category that includes a range of examples. For example, poor mine safety may boost profits in the short term by reducing running costs, but the long-term damage to revenues due to shut-downs and potential loss of life is large. I’d also lump Shoprite’s decision to (over)pay Christo Wiese for his voting shares (which have no economic rights to Shoprite) while retaining him as chair would also fall into this category. Shoprite’s two-class share structure was created almost 20 years ago. Through a rather non-transparent process, management have arrived at a valuation that seems over-generous at best.

After several years of poor JSE returns – which climaxed in the sell-off late last year – investors have become increasingly focused on governance. The biggest contributor to the underperformance is the woeful shape of the South African economy. If the economy is not growing, it is very difficult for companies to grow.

However, the deterioration in governance at corporates has compounded the problem. This has most greatly impacted the individual companies concerned. However, the erosion of investor trust has resulted in the overall South African equity market de-rating as a result. Until the Steinhoff debacle, most local and international investors thought that South African corporate governance was world-class. The King Codes were held up as evidence of best practice.

Following a very bleak 2018, equity markets have recovered nicely in 2019. Despite the weak economic climate, the JSE produced a 12-month compound annual growth rate of 9.4% in the three years to April 2019. However, the MSCI South Africa index has become cheaper over the same period – from an average forward PE of 13.5x to a current average of 11x. The emerging market composite forward PE is broadly flat over the same period. South Africa has de-rated – and a good portion of the reason is the much higher level of governance concerns. Unfortunately, governance codes are only as good as the people implementing them. Steinhoff and Eskom have shown us that governance box-ticking can be met superficially, without any supporting foundation. Fortunately, the private sector is quicker to punish underperformers. Tongaat has new management. African Bank went into curatorship. Resilient has started to address the market’s concerns. Steinhoff has gone bankrupt. McKinsey has repaid some of the hefty fees it charged Eskom.

I fervently hope that this week’s election leads to cleaner government in South Africa. This should boost confidence and ultimately growth. For South African savers, we also need to see cleaner business – with all four of the areas I listed earlier being addressed.

This article was originally published in the Daily Maverick.

Nazmeera Moola
Nazmeera Moola Head of SA Investments

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