Why Group Five is a watershed for shareholder rights

A special meeting at Group Five has reinforced the notion that boards of directors aren’t used to being told what to do by shareholders. But that may change as previously timid asset managers — who have allowed bad governance to thrive — start to flex their muscles to protect their clients’ investments

Philisiwe Mthethwa, the Group Five chair who resigned along with her board after a spat with the construction company’s 25% shareholder Allan Gray, says she couldn’t wait to walk out the door.

"The atmosphere had just become so poisonous," she told the Financial Mail.

Of course, the politically connected Mthethwa, who is also CEO of the National Empowerment Fund (NEF), didn’t have much choice.

Allan Gray, backed by Coronation (which holds 14.4% of Group Five), said it had "lost confidence" that the company — which built Durban’s Moses Mabhida stadium and parts of the Gauteng e-toll highways — was doing the right thing for investors. Part of the mistrust relates to an offer it got to buy its concessions business from private equity company Ethos earlier this year. But the board never told shareholders about this approach.

This is why Allan Gray took the extraordinary step of demanding a special meeting to replace the board, nominating five new directors. It’s a standoff that promises to form the basis of many MBA studies of shareholder activism in years to come.

This is the first time shareholders have flexed their muscles to axe an entire board. But it follows a spate of other interventions at companies, from Net1 (which led to CEO Serge Belamant leaving), a revolt against sky-high payments for the top brass at Pallinghurst Resources and a board shake-up at ailing cement firm PPC.

But, as was clear from the tense shareholder vote at Group Five’s extraordinary general meeting on Monday, boards of directors aren’t used to being told what to do by their shareholders.

As the meeting began, Mthethwa rounded on Allan Gray, saying that the way it conducted itself was "contrary to what we would expect from a highly respected and responsible fund manager". She said Allan Gray’s demand to dismiss an entire board "in the absence of clear governance failures" was evidence of its "disingenuous" way of cloaking its real agenda: to asset-strip Group Five in the interest of short-term profit.

Mthethwa’s board followed her lead.

Director Justin Chinyanta accused Allan Gray of having a secret agenda, which meant its actions weren’t in "the best interests of the company", but solely aimed at its own goal of making short-term cash.

Willem Louw, another member of Mthethwa’s board, warned shareholders to be wary of "those putting forward poison as medicine". He said Allan Gray’s "lies" had exploded in its face — ostensibly, a reference to Allan Gray’s denials that it wanted Group Five to unbundle assets.

There was nowhere to hide in Group Five’s auditorium for Leonard Krüger, Allan Gray’s sole representative at the meeting. But he stepped up to defend Allan Gray’s honour, saying the firm had "no alternative agenda as you allude to. We simply want what is best for Group Five and for the new board to take this company forward."

Krüger said the accusations were nothing more than "conspiracy theories".

It was one of the most heated shareholder clashes in recent years, made all the more intriguing because Allan Gray’s nominations for directors were, at least partly, opposed by the state-owned Public Investment Corp (PIC) which owns 20.1% of Group Five. (It had other layers of drama too, as the PIC is chaired by Mthethwa’s brother, deputy finance minister Sfiso Buthelezi.)

The PIC nominated two directors of its own, while Mazi Capital nominated another.

Before the meeting, Mthethwa said it was "50/50" whether Allan Gray’s directors would be elected, as she expected other shareholders to step up to "show major asset managers like Allan Gray they can’t just bulldoze decisions through."

That didn’t happen. In the end, all the nominations from Allan Gray, the PIC and Mazi Capital got enough votes to be elected.

But it was tight: Mike Upton (the former Group Five CEO until 2014) scraped onto the board with 61% approval as the PIC vetoed his election. Equally, Allan Gray voted against PIC nominee Cora Fernandez (who got 65% of the vote) and Mazi Capital’s nominee Edward Williams (who got just 57.7%).

After the meeting, Mthethwa, evidently searching for a silver lining, said that at least Group Five’s future will not be "dominated by any one shareholder".

"If any of the major shareholders wanted to unbundle the business and continue asset-stripping" they would now have to get the approval of 75% of shareholders, she said.

Still, the bottom line is Group Five’s shareholders won the day, in spite of stern defiance from the board — a victory for investor activism.

Mthethwa disagrees with this assessment, saying Group Five’s board were never resistant to legitimate shareholder activism.

"We always wanted shareholders to get involved. But what we’re questioning is why [Allan Gray] didn’t interrogate the core performance of the company. That is what was surprising. If it had said to us, the company is not performing well, let’s turn it around for the long-term sustainability [we would accept that], but it didn’t," she told the Financial Mail.

Rather, she said, Allan Gray pushed for a quick-fix unbundling — essentially an asset strip — that wasn’t in the best interests of the company. Allan Gray hotly denies allegations of an asset strip, saying its only goal was to restore confidence in the company and put in place an "independent board".

In part, what makes Group Five such a fascinating case study is that activism doesn’t come naturally to SA’s fund managers.

The prospect of venturing out of a controlled environment, where the variables can’t be knocked into shape through fancy spreadsheet analysis, fills many with dread.

But new demands from asset owners — ordinary South Africans whose pension savings form the basis of the asset manager’s power — have forced institutions like Allan Gray out of their comfort zones.

Chief investment officer Andrew Lapping admits there’s been a step change in the degree of Allan Gray’s activism over the past two years.

"The market moved on, and we did too. The level of seriousness of voting now compared to two years ago is chalk and cheese. But companies have also adapted: a decade ago, you’d never have met chairmen or remuneration committees, now we meet them quite regularly," he says.

Lapping says the Group Five vote illustrates how, until now, company AGMs have largely been a tickbox affair.

"Investment managers don’t often apply their minds to voting," he says. "But shareholders are paying directors to apply their minds for the benefit of the business. These directors must be held to account for what they’re paid. If they’re not delivering, investment managers have a fiduciary duty to do something."

To meet its new demands, Allan Gray has hired someone to scrutinise remuneration reports full-time, and it spends many hours poring over resolutions. "We look at boards. If something happens that we don’t like, we put a mark against the names of all the directors on the board ... if that director sits on another board where something untoward happens, we then vote against him or her as a matter of course," says Lapping.

It seems to be sending a clear message to companies: they will be held accountable. Last week, it emerged that Allan Gray voted against pay packages at 42% of the company AGMs it attended last year.

This displayed a far greater degree of activism than Old Mutual (which voted "against" 33% of the time), Investec (15% against), Stanlib (10% against) and Coronation (just 5.7% against).

The PIC also scored a gold star, voting against pay packages in 57% of the cases. An analysis of the PIC’s voting patterns last year showed that while it voted against pay policies at companies including Shoprite and Investec, it also took on other issues.

At Harmony, the PIC voted against re-electing auditor PwC, which has been the gold miner’s auditors for a staggering 66 years; and at the murky British American Tobacco, the PIC said it had "ethical concerns" about its policy of making political donations as this could be seen as seeking to "incentivise" governments to be lenient on anti-tobacco laws.

Patrice Rassou, head of equities at Sanlam Investment Management (SIM), agrees there has been a new wave of activism, driven partly by the people who invest their pensions with the institutional investors.

"Investment managers are now signatories to the code for responsible investing so they have to act," he says. "But it’s also because clients have a greater consciousness about environmental, social and governance issues and are demanding to know what we’re doing and how we’re voting."

Last year, Futuregrowth (owned by Old Mutual) took an activist stand against profligate state-owned companies, freezing their lending to companies like Eskom. It provoked a furious backlash from government. But in the end Futuregrowth’s Andrew Canter was vindicated, as the true horror of the finances of state-owned firms emerged.

Michael Harber, a lecturer at the University of Cape Town, wrote in a paper last month in the African Review of Economics & Finance that it was "encouraging to see an institution, which stands to lose a lot in the way of client funds and reputation, making a stand on behalf of clients".

Speaking to the Financial Mail, Harber says "the likes of Allan Gray and Coronation are stepping up, partly because the asset owners are now demanding it".

There is another reason for the new surge in activity.

In a sour market, where the JSE all share index has inched up just 5% over the past three years, retirement funds are demanding better investment returns from asset managers. This means those institutions can’t sit back and clock up fees like they used to.

Asief Mohamed, chief investment officer of Aeon Asset Management, says investment firms are "getting involved because they need to protect their returns on a sustainable basis".

"Allan Gray should be commended for what’s happened at Net1 and possibly Group Five," he says. "But it’s got to the stage where the large investment houses are so big, they can’t simply sell out because it has a huge effect on the share price. They’re now forced to get involved."

An example of this was Net1. It seems hard to fathom now, but Allan Gray’s emergence as triumphant shareholder activist at Group Five happens just weeks after it was roasted for not doing enough to halt shady behaviour at Net1, of which it owns 16%.

Claims of Net1 — which scored a dubious and unlawful contract to pay out social grants to 17m South Africans — fleecing poor South Africans were commonplace.

For an institutional owner, Net1 was the stuff of nightmares: a management team gone feral, cut adrift from any thought of responsibility to any stakeholder. But Allan Gray couldn’t simply dump its 16%, as there was so little trade in the stock.

So it was forced to get involved — culminating in Belamant walking the plank (with an immense R260m golden parachute). "Clearly with Net1 we didn’t know what we should have known," Lapping said afterwards.

It’s also become harder for investors to cut and run. In 2014, Coronation dumped its African Bank shares hours before it was put under curatorship. It might have been the right decision for the fund manager, but it prompted a devastating response from the Reserve Bank. As the Net1 example shows, it’s much harder to do this today.

There are implications for executives too. Mohamed says the new wave of activism means boards of directors are having to apply their minds far more than they used to.

"Previously, nongovernmental organisations would go to AGMs and complain about environmental breaches or health issues like silicosis, and boards would simply ignore them. But when shareholders ask these questions, directors wake up," he says.

However, as the Group Five example shows, boards aren’t necessarily going to take intervention in their stride.

Says Mohamed: "I attended the Santam AGM a year ago. The directors were uncomfortable and didn’t answer the questions I had. But I wasn’t telling them how to run their business — I was asking about expanding their supply chain to bring down costs. But they saw it as unwarranted questions."

It was a similar story, Mohamed says, when he questioned Coronation about their remuneration policy at their AGM.

Theo Botha, a long-time activist who has been attending AGMs for 15 years, has also been about as welcome as gum on a shoe at some of those meetings. "I’ve been attacked by Len Konar at JD Group, Danie Cronje at Sage and Koos Bekker at Naspers. Boards say they welcome questions, but not everyone really does," he says.

However, Botha says it’d be a stretch to say shareholder activism has suddenly caught alight. "Sure, Allan Gray has changed — we’ve seen that over the past two years — becoming more astute in their voting," he says. "But in general, far too many asset managers aren’t paying attention. As long as they’re getting dividends and the company is okay, they tolerate bad governance."

On this point, Rassou argues that it’s tricky for an asset owner to stick its head above the parapet, partly because the very act of doing so can damage the stock.

"At the end of the day, we want to preserve our investment. A very public process risks becoming destructive and a company can become dysfunctional. That’s why we prefer to use quiet diplomacy, unlike what you saw in Group Five," he says.

Rassou says SIM has forced companies to make changes to boards, directors’ pay and management. "We had success at Barloworld, which unbundled noncore assets, and our engagements with Old Mutual also culminated in their managed separation of their African and overseas assets. So it does work." This is why he favours a "backroom approach", rather than a public one. "Look at PPC, which was very public. Today, two years after the interventions, the company is in a far worse place than it was before."

PPC is a fascinating case. In 2014, Foord Asset Management decided it had to do something about the resignation of highly rated CEO Ketso Gordhan, and the subsequent plunge in the value of its stock.

Foord called a shareholders’ meeting under section 61 of the Companies Act — exactly as Allan Gray did in the Group Five case — to re-install Gordhan as CEO and eject finance director Tryphosa Ramano.

But the cement firm delayed, obfuscated and wore down Foord for four months.

While Foord’s Daryll Owen argues that his company ensured the PPC board was reconstituted, the sad fact is that only one of its six board nominees were elected.

Gordhan fell by the wayside long before the drama-filled shareholder meeting in January 2015. Ramano remained on the board, as did chairman Bheki Sibiya.

Finally, Foord did what it probably wished it had done four months earlier: it sold its PPC shares. It booked an immense loss into the bargain, as the stock had fallen from R32 when the saga erupted, to R22.

Today, Foord’s decision to sell looks inspired, as PPC’s shares are R4.57 — 85% lower than the day before Gordhan quit. The cement company has realised all Foord’s worst fears. It got worse this week when CEO Darryll Castle resigned with no explanation — worrying signs that the company has little clue about transparency.

But there is a significant reason why the PPC outcome is different from Group Five’s, apart from Allan Gray’s much heftier 25% stake in Group Five.

In the most recent case, Allan Gray made much better use of the Companies Act, never allowing things to stall; as Napoleon learnt in Russia, delays suit the incumbent.

And, significantly, Allan Gray was aided by a proposed amendment to the JSE listing rules which obliges a company to hold a special shareholders’ meeting within a set time. Foord never had that benefit.

The result: Allan Gray now has a Group Five board overwhelmingly to its liking. This should encourage other institutions to rise from their slumber.