Issue: June/August 09
Editorials

THE BIG ISSUE

Roberts...listen to Pinelands pining

Roberts...listen to Pinelands pining

Old Mutt on a tight leash

Benefits of demutalisation are squandered by a failed offshore strategy. Old Mutual’s board has a lot to answer for. Control of SA’s largest financial-services group should be brought back to SA where OMSA sparkles in OML’s tarnished crown.


MORE TO THAN FRO

This article, by TT editorial director Allan Greenblo, originally appeared in Business Report on April 16. Roberts and OML declined invitations to respond.

OML was then advised that it would be requested at the OML agm, in London on May 7, to respond to each of the 11

propositions identified in the article by distinctive type. The request was then made formally in a shareholder capacity.

Various communications did take place. From the following pages of this TT edition, readers can decide for themselves whether they adequately addressed the issues raised.

Julian Roberts, chief executive of Old Mutual Plc (OML), is invited to challenge the following propositions before next month’s annual general meeting of shareholders:

  • There has been huge destruction of shareholder value. This is evidenced by the fall in its share price (at its worst, by some 70% in 52 weeks, on announcement in early March of the OML results for the year to end-December 2008); the share’s underperformance against major indices, including the FTSE 100, and against peers Sanlam and Liberty on the JSE; the steep discount at which its bonds are traded, and the passing of its dividend (see box).
  • The destruction has been caused by OML’s over-ambitious international strategy. The share and bond markets are saying precisely this. Roberts is implicitly saying so too, or OML wouldn’t now be embarking on what he describes as a “simplification” of its businesses outside SA. Integral to “simplification” is the scaling down and closure, where it can, of those businesses. Over recent years, they have expunged substantial capital.
  • The pillars of OML are its operations in SA. These are wholly-owned Old Mutual South Africa (OMSA), 55%-owned Nedbank and 74%-owned short-term insurer Mutual & Federal (M&F). Together in 2008, they respectively contributed adjusted pre-tax operating profits of R7,9 billion, R5,3 billion and R872 million.

This roughly equates 940 million, whereas the OML adjusted operating profit (pre-tax and net of minority interests) was 727 million. In other words, the profits from SA sustain and overshadow the profits of the OML group. Put differently, OML without SA would have produced a loss.

  • Maximum value must be extracted from OMSA by OML to support its disastrous US Life business. OML has little alternative because US Life is not sufficiently large, like insurer American International Group, to be rescued from failure by a US government bailout. So it must gamble on the timing of a sustained market recovery. Only when policies of US Life and Bermuda (US Life offshore) mature can the size of the “black hole”, filled during the past year by a 314 million (R4,27 billion) injection into US Life, be finally determined.

Until then, the unprofitable businesses are fed from capital reserves and subsidised by profitable businesses. At the behest of OML, OMSA has already delivered R1 billion in “savings” and OML is looking for more. Thus does OML rely primarily on OMSA to top up its resources.

This might impact adversely on OMSA’s competitiveness. But it’s uncertain whether the SA regulator, treasury and exchange-control authorities will allow transfers abroad of cash dividends from OMSA to OML in amounts that might be required.

  • To list OMSA separately on the JSE is not a solution for OML. It would entail the entry to OMSA of SA minority shareholders and the formation of an SA board obliged to advance the interests of all OMSA shareholders, no longer being OML alone. Although OML would presumably enjoy a once-off bonanza as the vendor of shares, its future dividend flow (capable of remittance abroad) will reduce.
  • On the other hand, a JSE listing for OMSA is a solution for OMSA. It will relegate OML from the shareholder to a shareholder. Even as controlling shareholder, the influence of OML will be restricted by the responsibility of the OMSA board being to OMSA only.
STILL AS SA AS CAN BE

Dividend policy, for instance, will be defined in the interests of all OMSA shareholders. Management remuneration will be reflected in bonuses which relate to the OMSA and not the OML share price.

Critically, also, it might well be the means to salvage the OMSA black empowerment consortia. These empowerment schemes are deeply underwater and the more likely to drown because the OML passing of its dividend negates their ability to service debt from a dividend.

  • The control of OMSA by South Africans could resolve other paradoxes. Prior to demutualisation, Old Mutual was owned by its policyholders who included many thousands of black individuals. Subsequent to demutualisation, ownership passed to OML offshore. Thus was black empowerment mitigated.

Moreover, the economic interest of local shareholders has been diluted by OMSA dividends going not to them but to the OML shareholder abroad, where they’ve been dissipated. The question, then, is whether OMSA can again become owned by shareholders representative of its client base.

  • The cost of the OML head office is unjustifiable. So far as can be gleaned from OML presentations, the cost over the past two years has been at least 72 million. Translated at R13,60/1, it comes to almost R1bn. Add to it the 2008 directors’ emoluments of 4,55 million (R61,9 million), for two executive and two former executive directors as well as eight non-executive directors and one former non-executive director.

It might be asked where or how value has been commensurate with cost. There is surely little handled by the OML head office in London that can’t be handled, at significantly lower cost, within the existing infrastructure of the OMSA head office in Cape Town.

Will any shareholders take the initiative to propose resolutions of their own, or will it be another ritualistic agm where they perhaps go no further than voting against resolutions that the board is formally obliged to put before them?

  • The OML board should be restructured. Of its 10 directors, including the non-executive chairman, only two are South African. Both executive directors are non-South African. This is an imbalance because, 10 years after its London listing intended to pursue acquisitions abroad, the OML group remains reliant for its profits on SA.

The preponderance of non-South African directors belies this reliance. The international strategy has been turned on its head from pursuit of acquisitions to conservation of capital and liquidity. Yet a board, collectively responsible for abortive acquisitions, remains in place to make the best of them.

  • The failed international strategy is being reversed. OML is selling out of Australia, exiting Portugal, “significantly” scaling back in the Far East where the Hong Kong office is being shut, and closing Bermuda to new business.

As ongoing operations, it isn’t obvious why Skandia in Europe and asset management in the US aren’t self-standing, i.e. why they’re any better served by OML direction. The original rationale for the group being ruled from London has collapsed.

  • It follows that control of Old Mutual be returned to SA. Once this principle is accepted, the rest – what happens with the London listing, how SA can be separated from the businesses it subsidises, whether or when remaining offshore operations should be sold – become matters of detail. On the face of it, there’s nothing that can be done more cost effectively or efficiently in London than Cape Town. The retention of OML now requires as much justification as the arguments which led to its establishment in the first place.

The public forum for shareholder concerns to be addressed is the annual general meeting. Assume that there are shareholders sufficiently concerned about OML that next month they attend its agm to express their feelings. But how does it go beyond feelings? Will any shareholders take the initiative to propose resolutions of their own, or will it be another ritualistic agm where they perhaps go no further than voting against resolutions that the board is formally obliged to put before them? How will votes influence the board?

Under the circumstances, it’s hardly conceivable that there aren’t significant OML shareholders with serious concerns. Although they may privately engage with the board, and can say what they want at the agm, there might be constraints on them cooperating with one another to agree and effect the changes they consider necessary.

For attempts to change the board, a precedent was possibly established by the Securities Regulation Panel (SRP) in its December 2003 ruling on JSE-listed Comparex. Having banded together, various institutional asset managers kicked out the board in which they’d lost confidence. The Comparex directors were replaced by the institutions’ nominees.

The question before the SRP was whether the institutions, whose combined shareholding exceeded 35%, had acted in concert to take control of Comparex. If they had, they would have been obliged by JSE rules to offer minorities a buyout. Recognising that the institutions represented a range of beneficial shareholders, such as retirement funds, the SRP differentiated between fully-discretionary and partially-discretionary voting mandates from beneficial shareholders.

VOTE OF NO CONFIDENCE

Old Mutual is an icon of South African business. For 164 years, it’s been a trusted brand in financial services. By sheer size, it has led the sector. Its reputation has never previously been threatened by fear of failure. The markets, however, are voting with their feet and their money:

  • By early April the OML share price had recovered, relatively, from its all-time low at under R5. It had fallen over the past year by 57,1% compared with declines of 13,5% for Sanlam and 23,1% for Liberty;
  • Its market capitalisation on the JSE stood at R43,6 billion. Within this figure are the proportions represented by Nedbank (55%-owned) and M&F (74% owned), respectively with market capitalisations of R39,1 billion and R4,2 billion. Deducting these proportions (respectively R21,5 billion and R3,1 billion) leaves the OML market capitalisation at R19 billion compared with R38 billion for the smaller Sanlam. The message is that the OML operations outside SA are priced at a massive negative;
  • Worse is the message from the bond market. The OML offshore bond is trading on a yield of 23%, having earlier been as high as 30%. Such an attractive yield would be a no-brainer for purchase of the bond if (as in days gone by) the prospect of an OML default was unimaginable. Instead, this level of yield reflects the possibility of an OML default. On round numbers, the market’s pricing suggests that investors in the bond will only get back something like $0,60 for every $1 were OML to go bust.
  • OML has passed its dividend. This is not what OMSA policyholders, excited to support demutualisation and become shareholders, might have expected.

On analysis of the respective institutional shareholdings, and their mandates, the SRP ruled that the asset managers had not breached the 35% threshold whereby an “affected transaction” requires an offer to minorities.

“Unless the various beneficial owners (of 35% in the aggregate of a company) act in concert by virtue of an actual agreement, arrangement or understanding, there is no affected transaction,” the SRP stated. “The person who can direct the exercise of the voting rights is the beneficial owner, i.e. the clients of the asset manager. Thus, unless the owner has given a fully discretionary mandate to the asset manager to vote the shares, it is the owner and not the asset manager who votes the shares.”

So the institutional shareholders can put up resolutions and vote in the best interests of their clients, as seen in terms of fully-discretionary mandates, or as directed in terms of partially-discretionary mandates. They can also collude, with an eye to the consequences should collusion cause them effectively to take control from an incumbent board.

So the institutional shareholders can put up resolutions and vote in the best interests of their clients, as seen in terms of fully-discretionary mandates, or as directed in terms of partially-discretionary mandates. They can also collude, with an eye to the consequences should collusion cause them effectively to take control from an incumbent board.

Then, presuming that there will be contentious resolutions, there’s the question of how asset managers in the Old Mutual stable will themselves vote. Consider the numerous unit trusts and retirement funds they administer and manage. Omigsa and Nedbank Nominees are registered shareholders. Obviously, they must exercise independent discretion. To vote against their bosses might not be their smartest career moves, made the more complex if the bosses at Lambeth Hill and Pinelands are singing from different hymn sheets.

The saddest commentary on activism, accountability and sustainability – concepts enshrined in the King code on corporate governance – will be an agm that progresses with the tranquillity of a tea party.