Nedgroup Investments and Abax Investments take their responsibility towards client assets seriously. We aim to ensure that the management of the companies invested in on behalf of our unitholders are accountable for company performance and conduct. We believe that it is our duty to exercise shareholder rights in the best interests of our clients.
It is therefore on behalf of our investors, that we have undertaken to challenge the board and the majority shareholder of one of the Nedgroup Investments Entrepreneur Fund’s largest positions – Howden Africa Holdings.
Howden installs and maintains fans and heat exchangers for the mining and industrial sectors and provides engineering solutions to industrial processes that assists in reducing pollutants produced in liquid or gas form from those processes. It counts Eskom as its single largest client. This combination of established business activities in the context of the current problems Eskom and pollutive industrial firms find themselves renders this firm of fundamental high attraction. Howden has been a top performing position for the fund for several years as the firm which has operated in South Africa since the early 1960’s grew its profits and dividends consistently.
However in 2012 the previous controlling (55.4%) shareholder was bought out by an American firm called Colfax and shortly thereafter the problems started. Almost immediately the parent company started to charge Howden for software and management services it had been competently providing internally for the previous 50 years. These charges have escalated quickly, with no apparent basis of calculation offered or disclosed and with no incremental benefit in the form of additional revenue. In 2012 these charges amounted to R4m, rising to R36m in 2013 and R61m in 2014. These charges now account for 19% of the firm’s total operating profit.
After the board was challenged by Abax and other minority shareholders (which included the exchange of several letters) questioning the basis on which these agreements were entered into, they eventually agreed to put the agreements to a shareholder vote in January 2015; nearly three years after the commencement of these payments. As minority shareholders, we were surprised to learn that the Howden board ruled that Colfax (the controlling shareholder and exclusive beneficiary of these agreements) could have their votes count on this matter. We approached the JSE as a collective group of minority shareholders for relief under paragraph 9 and 10 of the JSE Listing Requirements as we believe this constitutes a related party transaction and is not in the ordinary course of the firm’s business. The JSE found that the transaction is in the ordinary course of the firm’s business and therefore that the Colfax shares could be voted. In the context of the scale to which these payments have already escalated it remains our contention that this is a related party transaction and the Colfax should be excluded from the vote. We continue to engage with the JSE on the matter.
With the JSE ruling in hand, Howden circulated the voting documents to shareholders, but in disregard of minority shareholders’ views the board did not wait for the closing date of the vote. They announced the outcome of the vote two weeks prior to the closing date and with only 56.6% of the votes counted (Colfax owns 55.4%). The opinion of minority shareholders on the matter appears to be of little interest to the Howden board.
Howden has long been a highly cash generative firm which is one of the reasons we were attracted to it. It has reliably paid an interim and final dividend with an extra special dividend every few years when excess cash built up – as it regularly did. However at the end of 2013 dividend payments were surprisingly suspended with the only explanation given - to consider a BEE deal. While we support the firm’s strategy to improve its BEE rating, we are disappointed that the explanation is not more detailed, that no progress appears to have been made on the deal in nearly two years, and that cash of R630m has built up (representing nearly a quarter of total market cap). With this war chest Howden could pay out half of its annual profits in dividends and still be left with more than R500m to consider possible deals – BEE or any other kind of M&A.
The following chart illustrates the divergent experiences between minority shareholders and Colfax since they started charging the company for support services, while at the same time suspending dividend payments. All shareholders interests were aligned pre-2012, but since then cash returns have diverged widely. This seems to us to be a one-sided and unsatisfactory situation for minorities.
One has to wonder why Colfax would behave in this manner. We have given the matter some thought and can only suggest that it may be a conscious strategy to undermine the clear attraction of the business, drive the share price as low as possible with the purpose of making an offer to battle-weary minority shareholders, who would then accept.
Abax has attempted on multiple occasions to address these issues with the Howden board as pro-actively and constructively as possible, yet we have been met at every encounter by an increasingly defensive executive management team, non-executive board directors (whose duty it is to protect the minority shareholders rights) and company secretary. We can however assure you that we are not battle-weary and remain confident that through gradually escalating the pressure, sense and fairness will eventually prevail.