Departing Tongaat Hulett CEO was handed a ‘poisoned chalice’

Gavin Hudson was handed a poisoned chalice when he accepted the CEO position of scandal-plagued sugar and land group Tongaat Hulett in 2019.

That’s the view of long-time Tongaat watcher and chief investment officer at Opportune Investments Chris Logan, speaking to Moneyweb following news that Hudson has resigned from the embattled KZN-based group and will leave at the end of February.

Read: Gavin Hudson resigns as Tongaat Hulett CEO

One of Hudson’s first decisions as CEO was to appoint PwC to conduct a forensic investigation into accounting and governance malpractice for the 2018 and 2019 financial years – when the former management team under (then) CEO Peter Staude was found to be cooking the books to boost executive bonuses.

Outgoing Tongaat Hulett CEO Gavin Hudson. Image: Supplied

Hudson may not have fully appreciated the depth of swamp he found himself in when first taking on the CEO position.

The financial statements were worse than meaningless – they were criminally deceptive, as demonstrated by the 97% share value wipe-out since 2018.

Staude and former chief financial officer Murray Munro were among several former executives who appeared in the Durban High Court in September 2022 on charges of fraud amounting to R3.5 billion, all related to their tenure at Tongaat. The case resumes on 17 February.

Read:
Tongaat Hulett pursuing civil, criminal action against former execs (Aug 2020)
Tongaat Hulett confirms civil claims totalling R450m against implicated former executives (Jan 2022)

In October last year Tongaat announced that it would enter business rescue proceedings for two of its SA operations: Tongaat Hulett and Tongaat Hulett Development.

Hudson and his team had toiled since 2019 on a turnaround strategy and made good progress in certain areas, noticeably in reducing debt from a high of R11.7 billion to R6.5 billion, though darker angels conspired to frustrate the recovery plan.

Covid, lockdowns, floods and riots in Kwazulu-Natal cruelly derailed a recovery that seemed to be on track until early 2020.

Late last year we found out that unless the company finds R1.5 billion for working capital, it would not be able to trade through 2023.

At that point, control of the company effectively passed to the business rescue practitioners (Trevor Murgatroyd, Peter van den Steen and Gerhard Albertyn), with Hudson and his team being made functionaries. Business rescue also puts a court-sanctioned freeze on any creditor claims, allowing the company time to trade its way back to solvency.

The business rescue plan should have been published on 1 December 2022, but the practitioners asked creditors for an extension, first to 31 January 2023, and then again to 28 February. At the latest count, the company has more than R8 billion in debt, while creditor claims are currently being verified.

The company’s Botswana, Mozambique and Zimbabwe sugar operations are not financially distressed and continue trading normally. These businesses are funded independently of Tongaat’s SA operations and are expected to be largely unaffected by business rescue proceedings.

In December, the business rescue practitioners (BRPs) announced that the Industrial Development Corporation (IDC) had advanced post commencement finance for working capital and off-crop maintenance and capital expenditure.

This would allow it to complete the current milling season, carry out necessary off-crop maintenance and capex and prepare for the start the 2023/4 season.

The IDC’s role in the rescue of Tongaat appears to have been prompted in large part by the outsized role the company plays in the SA economy, with an estimated half a million people involved in downstream sugar-dependent businesses, including transport and logistics.

‘Undesirable’ accounting practices

The PwC investigation in 2019 found ‘undesirable’ accounting practices such as premature revenue recognition and expenses being capitalised as assets. “This resulted in profits in the respective years being overstated, and in the overstatement of certain assets in (Tongaat’s) financial statements,” reads the report.

Investec Securities analyst Anthony Geard was first to smell a skunk in 2018, when he called for then-CEO Staude to resign after racking up 10 years of negative cumulative free-cash flow and declining returns.

Around the same time investment analyst David Woollam ran the spreadsheet numbers over 10 years and wondered aloud why a company that reported cumulative after-tax profits of R9 billion and paid dividends of R2.7 billion needed to borrow an additional R7.5 billion. Deduct the dividends and it begs the question: where did the remaining R14 billion go?

• Some R8 billion went on capex, though the company was vague on details.
• Apart from a new mill and refinery in Mozambique costing perhaps R800 million, we know that no new mills were built in SA or Zimbabwe over the prior 10 years.
• Nor were there noticeable expansions in farming operations or land acquisitions.

“A cynic might conclude that a substantial amount of otherwise normal operating expenses were somehow capitalised as fixed assets,” concluded Woollam.

Sugar cane assets were also reported to have increased 173% over 10 years at a time when yields and sugar prices declined. There was an increase in hectares harvested, but still not enough to account for this massive increase in biological assets.

Land sales were also grossly overstated, something the complex and judgment-inviting International Financial Reporting Standards (and their reliance on auditor judgment) seem to foster. IFRS 15, which sets out guidelines for revenue recognition, says the risks and rewards of ownership must pass from the buyer to the seller, and there must be a reasonable assurance that payment will be made before revenue can be counted. Land sales are notoriously protracted and subject to all sorts of conditionalities, such as zoning and funding approval. Many of the land deals in concluded between 2016 and 2019 appear to have been unwound.

Logan argues there seems to have been a change in culture after Anglo sold its stake in Tongaat in 2009 for R4.2 billion.

“That gave the then-management free rein to create the kind of incentives that rewarded executives, rather than shareholders,” says Logan.

“It was those incentives that created such massive accounting fraud in the group, where revenue was over-stated and expenses were capitalised as assets,” he tells Moneyweb.

Adds Exness Africa market analyst Terence Hove: “On face value it, Hudson’s departure seems to be a performance-related departure. However the trade of sugar regionally has become quite difficult business terrain to maneuverer.

“Runaway costs have been the biggest factor to address, but to do that in the current environment is difficult. The complex work streams that the business rescue practitioners have battled with, and [the fact that they have] subsequently requested to extend the deadline, are testament to this difficult environment.”

The BRPs are looking to cut costs any way they can – and cutting out a CEO salary will certainly help. Also on the chopping block are development costs, pending the release of the business rescue plan. Asset and business sales are likewise under consideration.

With the BRPs now in the driving seat, it makes little sense for Hudson to remain on. He will leave it to others to finish the job he started.

Listen: JustOneLap founder Simon Brown on Tongaat Hulett’s CEO exiting, and Spar’s chair becoming its interim CEO (or read the transcript) 

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