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A cautionary corporate governance tale for Good Money Week

To mark Good Money Week, here is an example of how we incorporate environmental, sustainable and governance considerations into our investment process, here on The Value Perspective

02/10/2018

Juan Torres Rodriguez

Juan Torres Rodriguez

Research Analyst, Equity Value

From 29 September to 5 October 2018 is Good Money Week – an initiative that aims to grow awareness of the possibilities associated with sustainable, responsible and ethical finance.

It therefore seemed timely to offer an illustration of how we incorporate what are now broadly known as ‘environmental, sustainable and governance’ or ‘ESG’ considerations into our investment process, here on The Value Perspective.

TVP on ESG

Headquartered and listed in South Africa, MTN is a multinational telecoms company, with operations across the emerging markets – not least Nigeria, from which it has historically derived a significant amount of its value. For much of this century, MTN was the darling of the emerging markets telecom world, with a large portfolio of assets and great growth potential and then – for reasons we will come to shortly – it wasn’t.

As we have discussed before in articles such as Forget the acronyms, here on The Value Perspective, we have always viewed the ideas embodied by ESG as integral to a proper analysis of any business.

We do not, however, obsess about what each letter represents but instead have always focused on a business’s governance and stakeholders and how these areas could impact risk or future profits.

One of the most noteworthy aspects of the MTN success story was the earnings it was generating from its Nigerian operations. For a sustained period it was delivering hugely impressive EBITDA – that is, earnings before interest, taxes, depreciation and amortisation – margins of 50% to 60% when a business in its position might reasonably be expected to deliver something closer to 40%.

This was even more remarkable given a relationship with the Nigerian government that was, to put it mildly, strained.

A major bone of contention here was MTN’s practice of selling unregistered, prepaid SIM cards. To be fair, the company was by no means alone in this but it was the largest player to do so and, as a result, the Nigerian government would constantly threaten it with significant penalties if it did not stop.

For whatever reasons, MTN ignored these threats but then, as can often happen, its good run came to an abrupt end.

In 2015, a member of the Nigerian government was kidnapped and, from the resulting investigation, it emerged that one of the kidnappers had used one of MTN’s unregistered, prepaid SIM cards.

An eye-popping fine 

Clearly fed up with the whole situation, the government fined the company an eye-popping $5.2bn (£4bn).

This was such an extraordinary sum that, initially, the company’s share price did not really move – the market presumably deciding the fine had been misreported. When it finally sunk in that, yes, it really was $5.2bn, however, MTN’s share price sank and it has kept on sinking, with the company’s current $12bn market capitalisation roughly a third of its summer 2014 high.

The fine was later reduced to around $1bn after negotiations that included MTN pledging to list on the Nigerian stock exchange but the company’s fortunes have not improved.

Indeed, it has since found itself embroiled in a fight with Nigeria’s central bank over the repatriation of $8.1bn out of the country and a second dispute over $2bn in back taxes, which is raising question marks over the aforementioned listing.

Spot the warning flags

To be clear, we are not suggesting a close analysis of MTN would have confirmed any aspects of this corporate horror story would occur.

You can, however, spot red flags in a company’s approach to corporate governance, which should involve treating customers respectfully, caring about your employees and your suppliers – and engaging responsibly with the governments and regulators in the countries you do business.

As we have discussed before, here on The Value Perspective, we have seven ‘red questions’ – set out below – that we ask of every single business we analyse as a potential investment. And in connection with that crucial last one on risk, we pay very close attention to a company’s approach to environmental, sustainable and governance considerations.

In the case of MTN, then, in addition to adjusting the company’s EBITDA down to levels we believed were more sustainable over the long run– after all, something always happens to revert such extremes to their longer-term mean – we  would have adjusted the associated risk scores to reflect the lack of governance in the way the company was choosing to engage with the government of its most important market.

 

Our seven ‘Red’ questions

  1. Has anything been missed off from the company’s enterprise value?
  2. Have profits – that is, the company’s net operating profit after tax – been misrepresented?
  3. Is the company’s past a good guide to its future?
  4.  Do the company’s profits turn into cash? 
  5. Is the company’s balance sheet good enough? 
  6. Is the business itself good enough? 
  7. Are there other risks to consider?

Source: The Value Perspective

Author

Juan Torres Rodriguez

Juan Torres Rodriguez

Research Analyst, Equity Value

I joined Schroders in January 2017 as a member of the Global Value Investment team. Prior to joining Schroders I worked for the Global Emerging Markets value and income funds at Pictet Asset Management with responsibility over different sectors, among those Consumer, Telecoms and Utilities. Before joining Pictet I was a member of the Customs Solution Group at HOLT Credit Suisse.  

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