The Director’s Dilemma – June 2019 Edition
This edition of the newsletter was first published on The Director’s Dilemma website and the full newsletter is available for viewing here. To subscribe to future editions of the newsletter, click here
The Director’s Dilemma - June 2019
This month our dilemma is based upon the true case of a listed company that suffered a sudden drop in market cap resulting from the actions of short-sellers.
Lawrence chairs a medium sized listed company. He respects and trusts his fellow directors and the management team. Now a large listed financial firm based overseas that has been actively trading his company’s stock has issued an ‘online opinion piece’ that places a value per share which is well below the current market price.
To make matters worse, the local financial press has reported on the opinion piece in articles that are drawing investor attention to the low valuation and that, to Lawrence, appear to be carefully worded to avoid defamation or stating the author’s own opinion. The share-price is falling rapidly. Investors are asking questions and demanding information.
The investor relations manager has drafted a statement that counters some of the arguments in the opinion piece but, due to the listing rules, this doesn’t contain a valuation or share-price target, and, due to company policy, doesn’t contain any forward-looking statements or projections. The company is not currently raising capital and the bank, whilst concerned, appears supportive. The stock is widely held and there is no big supporter on the register who can outweigh the selling that is now affecting the price.
Two of the five directors are qualified accountants but none of the board or senior executives have ever had to justify a valuation like this. Much of the value is dependent on assumptions that appeared reasonable but are now hard to defend. Their asset valuations don’t drive a share-price model. The company’s stockbroker is furious because his clients are complaining but has no advice on strategic responses.
What should Lawrence, and his board, do?
Lawrence should review his company’s valuation policy and the last independent valuations done to support audited financial statements. Is there any discrepancy; or anything optimistic or vulnerable to manipulation?
The board should regularly review the value of assets. The cost of property, plant and equipment can be recognised as an asset only if it is probable that future economic benefits associated with the item will flow to the company. Assets can be impaired at any time. As a general rule companies must disclose anything that is likely to affect their share price as soon as they become aware of it. That includes impaired assets.
Next Lawrence needs to understand the arguments in the ‘opinion piece’ and where they differ from his company’s valuation assumptions. He should ask the company’s financial adviser to compare and contrast the two valuations and highlight the differences.
ASX listing Rule 3.1B allows companies to respond to comments and rumours if they contain false information that could, or does, lead to an inaccurate share price. It also allows companies to confirm statements that are accurate. If Lawrence agrees with any of the statements in the ‘opinion piece’ he must confirm them, even if they disagree with the investor relations manager’s statement and previous valuations.
In theory regulators will sanction market manipulators. In practice they will not move quickly enough for Lawrence to rely on their help. They are more likely to investigate his board, especially if disclosed valuations are indefensible.
Lawrence must also look at the information his board receives from management. How can valuations that appeared reasonable now be hard to defend? Were assumptions incorrect? If so, say so. Have management reported all material information, good or bad, or has there been bias? Has bad news gone out instead of up? Something about his company attracted interest from short sellers and market manipulators; he needs to find it and fix it, Fast!
This is reminiscent of a case in which Viceroy Research Group took on Capitec, in a strongly-worded and emotive report that took aim at the quality of their loan book and business model.
Since Viceroy had recently exposed the Steinhoff scandal – the single biggest scandal in South Africa’s corporate history – Viceroy attacked from a position of strength.
Capitec’s response has been hailed as a model of how to deal with unscrupulous short-sellers and manage reputational fall out. Here’s my advice:
Lead from the front: This needs leadership from the very top. Lawrence and his CEO need to swing into action and be visible, available and vocal.
Understand the parameters: Engage with their legal counsel, the company secretary and their sponsor to be clear what they can and cannot say under the listing rules.
Identify the key influencers and have a plan to engage them, including the issuers of the report: understand why they believe the business is overvalued and check their bona-fides, then report back on efforts to engage with them. If they won’t engage, this is a powerful indicator that something is amiss and there is a short-selling agenda that needs to be flagged.
Have a clear, positive message for shareholders, preferably one that counters all – and not just some – of the opinions. Remind shareholders of previous successes as well as past and current performance against targets and strategy. Use every available platform to reach them. Make it easy for them to engage with you.
Rapid rebuttal: Monitor all social media and traditional news channels and swiftly correct inaccurate reporting. It’s better to refute quickly than to spend days formulating a response. Independent commentary is the best antidote to fake news: In Capitec’s case they had built up a sufficiently strong relationship with the regulator and this paid dividends when the Reserve Bank was able to give an independent assessment of the loan book, going so far as to publicly castigate Viceroy for irresponsible reporting. Lawrence should hire an independent expert to value the business, and disclose this to shareholders. The caveat is that they need a strategy to deal with any potential value gap that might result.
Put a defence strategy in place to monitor high and unusual trades.
When the dust has settled, they need to review their shareholder and media engagement strategy with a view to increasing transparency and keeping in touch with shareholders.