Corpcapital

Bringing home the bacon

By Deon Basson
dbasson@media24.com

MINUTES after Finance Week interviewed Corpcapital CEO Jeff Liebesman last week, he phoned hastily to complain: "We never discussed Corpcap's vision for the future." He's right – there wasn't enough time to deal with that, considering all the issues that needed clarification on the group's accounting policy with regard to its investments.

Analysts were probably using their calculators overtime this week to compute Corpcapital's real headline earnings per share for the year to August out of a maze of figures published.

The result of this frenzied number-crunching will probably also have a few shareholders questioning if Corpcapital's directors really did earn bonuses that are unusually generous, even compared to much larger financial institutions.

At the time of going to press, the share price was 154c, putting the "official" price:earnings ratio – based on the JSE Securities Exchange SA method of calculation – at 2,7. This would indicate "official" headline earnings per share of 56,9c, reflecting HEPS on continuing operations, excluding the headline loss of 20,4c/share on so-called discontinued activities.

The headline loss on discontinued activities amounts to R76,6m, which is a substantial sum in any terms considering that income in this category was only R119m . There is also the impression that this loss includes losses on continuing operations.

But Corpcapital has not differentiated between the headline earnings and the attributable profit for continuing and discontinued operations. The R204,9m gulf between the attributable loss of R68m and headline earnings of R136,9m will certainly come as a surprise to some.

The definition of headline earnings is probably so distorted that any p:e ratio is merely a theoretical figure. At the current share price, Corpcapital's market capitalisation is R678m, representing a 33% discount to net asset value. This may be a better measure than a p:e ratio and drives home the message that the market does not appear to trust the balance sheet values of Corpcapital's assets.

Corpcapital has assets of about R3bn, including investments of R332m and associated investments of R213m. The total of R545m (R784m in 2001) equals 54% of the group's shareholder equity. The investments and associated investments should thus be regarded as real. The reclassification of certain investments as associated investments had a material impact on the group's profit figures.

The accounting policy related to investments is designed to show them at fair value on the balance sheet, comprising a market value in the case of listed investments and an estimated value, based on price:cash flow ratios, in the case of unlisted investments.

An important point is that profits and losses resulting from the revaluations are shown in the income statement and not on the balance sheet.

Corpcapital historically had a number of investments in companies that normally would have been regarded associates or even subsidiaries. But in accounting terms, they are usually considered investments, so they are not consolidated or accounted for by the equity method.

Those mentioned in the 2001 annual report are Aqua (30%), OneLogix (65%) and Forza (25%). Unlisted investments also mentioned at the time were Norman Bissett & Associates (30%), Corpcom (33%), CFI (50%), Compensation Solutions (35%), GT247 (13%) and Netainment (47,5%). The last was renamed Cytech.

Corpcapital is the latest incarnation of Corpgro, which merged with the former Corpcapital and Corpcapital Bank last year. Liebesman says Corpgro accounted for its investments using the equity method or consolidated them, while the other two companies accounted for them as investments at fair value.

Now all of its long-term investments are treated as subsidiaries or associated investments. Only the short-term investments are still shown as "investments" on the balance sheet. This approach brings the group's accounting policies closer to generally accepted accounting practice (GAAP).

But the reclassification of investments could hardly have come at a more convenient time for Corpcapital and its management. The annual report should detail the impact of the reclassification on the compensation of executive and non-executive directors.

And while the formula for calculating their packages is not available, compensation should correlate with the group's headline earnings. But this year's profit figures are so open to interpretation that they will present the compensation committee with unusual challenges.

In 2001, Corpcapital's headline earnings were R191m. Liebesman's pay was R5,4m, comprising R2m for basic salary, R99 000 fringe benefits and a R3,3m performance bonus, half of which was retained to be paid in the current financial year.

The five other executive directors each earned about R3,5m, including basic pay of R1,2m and a R2,25m performance bonus. The 50% payout method was applied to their bonuses too.

Interestingly, Liebesman's gross package last year was close to that of FirstRand's Laurie Dippenaar and Paul Harris who each earned R5,5m. FirstRand's headline earnings, however, were nearly 15 times greater than Corpcapital's.

So, against this background, the reclassification of investments is meaningful. The pro forma headline earnings for 2001 were R145m, in comparison with the actual figure of R191m. But the drop does not mean the bonuses will be paid back. For 2002, actual headline earnings were R137m; so, superficially at least, it seems a decline in the performance bonuses is justified.

Historically, an increase in the value of investments would probably benefit directors' bonuses since it is reflected as profit in the income statement. But this is no longer the case. The reclassification of investments also means that a decline in their value will no longer negatively affect profitability.

This brings us to the R204,9m difference between attributable loss and the headline earnings in the financial year to August. The major portion of the difference is amortisation of goodwill (R105m) and a goodwill write-off (R94m).

In practice, this means that actual headline earnings were not R137m but probably more like R35m if you use the old classification. This also shows why the bonuses will probably be a sensitive issue this year.

The effect of the reclassification of investments on Corpcapital's headline earnings is illustrated by Aqua and OneLogix, both listed technology companies seen as "investments" until August 2001. Neither pays dividends; so the only source of profit or loss would be the change in the share price.

Profit or loss accounted for by the equity method is, of course, calculated completely differently. To put it simply, it is Corpcapital's share in the profit or loss of the two companies. The table (p11) shows the estimated differences the change of classification makes.

OneLogix's loss this year probably would have been R83m had the old market-value basis been retained. Now it may show a small contribution to headline earnings. Aqua's loss now probably will be only about R3m compared to a R49m loss under the old method.

The new method would have benefited the two companies last year too but not in every respect of Corpcapital's activities as the pro forma figure for 2001 shows that the headline earnings, in terms of the new method, came in R46m lower than they would have under the old set-up.

Losses attributed to the two companies were blamed on falling share prices in 2000 (see two graphs p10). In that financial year, the former Corpcapital Bank would have made profits from both as technology shares rose swiftly until the first reversal on Wall Street.

OneLogix's share price rose sharply in 2000 and 2001 just before Corpcapital's year-end in August. The same goes for Aqua in August 2000 (see graphs). This presumably shows how unsuitable the old method was but it is clear the change made the management look good in 2002. The question is what the headline earnings would have been had the previous method still been in use.

The market caps of OneLogix and Aqua are now so low that the investments could just as well be written off. But it remains to be seen how they will be valued. Liebesman has promised disclosure about these companies in the balance sheet.

Much the same applies to the unlisted Cytech, an online casino registered in the British Virgin Islands. Online gambling is a growth industry; so competition is a problem. Thus it would not be surprising to see tax feature heavily in the valuation of this tax haven-registered company. An historical valuation of over R200m would not have been out of the question.

But this value is probably not sustainable in the face of competition. Considering falling technology share prices, a R100m write-off would not be far-fetched.

Again, with the new methodology, it may be dealt with as amortisation and a write-off of goodwill won't affect headline earnings. The old method would have seen a direct impact on headline earnings.

Cytech is clearly important to Corpcapital's results. It is now valued by PricewaterhouseCoopers. Historical valuations apparently contributed to fat bonuses for executive directors. Corpcapital owes shareholders proper disclosure about Cytech and other similar investments.

By DEON BASSON deonbass@mweb.co.za