FUND EXPOSURE TO STEINHOFF SECURITIES

Transcription

1 FUND EXPOSURE TO STEINHOFF SECURITIES Update from Nedgroup Investments on the Steinhoff positions held within Portfolios Introduction During the week commencing 4th December 2017, the share price of Steinhoff International Holdings NV has come under intense pressure and fallen from a closing price on Friday 1st December of R55,60 to its current level around R10,00 at close on December 7th. This translates into a fall of 82%. In addition, the prices of the primary equity listing in Frankfurt and the Euro-denominated bonds have also reacted negatively to recent announcements. Why has the Steinhoff share price fallen by so much? On 4th December 2017, Steinhoff issued a statement regarding their 2017 Results and audit process. This announcement conveyed a message of uncertainty as it stated that 2017 consolidated financial statements would be released on 6th December in an unaudited form. It went further to state that the Board and Auditors had not been able to finalise their review of certain matters initially raised by the criminal and tax investigation in Germany. Despite stating that no additional information initiated a change to the previous views expressed regarding the investigation. Late on Tuesday December 5th, Steinhoff announced an investigation into accounting irregularities and the resignation of CEO, Markus Jooste, with immediate effect. In Wednesday morning s statement, the board announced that new information had surfaced relating to accounting irregularities requiring further investigation and they had approached PwC to perform an independent investigation. Further, the statement went on to announce that audited 2017 consolidated financial statements are to be delayed and there would be a review of prior years financial statements. Nedgroup Investments Fund Exposure A number of Nedgroup Investments Funds hold exposure to Steinhoff issued securities, (see tables 1 & 2 below) and these positions are in place following significant fundamental research into the company over many years. In addition, the Best of Breed TM approach applied across our funds means that many experienced investment professionals, from a diverse group of underlying asset managers, have assessed the company as an attractive investment. Later in this note, I will summarise the views and positioning of each of our asset manager partners. Table 1: Nedgroup Investments Funds exposure to Steinhoff ZAR and EUR bonds and SA listed Preference Shares. Portfolio Description Steinhoff % Portfolio 01/12 Steinhoff % Portfolio 06/12 Nedgroup Investments Flexible Income Fund Nedgroup Investments Opportunity Fund

2 Table 2: Nedgroup Investments Funds exposure to Steinhoff International (SNH) JSE listed equity. Fund Name SNH % Holding 01/12 SNH % Holding 06/12 Nedgroup Investments Rainmaker A Nedgroup Investments Growth R Nedgroup Investments Value R Nedgroup Investments Private Wealth Equity A Nedgroup Investments Balanced A Nedgroup Investments Managed R Nedgroup Investments Core Accelerated B Nedgroup Investments Core Diversified B Nedgroup Investments Opportunity A Nedgroup Investments Stable A Nedgroup Investments Core Guarded B Source: Nedgroup Investments Performance Comment Disappointingly this has directly resulted in a drop in the price of each fund holding any Steinhoff securities. Please refer to Table 3, for the impact on the prices for affected funds since December 1st. Table 3: Nedgroup Investments fund price impact Dec 1st to Dec 7th. Total Return from 2017/12/01 to 2017/12/07 Fund Name Return Nedgroup Investments Rainmaker A Nedgroup Investments Growth R Nedgroup Investments Value R Nedgroup Investments Private Wealth Equity A Nedgroup Investments Balanced A Nedgroup Investments Managed R Nedgroup Investments Core Accelerated B Nedgroup Investments Core Diversified B Nedgroup Investments Opportunity A Nedgroup Investments Stable A Nedgroup Investments Core Guarded B Nedgroup Investments Flexible Income Fund A Source: Morningstar

3 This can be understandably concerning for a number of fund holders and it is now that we need to reiterate the patience required when following a long term investment objective whilst investing in risky assets. The prices above predominantly reflect a change in share price for a single holding and do not necessarily correspond to the underlying value of the earnings, cash flow and/or assets within Steinhoff International. It is argued in a few comments from our asset managers below, that this plunge in share price is an overreaction to disturbing corporate news and perhaps not fully justified. The JSE All Share index and all ASISA peer group of funds are also showing a negative impact, as a huge number of professional investors have been convinced of the investment case for Steinhoff, through many hours of fundamental analysis. The relative performance of the Nedgroup Investments Funds over the short period outlined above is very disappointing and we are working hard to ensure as much of this fall is regained as quickly as possible. Concluding Comments The investment team at Nedgroup Investments have spent the past two days analysing the information available in the market and engaging with each of the asset managers responsible for the funds listed above. We have received a variety of responses and I have provided a summary for each fund below. More detailed notes from the managers are available upon request. Following events such as the past week, we are eager to draw attention to four of our core principles when it comes to investment. It is important to invest with Appropriate Investment Horizons and staying the course leads to a higher probability that markets reflect your expectations. Manage risk by aptly spreading your exposure across independent holdings, utilising the benefit of Prudent Diversification. We are keenly aware that we are managing Other People s Money. Hence, sound stewardship principles and transparent communication, such as this statement, help us to actively positioning investors interests first to help clients meet their goals. Portfolio Management Matters and excellence in portfolio management is distinct from the ability to find good investments. Reaction to such extreme events must maintain the focus on a strategy s objective and timeframe. Thank you for trusting us to manage your investments and please contact us if you have further questions and would like to discuss recent events or our positioning further. Kind regards, Robin Johnson Head of Investment, Best of Breed

4 FUND ASSET MANAGER S CURRENT POSITION Nedgroup Investments Opportunity Fund and Rainmaker Fund Abax Investments Our shareholding in Steinhoff was premised on: 1. Attractive Valuation, with Steinhoff trading at a 30% discount to European discount retail peers. 2. Strong earnings growth forecast from their Eastern European, United Kingdom and South African Retail assets. With the potential for turnaround with Mattress firm in the US 3. Management strength, now discounting Markus Jooste, there are several highly experienced, respected and competent business leaders in management and on the board. After publication of an article on Steinhoff in Manager Magazin in Germany (in August 2017), concerns arose around a dispute Steinhoff had with a former JV partner. Through independent research we learnt that the individual concerned is by nature an aggressive litigant and we engaged an independent legal firm in Germany to advise us on the veracity of the claims and evidence. In addition, due to management being implicated in the article, we engaged with one of the non-executive directors on the supervisory board and this gave us much comfort. On the equity position in the Nedgroup Investments Opportunity Fund, we had a protection structure in place. This protected the first 10% fall in price, but was ineffective due to the magnitude of the fall and the Fund shared in the full downside below the floor of the hedge. There were no structures in place on the Nedgroup Investments Rainmaker Fund which hence incurred the full drop in the Steinhoff equity price. Within the Nedgroup Investments Opportunity Fund the Steinhoff fixed income holding is a ZAR locally listed bond with 2 years until maturity and the offshore EUR convertible bond, which has an average maturity of just below 5 years. It is possible to sell the convertible bond back to Steinhoff at par in January 2019 and the credit risk associated with this bond is therefore lower. In summary: While very little further information has emerged, we would expect the accounting irregularities to have occurred in their European operations only. With the uncertainty surrounding the outcome of the investigation, it is extremely difficult to establish what the true fundamental value is for Steinhoff. Our current view, based on a sum of the parts calculation following recent market changes and assuming a negative impact from unrecoverable assets (Steinhoff est. 6bn), is a price per share value of R Although appearing extremely cheap, at this juncture we will not be increasing our allocation to Steinhoff equity or bonds, until certainty emerges around the extent of the irregularities and potential liabilities. We would like to assure clients that the position will continue to receive our investment team s closest attention.

5 Nedgroup Investments Growth Fund Electus At Electus, we suspect that it may ultimately transpire that there has been accounting and tax related fraud at Steinhoff, and there have been indications of these possibilities due to recent German and Dutch investigations. It is concerning that Steinhoff s main auditor, Deloitte, is not also the auditor of all of Steinhoff s underlying investments and operations. We acknowledge that Steinhoff has some very good investments such as STAR, Pep (Europe), PSG and KAP, which might underpin the Steinhoff valuation. I understand that this is the reason why many good investors would now want to hold onto their Steinhoff shares, rather than realise a big permanent loss. However, based on the above risks, and especially as we have no reliable or accurate financial statements for Steinhoff, based on our risk-management, we will not look to hold any Steinhoff shares in the Growth Fund, at least until there are audited financial results and the conclusion of PWC s independent investigation. The Growth Fund had a weighting of 2.9% in Steinhoff at end November From a risk management perspective, given concerns outlined above, we ensured that Steinhoff was not in the Top 10 shares in the Growth Fund. On Monday 4th December, following the announcement that Steinhoff would not have audited results published on Wednesday 6th December, we sold a third of the Steinhoff shares at ±5200cps. On Tuesday 5th December, as a further de-risking measure, we sold half of the remaining Steinhoff shares at a price of ±4800cps. When Steinhoff announced the indefinite delay of their results on December 6th, due to clear historic accounting errors, and the Steinhoff CEO s resignation, we sold the balance of the Steinhoff shares to zero. At closing price on Tuesday 6th December, had a weighting of <1% of the total Growth Fund. The above is very disappointing, especially given the concerns we had surrounding Steinhoff, but at least we took strong action this week, saving the Growth Fund from a much larger loss. Nedgroup Investments Value Fund and Stable Fund Foord Our investment thesis on why we own Steinhoff shares on behalf of investors is premised on fundamental analysis of the company s financial statements and judgement of its future economic prospects, to determine a fair market value range. This process focuses on the publicly available facts rather than market speculation. In executing this mandate, Foord places material reliance on the accuracy of audited, published financial statements. Foord holds no inside information. Steinhoff s strategy was to consolidate and then dominate fragmented sectors of the global retail market. The audited financial statements reveal that the balance sheet was geared at acceptable levels and management took sufficient care to structure the company s debt to mitigate liquidity risks. The allegations of potential historical reporting irregularities are not new and have been refuted by management. As part of our due diligence work, we have also engaged with a respected non-executive director of the Steinhoff group, who has stated that, to his knowledge, there was no financial misstatement, thereby discrediting the allegations. If, however, the audited financial statements were fraudulently or negligently materially misstated, we will reserve the rights of our investors with respect to any remedy that may be available to stakeholders that have suffered loss. Steinhoff shares are currently trading on innuendo and rumour rather than fact. Until Steinhoff quantifies the maximum exposure and potential restatement impact, Foord will exercise extreme caution on behalf of investors.

6 The Foord investment portfolios are well-diversified across many high-quality companies, many of which are listed abroad. Portfolio losses resulting from the significant downward price movement on Steinhoff shares are well contained. Nedgroup Investments Balanced Fund and Managed Fund Truffle Asset Management As a reminder, our investment team follows a fundamental valuation-based philosophy and disciplined investment process, coupled with a rigorous risk management approach that results in a well-diversified, risk-adjusted portfolio. Diversification generates superior risk-adjusted returns for investors by reducing overall portfolio risk. We do have an over-weight position in Steinhoff, but this is in line with our accepted risk process and approved portfolio construction process. The resignation of the CEO Markus Jooste, with a simultaneous announcement of an independent investigation into accounting irregularities by PWC, has significantly changed the risks and return associated with our original Steinhoff investment case: 1. While we have been aware of ongoing litigation involving Steinhoff, the severity of the statement and delay of the audited financial statements surprised us. 2. As custodians of our clients capital, we have been engaging with company management to improve its corporate governance and general disclosure. We expected, based on our discussion, that we would see a significant improvement at the results presentation. 3. From a valuation perspective the current share price would represent less than the value of Steinhoff s listed assets. 4. Even after deducting the group net debt of R23 a share, the current share price would imply that the rest of the Steinhoff assets, (European property, and European, UK, US, and Australian retail assets) appear exceedingly cheap. 5. Given the net debt in the business, Steinhoff s debt funders could be under pressure to minimise their exposure. We have taken the decision to hold our current position at this price level, but are evaluating this on a continuous basis. Nedgroup Investments Flexible Income Fund Abax Investments The majority of our Steinhoff holding is in two locally listed bonds which have just over 2 years to go until maturity. There is also an additional holding in the offshore convertible bonds which has an average maturity of just below 5 years. We have held Steinhoff for a number of years in both the local and offshore space, based on the following assessment of the company. In recent years the business had evolved and grown to a company with over R400bn in enterprise value. The increase in size and diversification, combined with an improvement in debt ratios, led us to believe that the credit quality had improved and the BBB- international credit rating was justified. 1. Integration of PEP/Shoprite and the listing of STAR resulted in large equity injections. 2. Large equity raises through share placements, including a share issue a year ago which raised EUR2.4bn. 3. Debt/equity mix had improved considerably in recent years due to these equity led transactions. The events of the last few days have resulted in Steinhoff debt trading at distressed levels in the offshore market. We are monitoring these developments closely.

7 There are several factors which allow us to positively view the ability of Steinhoff to service and repay its debt: 1. Several listed subsidiaries with an identifiable value of around R70bn. If you add the holding in PEP s European operations at R33bn, the tangible assets provide substantial cover for the R100bn net debt position. 2. Strong incentive for key shareholders, Christo Wiese as chairman and Pieter Erasmus (previous CEO of Pepkor) as an executive advisor, to stabilise the business and ensure that value is realised as a going concern. 3. The board announced steps to release Euro 2bn worth of liquidity in order to fund existing operations while investigations continue. Until results are released and more clarity is obtained regarding the extent of the accounting fraud, there is unlikely to be a recovery in the company s securities. We are therefore taking steps to mark the holdings in our portfolio to market levels in order to treat investors fairly. Steinhoff s SA listed bonds have not traded since the announcement and the JSE price is therefore not an accurate representation of the current trading level. We are therefore using pricing information from the offshore bonds in order to mark our portfolios. This has resulted in a 1.1% negative impact on the portfolio from this position. Our debt is primarily in the 2-year area maturing in 2020, which falls due before the company s large debt maturities from 2021 to We will vigorously engage with the company and stakeholders in order to assert our rights as debt holders and maximise the value of our client s investments. Nedgroup Investments Private Wealth Equity Fund Nedgroup Asset Management At this stage, it is difficult to determine an appropriate fair value for the group, given the uncertainty around the degree to which the group s accounts may have been manipulated and the extent of fines and/or penalties that may still be levied against the group. While we certainly try to minimize capital losses, recent events have highlighted again the benefit of having a diversified portfolio. We place a lot of emphasis on building portfolios that are diversified across sectors and also across asset classes and geographies. We need to emphasize that the impact of the accounting irregularities are unknown at this stage, and the valuation of Steinhoff could materially change as a result. However, using the latest disclosed information, we have adjusted our previous carrying values for Steinhoff International s operating subsidiaries. We have not made any allowances yet for potential fines or back taxes, which are possible and could detract further. At the time of writing, we estimate the group s portfolio of listed assets (including equity stakes in STAR, PSG and Kap) to be worth c.r16/share. A sizable property portfolio, which should be worth at least c.r12/share. We think Pepco should be worth a further R5/share at a minimum and other assets to add approximately R18/share. We estimate net debt for the group to amount to c.r16/share at present (FY17E). This leads to a Sum of the Parts calculation of R35/share, but the breakdown above is for informational purposes only and is subject to change. Dr. Christo Wiese will be taking over as Executive Chairman and former Pepkor CEO Pieter Erasmus will be returning to the group, which we view as a very positive development, given his excellent track record and strong standing among peers. However, we recognise that it will take time for management to address the various issues and regain the market s trust. Based on our view around the potential intrinsic value for the stock, we will be holding onto our position for the time being, while continuing to review our assumptions and waiting for the review from the auditors to assess the situation. Share price volatility is likely to continue until some clarity emerges from the independent review. There clearly is significant uncertainty, but we do not think selling out at this stage without any facts is the right course of action.

8 Nedgroup Investments Core Guarded Fund, Core Diversified Fund and Core Accelerated Fund Taquanta Asset Management Due to the rules-based replication strategy of the equity portion of the Nedgroup Investments Core range of funds, Steinhoff International JSE listed equity is held across the portfolios. This has had the resulting impact on recent performance as detailed above. Following the share price fall on Wednesday 6th December, the Steinhoff holdings are now relatively small (under 0.5%) in all three funds and so any further declines will have a smaller negative impact on future performance. We can confirm that none of these funds have any exposure to fixed income securities issued by the Steinhoff Group. Taquanta s credit process resulted in an active decision not to include Steinhoff debt in these funds. This was primarily due to the volume, scale and complexity of acquisitions and restructuring undertaken in a relatively short period, across multiple jurisdictions, without the necessary lapse of time in order to judge the success, or otherwise, of such relatively aggressive corporate actions.