While the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry left many executive careers in tatters and many companies and shareholders bearing the economic pain, perhaps none suffered more than IOOF shareholders and its executives.
A time for change
The indifferent attitude shown by IOOF’s CEO at the Royal Commission hearing precipitated an Australian Prudential Regulatory Authority (APRA) charge that led to a 40% fall in the share price in December 2018, and ultimately led to the removal of the Chair, CEO, CFO and other senior executive staff. Unfortunately for investors, it took 12 months for the share price to eventually recover these losses in absolute terms, with the stock still lagging the ASX200 from a relative perspective.
The question that still remains is: “Has IOOF’s corporate governance sufficiently changed so that investors won’t experience a repeat of the trauma of December 2018?”
Applying a discount to valuations
Pre APRA’s charges in December 2018, we valued IOOF on a 110 real earnings yield (REY), implying a 10% discount to the market as well as a 10% discount to how we had valued IOOF six months prior in June 2018. This was a 20% discount to the historic multiple that IOOF had traded on. This 10% discount was a $300m impact to valuation. Another way to view it is that our 10% Royal Commission discount to the underlying valuation implied a $400m fine and/or remediation.
At the time, we felt this discount would cover an extreme remediation event. In addition, this discount was placed on IOOF despite the company scoring strongly on the MSCI ESG Manager’s scorecard (AA rating and top 13% within its industry).
APRA’s stance to accuse the Chair, CEO, CFO, Head Counsel, and Company Secretary of failing the “fit and proper” test went well beyond our initial expectations, with the 40% share price fall proving our 10% ESG discount was insufficient.
Despite the significant share price fall, we were of the strong view that this was an overreaction given our scorched-earth scenario analysis indicated a valuation of at least $5.50/share. This scenario analysis was underpinned by the fact that that the company had $600m of net cash on balance sheet, which provided a floor to the intrinsic value of the company.
That said, our view was that the intrinsic value in IOOF could only be unlocked with material changes to the company’s corporate governance, which ultimately shapes the IOOF franchise and culture.
As steward of our client’s funds, through our multiple interactions with the current Chair and CEO, we have been actively involved in IOOF’s journey to establish best in breed corporate governance frameworks.
Transforming the company culture and structure
From the top, IOOF now has a new Chair, driving cultural change. This is reflected in the changes to the Remuneration Report, which now puts more accountability on the executive team and is more aligned to shareholder’s interest. New scorecards for ESG matters, people/cultural engagement scores, and client/Net Promoter Scores have been introduced in the long term incentive plan, replacing the old hurdle based purely on tenure.
We have also seen a refresh of the six-person board, with the introduction of Andrew Bloore and Michelle Somerville. Mr Bloore’s background in financial services technology and Ms Somerville’s background as an audit partner at KPMG complements the current board’s skill set and provides the necessary skills to move the company forward. In addition, we have been actively engaged with the Chair regarding identifying short falls in the board’s current skillset, and believe an additional board member with certain skills should be added. Watch this space!
In addition to the board changes, the CEO change has led to a complete refresh of half the executive team, with a new Chief Financial Officer, a new Chief People Officer, a new Company Secretary, a new Chief Legal Officer, a new Chief Risk Officer, and a newly created role of Chief Transformation Officer. The new executives complement the existing executives who have had longer tenures, including the Chief Operating Officer, the Chief Information Officer, the Chief Distribution Officer, the Chief Investments Officer, and the Chief Advice Officer.
While wholesale executive changes bring with it risk, what gives us comfort is the fact that the current CEO has been with the company for 17 years in an operational capacity, and thus knows the company very well. That said, given the predicament the company had found itself in, no change to the executive team relative to wholesale changes would have posed a materially higher risk to shareholders.
Has IOOF done enough?
So, have these personnel changes made an impact to the company? Ultimately proof is in the pudding. We have seen the relationship between IOOF and the regulators improve drastically. IOOF has addressed all the concerns raised by APRA in its Management Action Plan. We have seen internal restructures of processes take place, so that the company has:
- introduced best corporate governance practices (such as the splitting of the Registrable Superannuation Entity (RSE) and Responsible Entity (RE) licence functions
- established a separate office to support the REs
- instigated a majority of independent directors and Chair for the REs.
APRA approved the company-transforming acquisition of ANZ Pension and Investments business and we expect APRA will also approve the MLC acquisition in 2021.
With the corporate governance issues addressed, we witnessed a recovery in the share price, with the stock trading at $7.60/share before the COVID-19 induced market wide sell off. In our view, with materially improved corporate governance over the past two years, the platform has been laid to reduce regulatory risk so that execution of the ANZ and MLC deals will see the next catalyst for value realisation.
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