03/03/2004 11:49 - (SA)

Deon Basson

Cape Town - Eighteen years ago, in 1986, when Old Mutual last supported a Nedcor rights issue, the size of the issue was more than 11 times the total capital of Rand Merchant Bank (RMB).

At that time, RMB was still one of SA's smaller independent merchant banks.

Like now, Nedcor was then in troubled waters.

However, a lifeboat from the South African Reserve Bank probably saved Nedcor from having to declare a loss in the midst of the 1985/1986 crisis.

In fact, the Reserve Bank showed a R91.3m attributable profit and even distributed dividends of R54m to shareholders. Just these dividends from a struggling bank alone exceeded RMB's capital at the time.

The R345m rights issue at a share price of 630c (compared with today's rights issue of R5bn) shows again the power of compound interest.

At that time, Old Mutual contributed about R316m to the rights issue. The then unlisted mutual insurer had assets of R17.5bn at the time. Its capital was a huge secret, but was probably around R2.5bn. It was the leader among SA's financial institutions.

That rights issue put Nedcor on a new growth path. However, it did not trigger a cultural revolution - and 18 years later the same malaise that nearly destroyed it in 1985 was to cause great damage again.

Now Old Mutual is determined that checks and balances must prevent a single individual dominating Nedcor, clearly a reference to recently departed CE Richard Laubscher.

Change

In 1986, former CE Rob Abrahamsen was later referred to as "arrogant". He, like Laubscher, was once the hero of analysts and portfolio managers at the height of his popularity, which goes to show how history repeats itself if there's no meaningful change in culture and direction.

Old Mutual didn't bring about change after 1986. For 18 years a time bomb was ticking away while everyone (including the media) praised Nedcor's achievements.

Since 1986 there have been four CEs - Gerry Muller, briefly in charge in 1986, Piet Liebenberg (1986 to 1990), Chris Liebenberg (1990 to 1994) and then Laubscher, until 2003.

In the same period, there were only three chairpersons - Owen Horwood (to 1989), John Maree (to 1996) and then, of course, Liebenberg.

The rights issue of 1986 and the latest one have the implicit reassurance of Old Mutual's support if things go wrong.

It's debatable, but that probably also had an influence on the banking group's philosophy on risk and capital.

From the Eighties, on the other hand, RMB had to work carefully with its capital. It was small and there was no big daddy in the background to fall back on.

Without the capital of a supporter, RMB and its controlling company Rand Merchant Bank Holdings (RMBH) were involved in the reverse takeover of Momentum in 1992, and the latter completed the takeover of First National Bank (FNB) and Southern Life in 1998, bringing into being FirstRand.

Bad news

After the bad news about Nedcor was announced last week, the market cap of Old Mutual - which was listed in 1999 - is around R43bn and Nedcor's at R16.6bn.

FirstRand's market cap is R50bn. Of course, the market caps of these giants can change from day to day, but behind FirstRand's present lead there lies a tale of deep-seated cultural differences - particularly obvious after the latest debacle.

After the 1986 rights issue, Nedcor had 144.8m issued shares. At end-December 2003 the figure was 274.7m, with only the BoE takeover of 2002 really regarded as big.

If the rights issue were to take place at the present price of around R60/share, a further 83.3m shares will be issued.

Of course, RMBH and Momentum also had to issue large numbers of new shares in 1992 and 1998 respectively.

Also in 1998, at the time of the establishment of FirstRand, there was a rights issue of more than R5bn.

However, that was a completely different scenario because each time it was actually a case of a goldfish swallowing a whale. Since 1998 there have been no new share issues.

Shares increased by 21%

Since 1997 Nedcor's issued shares have increased by 21% to the current total. Not only does this dilute earnings per share, it also creates a false feeling of confidence in relation to the banking group's capital.

Poor risk management was given in 1986 as the reason why Nedcor suffered losses with its foreign loans, its gilt portfolio and its exposure to Louis Luyt's Triomf group. Now, 18 years later, the events of 1986 are recurring with foreign exchange losses of R1.6bn.

Same philosophy

Though carefully and not with equal amounts of passion, the two green companies now talk the same philosophical language as their FirstRand neighbours on the north side of Fredman Drive.

New CE Tom Boardman even refers cautiously to so-called clusters, a word widely used by FirstRand to describe a collection of smaller business units.

The FirstRand philosophy is to split the group into smaller business units.

Capital is given to the business units that are successful. Those that aren't are closed.

Old Mutual CE Jim Sutcliffe feels strongly that capital should be employed efficiently. He doesn't say so, but with its overseas takeovers Old Mutual had first-hand experience of the results of unwise investment decisions.

Old Mutual published its last balance sheet as a mutual company in December 1998. At that stage it had capital of R24bn.

Six months earlier it was more than R30bn. The point is that the bull market that continued to mid-1998 was a kind of sedative for insurers such as Old Mutual.

Insurers show their assets at market value. Therefore capital gains or losses have a direct effect on their capital and, consequently, also on the magical embedded value - a concept whose importance is probably overemphasised by analysts.

OM's Nedcor stake

Between 1994 and 2002, Old Mutual's capital and the value of its stake in Nedcor improved strongly. Old Mutual also maintained its 51% to 53% interest in Nedcor despite the increase in the number of Nedcor's issued shares.

In 1986 (after the rights issue) Old Mutual owned 75.3m Nedcor shares.

By 2002, that had increased to 142.7m shares. One of the reasons for this is that over the years Old Mutual did not consistently receive cash dividends, preferring to take up new shares in Nedcor.

Provided that the share price kept increasing everyone was happy.

Piet Liebenberg's resignation in 1990 can be linked to his dissatisfaction at Old Mutual's former chairperson, Jan van der Horst, being in favour of Nedcor taking over the former United.

And Luyt says in his autobiography Walking Proud that in 1986 Nedcor first had to submit its debt settlement with him to Van der Horst.

Both these examples create the impression of autocratic management by Old Mutual. The picture sketched by present Old Mutual CEO Jim Sutcliffe last week suggests exactly the opposite.

As the years went by following Van der Horst's retirement in 1990, Nedcor began looking more and more like a portfolio investment. Besides, Old Mutual didn't want to strengthen the perception that, like its competitor Sanlam, it controlled its large investments.

Demutualisation

Admittedly, Old Mutual was represented on Nedcor's board. It included chairperson Mike Levett.

Only with Old Mutual's demutualisation and listing in 1999 were there serious efforts from Pinelands to bring Nedcor closer to Old Mutual.

Nedcor - especially Liebenberg and Laubscher - objected, which led to the promising Old Mutual Bank project being shelved for several years.

After Old Mutual's listing in 1999 it was clear that it intended playing a major strategic role in the banking industry. That's shown by Nedcor's failed attempt to take over Standard Bank.

Laubscher was at that stage on the crest of the wave.

The boards of Nedcor and Old Mutual must have had complete confidence in him, otherwise they would not have allowed him to go ahead with his ambitious Standard Bank takeover plan.

The tonic of a rising Nedcor share price, which gave Old Mutual's capital so much shine, probably also blinded the Cape giant.

Only after Sutcliffe's appointment in 2001 did movements start in Nedcor's boardroom. Nevertheless, that couldn't prevent or even stall the BoE takeover. Nedcor's (or Old Mutual's) ambition to be SA's biggest bank was too overpowering for that.

Only with Old Mutual's listing did it become known that its interest in Nedcor had grown so large that the SA subsidiary, Old Mutual Life (SA), couldn't keep it on its balance sheet.

From a risk viewpoint it wouldn't make sense. Old Mutual Life (SA) is after all an independent legal entity, which is regulated in SA and has to comply with specific cautionary guidelines to protect policyholders.

Network

At the time of the listing (and subsequently) a network of companies was formed in SA and overseas. Old Mutual Life (SA) now holds a 33.9% interest in Nedcor, the major portion of which (93%+) is financed by shareholders.

Policyholders hold the rest.

A private company called OM Portfolio Holdings (SA) holds the remaining 18.8%. The shares in the latter are in turn held by Old Mutual (SA), which forms part of the extremely complex structure.

Another subsidiary of Old Mutual (SA) - Old Mutual Specialised Finance - was the company that recently advanced R2bn to Nedcor.

That loan will be repaid from the proceeds of the rights issue. Sutcliffe says that most of the costs of the rights issue will be carried by Old Mutual Life (SA).

It will probably amount to at least R2.6bn but could be significantly higher, depending on the underwriting and the support the rights issue gets.

About R7bn of goodwill was wiped from Old Mutual's balance sheet last year.

Of that, R1.9bn can be attributed to the selling of subsidiaries such as Gerrard, R2.4bn to the amortisation and impairment of goodwill and R3.7bn to the strong rand.

There's R15bn of goodwill left on the balance sheet. Given Old Mutual's investments in offshore asset management companies, goodwill is justified - provided, of course, that it brings in an acceptable return for shareholders.

Since its listing Old Mutual has attracted around R15bn of ordinary share capital.

Offshore companies

Finance Week estimates the net asset value of offshore companies (after the deduction of the remaining interest-bearing debt that they're financed with) to be around R6bn.

Add the value of inforce business of the US insurer and one gets a figure of about R12bn. That's less than the capital Old Mutual has attracted since its listing.

In the four years to 2002, Old Mutual Life (SA) added value of around R21bn, while for the five years to 2003, Old Mutual could only add total value of about R5.6bn.

The former's figures for 2003 are not yet available but they indicate that overseas subsidiaries are losing value for Old Mutual.

Unlike Nedcor, its operating subsidiaries did well at operating level.

However, no value is really coming through as yet, even though Old Mutual has drastically cut its debt.

There seems to be common ground in the philosophies of Nedcor and Old Mutual that can be seen in practice - both have attracted substantial capital in the past few years but failed to earn a sufficient return on it.

Though much has been said and written during the past week, only a deep-seated cultural change will really make a difference to both companies.

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