What EOH says about corruption and accountability

Corporate collapses on the JSE happen with alarming regularity.

Some companies crumble into worthless heaps. Think Regal Treasury Bank, Tigon, LeisureNet, Tollgate, Blue Financial Services, Macmed and, more recently, Conduit Capital.

The more fortunate get saved at the 11th hour. These include Super Group (courtesy two rights issues), MGX (now Metrofile) and Seardel (now Deneb).

Others get smashed to smithereens, but manage to hang on by their fingernails — including Steinhoff (where liabilities exceed assets by billions of euros), Ascendis, Tongaat Hulett and EOH.

So is it time for an independent authority to step up to prevent more calamitous collapses of listed companies? One authoritative think-tank, the Overseas Development Institute (ODI), reckons such a development is long overdue.

In a new report, “Addressing Corporate Corruption in South Africa: The EOH Experience”, it calls out the regulatory flaws that not only put the JSE at risk, but also the country’s reputation as an investment destination. And it rejects the idea that companies can simply regulate themselves.

This EOH case study, authored by research economist Stephen Gelb, argues that these corporate failures — whether through slack corporate governance, corrupt activities or reckless trading — could have been prevented through better oversight.

Hero to zero

But first, how did EOH end up here? Originally known as Enterprise Outsourcing Holdings, it was founded in the 1990s by  Morocco-born and Israel-raised engineer Asher Bohbot. It listed on the JSE in January 1998, as part of the technology boom, along with a slew of other small caps hoping to cash in on the internet trend.

While many of the other tech stocks fizzled, EOH flew — thanks to a series of acquisitions. These acquisitions, 273 of them by 2018, meant its revenue grew from just R33m in 1999, to R300m by 2004, and to a peak of R15bn in 2017.

The market loved it, and EOH’s stock rocketed from 115c in 1999 to a record high of R178 in August 2015, valuing it at R26bn.

Then it all fell apart. As Gelb tells it, EOH’s implosion provides a crisp example of how an unchecked growth-by-acquisition strategy can spiral dangerously out of control.

Under the bonnet, it was an utter mess: the new subsidiaries weren’t integrating properly into the wider EOH group, with the original start-up entrepreneurs running their businesses as autonomous units, with no proper controls at the centre.

“When bidding for contracts, the acquired businesses benefited from EOH’s JSE listing, its BEE certification and its market power, while the entrepreneurs of the business, many of whom became EOH managers, continued to gain financially as long as EOH’s share price was rising,” says Gelb.

By 2017, however, the first reports of corruption involving EOH surfaced. Tales of shenanigans in bidding for state contracts abounded. These included social grants, security equipment for the police and an IT system for the department of water & sanitation. 

Shareholders demanded change. So in June 2017 Bohbot quit as CEO, became nonexecutive chair in March 2018, before leaving altogether. (Today, EOH is suing Bohbot for R1.66bn in damages for the malfeasance under his watch.)

As the allegations mounted, EOH’s share collapsed, from R178 down to 158c today — a 99% destruction of value.

Perhaps the move Bohbot regrets most was giving in to shareholder demands, in September 2018, to shake up the executive team.

Private equity firm Lebashe (which owns the FM) had promised to inject R250m in equity and R3bn in funding to EOH. But one of the conditions was that a new CEO was hired. This paved the way for the appointment of Stephen van Coller, a former executive at Absa and mobile phone services group MTN.

“In retrospect, if I were offered the job again ... I’d probably walk away,” Van Coller tells the FM.

As Gelb argues: “It is fair to say he [Van Coller] would probably not have been hired, had [Bohbot] and his allies realised that they were getting someone with not only a willingness to undertake organisational change but, as importantly, solid ethical integrity and a commitment to completing tasks”.

Van Coller soon realised the rot went far deeper than he thought. “The financial and accounting management systems were completely unfit for purpose, while governance, risk and compliance processes barely existed,” Gelb says.

Cash flow management was haphazard, there were no standard procedures for executive committee meetings and no record of decisions — and all this in a business clocking up R15bn a year. Mind-bogglingly, just one employee was responsible for compliance, and there was no internal audit function at all.

An investigation by ENSafrica soon confirmed the worst: serious governance failings, unsubstantiated payments, tender irregularities and unethical business dealings.

ENS described “an enabling environment for wrongdoing”, revealing how EOH staff had conspired with suppliers to inflate software licence sales, and rigged tenders, thanks to connected middlemen. In other cases, R47m was paid for “overbilled” contracts and R750m paid where there was “no valid work”.

There were also “inappropriate donations”. Most notoriously, EOH “donated” about R11m to the ANC, and scored contracts worth R400m from the City of Joburg, mostly through the late mayor Geoff Makhubo, who was finance MEC at the time.

It reeked — and much was made of this at the Zondo commission of inquiry into state capture.

By the time Van Coller arrived, the damage had already been done. A bank loan of R3.2bn, taken in early 2017 to plug a cash hole, had largely been exhausted, quite possibly to sustain dividend payments (including to management who owned shares). 

Van Coller brought in a big broom. First, the 2018 accounts were dramatically restated — revenue, initially reported at R16bn, was suddenly revised downwards by R4bn. EOH, previously profitable, was now in the red to the tune of R2bn.

The previous executives were ousted or left, as did the board.

Within months, tech giant Microsoft cancelled its reseller contract with EOH in March 2019, citing concerns over corruption. It caused the share price to collapse further, down to 104c on the JSE.

Some analysts believed EOH was already on borrowed time.

 Turning the tide

So how did Van Coller save the company? First, it must be said that EOH is systemically important to the South African economy. As the main technology provider to most of the top 100 JSE-listed firms, and to many government departments, its demise would have hurt many.

Says Gelb: “The chief information officer of one major bank indicated it would take three years for the bank to replace EOH in its IT system, and similar situations exist in electricity, rail transport and port facilities and several major municipalities.”

Van Coller’s first step was to begin rebuilding EOH’s now-vacant executive suite, with people from outside the firm.

Significantly, Megan Pydigadu (now departing for Spar group) replaced John King as CFO. (King is also being sued for R1.7bn by EOH.)

Van Coller remembers the old EOH board members were a little worried at Pydigadu’s appointment. “They were concerned she might see things differently,” he tells the FM. “I was thinking, I bloody hope she does!”

Next was Fatima Newman as chief risk officer, whose first task was to put in place a risk and compliance system.

In part, this was about changing the rotten culture of EOH. Gelb says the company had powerful informal networks, with limited accountability which “legitimised coercion”.

Van Coller’s strategy to fix the broken culture was to find out what went wrong, be ruthless about eradicating it, be totally transparent about what went wrong, put in place measures to make sure it wouldn’t happen again, and pursue those responsible.

“It isn’t good enough to just fire people for bribery and corruption. You do that if you think they’ve done a bad job, not if they’ve done something criminally wrong,” he says.

But, he adds, fixing EOH was akin to driving down the highway at 120km/h, while trying to service the car at the same time.

“You still have to run a business, you still have to pay back debt, we needed to pay back the Special Investigating Unit, we needed to pay back the South African Revenue Service ... I think the total, if you add it all up, was about R4.8bn, and we were left with about R900m,” he says.

Disappointingly, he says there was scant support from the criminal authorities or regulators — if anything, once EOH fessed up to the JSE about what had happened, the exchange then levied its own fine on the company.

Which is hardly an incentive for any other companies to come clean.

The need for an independent regulator

Gelb argues that none of the agents of accountability — external auditors, analysts, or business media — had raised concerns before the first wave of journalism reports in 2017.

“The JSE’s rather limp intervention towards EOH has, to date, been the only public action taken by the capital market or other regulators in relation to the EOH case. In a system of voluntary self-regulation as in corporate South Africa, there is no way to adequately assess corporates’ self-reporting, beyond the financial accounts.”

Gelb says the JSE doesn’t have staff tasked with scrutinising listed corporations who might have picked up problems at EOH (or, for that matter, who could have flagged problems at other corporate miscreants such as Steinhoff).

He says the JSE has also done nothing to improve the performance, in flagging corruption, of stock analysts and financial journalists who, with a few notable exceptions, maintained an overly optimistic view of EOH long after a closer look was warranted.

Which is why he advocates the urgent setting-up of a regulatory body independent of the JSE, modelled on the US Securities & Exchange Commission (SEC).

The US beefed up the SEC and the US justice department in the early 2000s in response to transgressions of the Foreign Corrupt Practices Act. This involved hiring an independent auditor to report directly to the regulator on a company’s progress in meeting commitments under a corruption-sanctioning process.

Gelb says the logic behind the SEC’s monitoring approach is that fines, even heavy ones, or scapegoating of individual employees, have little effect on addressing the culture that led to the problems in the first place.

“Without an independent auditor with appropriate powers, it is hard to see what can be done to restrict corruption elsewhere.”

The US is, of course, different to South Africa. Regulators such as the SEC and justice department are institutionally separate from the stock exchanges. But here, the JSE operates as a “quasi-regulator” even though it needs these firms as clients.

Andre Visser, the JSE’s director of issuer regulation, tells the FM that while the JSE conducts a stock exchange, it also acts as the listings authority — a role it takes seriously.

“This can be demonstrated by recent public cases where the JSE exercised its powers to get companies to correct their financial reporting, imposed maximum financial penalties in many instances and disqualified directors from holding office.”

Still, this has hardly been a triumph. In some cases, such as EOH, the JSE hit the already-wounded company with fines, rather than pursuing those responsible.

In other cases, as with Steinhoff’s former CEO Markus Jooste, it barred him from being a director for 20 years, and fined him R15m — but this wasn’t exactly commensurate with the R200bn damage.

But Visser says there are laws that also govern behaviour, such as the Companies Act, regulators such as the Financial Sector Conduct Authority (FCSA) and state entities such as the National Prosecuting Authority (NPA).

He says shareholders also play a vital role in holding a company and its board accountable — most notably through voting every year on directors, and calling shareholders’ meetings.

“Only with the active and focused participation of all these role players in the ecosystem will companies be responsible and moral corporate citizens,” he says.

On Gelb’s proposal to set up an independent watchdog, veteran shareholder activist Chris Logan questions whether this would be feasible. “This is painstaking work. Teams of auditors and lawyers will need to be hired. That’s going to be expensive for a market of the JSE’s size. Ultimately the market needs to do this work,” he says.

Logan argues that exemplary work done by analysts on companies often gets ignored until it is too late. He cites the work of Investec’s Anthony Geard and Dave Woollam, who pointed out problems at sugar giant Tongaat Hulett long before the fraud was uncovered.

Yet Investec behaved poorly in that case, forcing Geard to apologise to former Tongaat boss Peter Staude. With Staude now facing criminal charges, Geard had the last laugh.

Accountability when?

Perhaps the biggest problem when it comes to corporate crime is the apparent inability of the criminal authorities to do anything about it. Six years on from Steinhoff’s denouement, Jooste has faced no criminal action in South Africa.

Van Coller says there’s been no criminal action taken against anyone involved in the corruption at EOH — even though he reported this to the police in May 2019.

“All we can do as an organisation is report criminal behaviour and it’s up to the police to obviously prosecute. We’ve done that, and I don’t think it’s my place to try to be the policeman. You need some kind of rule of law and if the [authorities] want to do it or don’t want to do it, that’s a whole other discussion,” he says.

It’s a point Business Leadership South Africa CEO Busi Mavuso reiterated this week.

“The problem we have in South Africa is that there’s very little disincentive for crime and corruption,” she says. While business must be called to order, the deeper problem is that the government isn’t implementing its own laws.

“What more can a CEO like Stephen van Coller do?” she asks. “If you want to sit with thieves who are masquerading as government ministers, then you have a problem ... you need a political leadership that is beyond reproach, because then they can make sure they can hold all of us to the same standard. But that is not happening.”

Gelb says it goes beyond the police, pointing out that neither the Independent Regulatory Board for Auditors, nor the SA Institute of Chartered Accountants has acted against EOH’s former directors.

“There has been no [public] action from the banks or banking regulators with regard to bank officials across several banks who advanced a very large loan to the company in early 2017 without undertaking adequate due diligence,” he says.

Instead, it has been left to EOH itself to become a de facto leader in the corporate sector’s anti-corruption campaign, says Gelb — including by suing its former executives for R6.4bn.

“The EOH case should be provoking South Africa’s business leadership to a careful reconsideration of limited corporate oversight in the economy,” he says.

Is EOH slowly bouncing back?

While CEO Stephen van Coller’s bold approach to tackling corruption hasn’t yet been fully recognised in EOH’s share price, it’s certainly helped the group get away a critical R400m rights offer last year — one that was reassuringly oversubscribed.

Still, the market is reserving judgment on EOH’s longer-term prospects. The share price has been range-bound between 150c and 170c for about six months.

But the hard yards are almost done. Van Coller says EOH has had to sell four of its good cash-generating software businesses and generate cash flow of more than R3bn to pay down debt and pay increased rates, acquisition debts and nonpaid licence debts, as well as pay money back to the government.

“And we had to get through Covid [and] the Ukraine war and still survive. That’s the resilience of a great business with great skills and people … and potentially why people invested in the rights issue so successfully,” he tells the FM.

The benefits of the new operational structure — with four main pillars in infrastructure services & applications, digital enablement, industrial technology and EasyHQ — should start showing in this financial year. By the 2024 financial year, the restructure could be transformative.

The latest trading update, covering the year to end-July, seems satisfactory under the circumstances. Top line should show a gain of about 8%, including an encouraging 45% hike in international revenue. There’s hearteningly been no sacrifice in pushing up revenue, with gross profit margins stable at 29% and the likelihood of achieving R110m in continuing operating profit, up on the previous financial year.

However, EOH did feel the pinch of higher interest rates, with the rights issue proceeds being banked only in February. Still, this paid down the bulk of EOH’s bridge loan facility and, more importantly, allowed for a debt restructuring with a single lender at markedly lower interest rates, as well as freeing up cash flow to make “meaningful” investments in the growth of the business.

Anchor Capital analyst Stephan Erasmus estimates EOH will get back to 30c a share in earnings in the 2024 financial year.

Van Coller is pragmatic about EOH’s recovery. “As you slowly generate cash, you will start paying down the remaining liabilities. One day it miraculously finishes, and boom — it’s just time.”

He believes by financial 2024 EOH will offer investors a much cleaner business. “By 2025 we will be almost 100% clean and when the business turns, it will turn hard. That’s probably why some big investors were keen to get in on our rights issue.”