42 finweek 15 August 2019 http://www.fin24.com/finweek
of debt and a high level of debt-servicing costs will lead
to a magnifying effect on the decrease of the net profit
of the company.
“Debt always magnifies the financial performance
of a company,” Verster says. Where a company
disappoints the market, the existence of debt would
lead to a larger disappointment on the bottom line. If
this disappointment is large enough and the level
of debt is high enough, it can even lead to the
possibility of a rights issue, he says.
“In those cases, we see a significant
tanking of the share price because
there is an expectation that the
current shareholders will be diluted
if the company is forced to raise
capital,” says Verster.
In many instances, companies
source debt funding to acquire other
businesses. Growth driven through
acquisitions should also be viewed
with circumspection.
“I have been in financial markets for
more than 20 years and there are seldom
‘good’ acquisitions,” says Beelders. “The
few ‘good’ acquisitions that I have seen have
generally been of companies that no one else
wants and hence a low price was paid for them.”
Verster has a similar view. When analysing historic
mergers and acquisitions, one will find that most
of these transactions didn’t “really” add value to
shareholders, he says.
“They lead to a destruction of value because the
acquirer usually overpays.”
Many acquisitions are justified on the basis that they
will create “synergy”, where duplicated expenses are
eradicated in a merged entity. The aim is to cut costs
and bring about better profitability than when the two
entities operated separately, says Verster.
“The problem is that in concluding the acquisition, the
acquirer pays a premium and usually pays away all the
benefits that would accrue to the combined entity on day
one,” says Verster.Management
When investors lose confidence, or sharply downgrade
their expectations of a company’s management, the
share price is bound to follow. Once-off events such as
a company’s CEO or finance chief leaving also raise red
flags, says Beelders. He also mentions companies where
the board of directors is dominated by a single person,
particularly when that person “built the company” and
has filled the board positions.
In addition, investors should be on the lookout
for accounting policy changes and particularly those
associated with the capitalisation of expenses anddepreciation and amortisation, he says.
Changes in how corporate information, such as
financial statements, is presented to investors should
also be viewed with suspicion. “For example, does the
management team often change the various reporting
segments? If so, it is generally a bad sign,” says Beelders.
When a share price slumps, the company should
address the handling of the events that led to
it. In extreme cases of share price declines,
company boards ask the stock exchange to
suspend trading in its shares. But is this
a correct approach?
“The damage has generally been
done and my sense is that the best
way to address it is to speak to the
market and tell them exactly what
you know,” says Beelders.
A sharp movement in a share
price, whether up or down, is in
itself not a legitimate justification
for suspending trading in the share,
says Verster.
There is, however, one legitimate
reason to suspend trading. “The only
objectively justifiable reason for suspension
of trading in a share is when important non-
public information is available to some in the market
but not all participants in the market have access to it,”
Verster says.
When a company realises that only some participants
in the market have access to such information, whether
positive or negative, it has a legitimate reason to suspend
trading in its shares, he says.
Tongaat suspended trading in its shares in June
amid the finalisation of a restructuring of the company’s
operations and debt.
“The decision to request the share suspension was
due to the board’s concern that while our comprehensive
review is underway there was insufficient information
to enable investors to make informed decisions,” says
Michelle Jean-Louis, a spokesperson for Tongaat.
Effective communication in such cases is crucial,
according to Beelders.
“If the management team has stuffed up, the sooner
they are fired and a reputable team is put in place, the
better,” he says.
That is what Tongaat did by appointing a new CEO,
Gavin Hudson, in February as well as gaining a new chief
financial officer, Rob Aitken, in March.
The more a company engages with its investors, the
better their expectations are managed. And the best
advice to manage expectations lies in communication.
“I would, until the matter is resolved, over-communicate
with the market,” Beelders says. ■
[email protected]What is the
DuPont model?
The DuPont model of breaking down the different
drivers of return on equity consists of an analysis of a
company’s operating efficiency, asset-use efficiency and
financial leverage, according to an article published in the
US-based scholarly journal The Accounting Review.
A company’s after-tax profit divided by revenue
represents its operating efficiency. The asset turnover ratio
is used to represent a company’s asset-use efficiency. It is
calculated as total sales divided by half the difference
between the opening and closing assets of a com-
pany. Financial leverage is calculated by
dividing a company’s average assets
by its average equity. ■cover story stocks
“I have been in
financial markets for
more than20
years and there
are seldom ‘good’
acquisitions.”