Steinhoff debacle raises questions of governance
Dieketseng Maleke and Philippa Larkin
The stark lesson corporate SA Inc must take to heart as the once mighty behemoth Steinhoff International reaches its end of days it that corporate governance failures can be fatal.
Steinhoff announced this week that its shareholders had supported its proposal to dissolve and delist the company from the JSE and Frankfurt stock exchange.
The furniture retailer, which in 2017 was valued at $22 billion (R393bn), and ranked in the Top 40 most valuable public companies on the JSE, made headlines in 2017 for accounting fraud in what is said to be South Africa’s biggest corporate fraud.
Steinhoff owns 44.5% of Pepkor and 75% of European discount retailer Pepco and stakes in US Mattress Firm and Greenlit brands, an Australian furniture seller. The group’s debts exceed its assets by €3.5 billion (R68bn).
In March 2019, Steinhoff released the summary findings of the independent forensic investigation. The investigation had found that Steinhoff had recorded fictious transactions amounting to $7.4bn over the period from 2009 to 2017, according to Wharton Forensic Lab based in the University of Pennsylvania, which conducted a forensic report on Steinhoff.
The investigation noted that a small group of senior management recorded fake transactions with “entities purported to be independent third parties to create the illusion of income used to hide losses at the company’s operating units.
The $7.4bn figure represented 7% and 85% of the Steinhoff’s cumulative revenue and operating income over the period.
In aggregate, from August 2017 to March 2019, Steinhoff lost 97%, or $21bn of its market value as investors reacted to the news.
Its executives are currently facing criminal charges.
In the fallout, Steinhoff, which has struggled with debt after facing litigation and repaying creditors, will be given a three-year debt repayment holiday due to its delisting, which comes after creditors approved a proposed debt restructuring plan in May.
The big question that the Steinhoff International debacle raises is whether the corporate governance requirement for having non-executive and independent directors to exercise oversight of management is a mere fig leaf; something that gives us a false sense of comfort, according to Ansie Ramalho, the chairperson of the King Committee .
Ramalho said on Friday that it was true that the Steinhoff matter was particularly complicated and, therefore, perhaps an outlier, but lessons needed to be learned to do better going forward.
“One of the big red flags was the culture of seemingly unconditional deference to the views and opinions of the former CEO (Markus Jooste).
“By all accounts the same culture existed at African Bank as well as at Tongaat, the other unfortunate examples of corporate failures in South Africa,” Ramalho said.
She said a healthy culture allowed for questions, debate and constructive dissent prevented a situation where a company was run based on one person’s judgment, which was (as is the case with all human beings) at best, fallible, and at worst, might be driven by greed.
“Professional scepticism is an essential attribute for non-executive directors if management and particularly CEOs are to be held truly accountable as intended by governance prescriptions. Professional scepticism is something that should be consciously and intentionally cultivated by non-executive directors because it is all too easy to go with the flow instead,” she said.
Wharton Forensic Lab's report said former CEO, Jooste, had held the role for nearly 20 years and in addition to being one of South Africa’s wealthiest people, was considered a “charismatic” leader and a “retail star". At Steinhoff’s peak in April 2016, Jooste held approximately $400m (R7 billion) worth of Steinhoff stock.
“While Steinhoff’s board of directors contained seven directors that appeared to be legally independent, many of Steinhoff’s board members held close ties to Jooste or were involved in related parties of the company.
“In an interview in 2017, Jooste described Steinhoff’s board as ‘a club of friendship and trust’ and had also been reported to say that 10 of his fellow executives were his best friends,” the forensic report found.
The report said further, management’s compensation was structured as an all-or-nothing rather than a scaled model, with long-term targets based on earnings growth, cash generation, and return on capital.
“The cash generation metric focused on operating cash flow only and therefore did not consider the impact of non-operating cash flows like debt or capital expenditures,” it said.
Shareholder activist Harry Smit this week commenting on the delisting of Steinhoff, said: “It is a pity.”
He said shareholders must keep a finger on the pulse of companies, attend annual general meetings, and be involved in all company resolutions.
“They must know what they are voting on because that is when red flags on company irregularities show. It is not enough for shareholders to sit back and think that big institutions, such as PSG and Investec, will screen resolutions and find errors in audited statements. It is often the little guy that picks up on issues,” he said.
Smit said: “When we see companies fighting back against share activists like myself, Albie Cilliers, and other shareholder activists, this raises the biggest red flags of all.”
Meanwhile, On Social Media analyst Martin Rodgers said the only people who benefited from Steinhof's downfall were the management and lawyers.
“The only ones to benefit from this drawn-out death are the advisors and lawyers, $495m since late 2017, plus the management of the company, they still received their pay.”
History of Steinhoff
In 1964, Bruno Steinhoff founded the Company as a low-cost furniture distributor that bought cheap furniture in East Germany to resell in the relatively more affluent West Germany, according to Wharton Forensic Lab.
Over the decade following its founding, Steinhoff expanded its procurement radius by sourcing in countries such as Bulgaria, Romania, Russia, and Czechoslovakia.3 In the 1970s, Steinhoff began producing its own furniture, a move that further accelerated in 1989, after the fall of the Iron Curtain provided Steinhoff the opportunity to buy East Germany upholstery and bedding factories at very favourable prices.
Steinhoff also expanded into South Africa, and in 1998, Steinhoff began trading on the Johannesburg Stock Exchange.
After subsequently building additional manufacturing and distribution capacity, Steinhoff turned to acquisitions and other investments to integrate retail into its business model. The Company pushed into new geographies, spanning 32 countries by 2016, and added new business lines, including apparel, consumer electronics, variety retailing, consumer finance, and industrial businesses.
Additionally, in 2015, the Company became listed in Germany on the Frankfurt Stock Exchange, becoming the year’s largest offshore listing.
BUSINESS REPORT