Is this EOH’s “New Dawn”?

Many (many) years ago when I was an equity analyst at Standard Bank, I decided to cover EOH Holdings Ltd (code: EOH). If memory serves me correctly, at this stage EOH’s market cap was only a couple hundred million.

I reached out to the founder-CEO, Asher Bohbot, and organized a meeting. Their financials and website were pretty vague on what they actually did, but their track record was good enough that I thought coverage of the small cap may add value.

I recall sitting in Bohbot’s office and mentioning how I could not find any results presentations on EOH’s website. Could he perhaps send me a copy of these documents?

Asher’s answer surprised me more: “We don’t have any results presentations. You are the first analyst to come see us.

That was music to my ears and I threw myself into covering the stock and, ultimately, I came to the conclusion that the Group was less an IT business and more a service firm that happened to align to IT (think of something like Accenture Plc or, even, some of the financial consulting or audit firms).

Back in those days, I rated EOH Holdings a ‘BUY’. It was cheap, it was growing and it was in the right space at the right time with an invested & highly-competent management team.

What could go wrong?

You could probably find my original EOH coverage and reports somewhere in Standard Bank (and, subsequently at Thebe Stockbroking too). The reports are likely quite embarrassing–I have grown far smarter and far wise with more experience!–but they do eventually arrive at an interesting conclusion: After the share had gone up a couple 100%’s, I eventually downgraded EOH to a ‘SELL’.

This downgrade was largely due to the share’s ever-expanding multiple. At a single-digit Price Earnings (PE), EOH had been cheap. At a hefty double-digit PE, less so… This was due to a large portion of the Group’s growth was bought (i.e. acquisitions made in present or previous years). While acquisitions are great, I do not really want to pay for acquisitive growth. Hence, when the Group’s multiple in the market expanded beyond any point where I could still justify it, I downgraded the stock to a ‘SELL’. That is the nature of the game.

Interestingly, I was also the first analyst to do this (as far as I could tell). I had covered the stock since sub-R1bn market cap and as it began approaching the largest African ICT business, I was–once again–an outlier in my view.

Despite my ‘SELL’ rating on the stock, the stock still went up a couple more 100%’s and I looked like an idiot. That is, unfortunately, also part of the game.

By now, though, I had moved on to AlphaWealth where I had set up a small cap fund–and decided to not invest in EOH–while the market continued to enraptured by the ICT service firm.

I have a couple “contra-indicators” in the market. A few popular commentators who pretend to be astute investors when, in reality, their real business is getting maximum media exposure. When a small cap pops up on these peoples’ radars, then there is a good chance that its growth story is over.

By this stage, all of these commentators were loving EOH.

Its growth story was over.

At around this time, I had also stopped going to the EOH results presentations. Not only were these events too popular (the amount of value embedded in a small cap’s valuation is inversely proportional to the number of attendees at its results presentation), but they were getting vaguer and vaguer with disclosure and the narrative.

Sure, there were witty replies and entertaining comments at these presentations. But when it came to hard, factual detail, it was a complete waste of my time to attend these events and, eventually, I no longer did.

The years went by, the share price’s rise slowed and slowly began to reverse and then things started to come out…

What subsequently happened to EOH Holdings, its share price and what has come to light, is what happened between then and now. I will not revisit nor unpack this other than to make the following two observations:

  1. Many people do not realize that EOH was formed by what was effectively a management buy-out of PG Bison’s IT department (PG Bison is now part of KAP Industrial). As a business that offered a complete IT outsourcing solution, it really was a great little business. What happened subsequently, I believe, is that growth, size and incentive all conspired to drive up the rate of acquisitions and drive down the quality of these acquisitions. At the same time, the complexity of the Group was ratcheting up far beyond the scope of the existing business. The combination of these factors scaling-up across time arrived at a large, messy Group with a sprawling operation and questionable capital allocation and without the systems or control to handle it. I believe that none of this was intentional, just incremental.
  2. The public sector in South Africa is about a third of the entire IT spend in South Africa. Almost all of this public sector IT spend is funnelled through the central SITA (good in theory, bad in practice). That means that there is a gatekeeper who controls a huge pay gate. Irrespective of anything, where there is a sales force that is incentivized to sell IT in South Africa, the temptation is very real for these human beings to get access to this (public sector) pay gate from the gatekeeper in means other than legitimate ones. Unfortunately, that is how human incentive works: if the pay-off is big enough, most peoples’ morals begin to become flexible, irrespective of how many nice, pretty policies a business may have.

Progressively over the years, I believe, that points (1) and (2) combined toxically to arrive at the point where EOH found itself a year or two ago. Allegations were flying around, the share price was collapsing, a major acquisition was reversed, cash flows were weakening, and management and staff churned as the boat looked ready to sink…

This all culminated in three key things happening:

  1. Stephen van Coller was appointed EOH Holdings’ CEO to righten the ship and, hopefully, turn it around.
  2. ENSAfrica was given unfettered access to investigate illegitimate practises the Group may have committed.
  3. Yesterday, the finding of (2) was presented to the market by (1).

Firstly, (3) can be summarized in ENSAfrica report (dated 16 July 2019). I recommend that you read the full interim report over here.

In summary, though, the report found c.R1.2bn of suspicious transactions. The majority of these were committed by a small number of individuals, were in the public sector space (surprise!) and from the ‘EOH Mthombo (Pty) Ltd’ subsidiary.

Importantly, though, do read through the report and find the list of measures, controls and subsequent actions that EOH’s “new” Board has implemented to correct past behaviour and prevent future circumvention of the rules.

“New” Board?

This leads me to point (1) above where Coller has driven a clean sweep across the Group.

Below is EOH’s pre– and post-Board. If you click on the below image to see the detail, you will notice that the last snapshot of the top management of EOH before all this came out is completely gone and an entirely new Board is now running the show:

I believe that this is potentially EOH’s “new dawn”.

I was impressed by Coller’s directness yesterday in unpacking what they found and how they have dealt with it. ENSAfrica’s report was concise in what they found and detailed logical controls and solutions to prevent it happening again. And, the clean sweep of management means that a new guard is driving this process with minimal legacy, minimal ego and maximum efficiency.

Afterall, EOH is a service firm first and an IT firm second. If you change the people and the processes in a service firm, you change the service and arrive at a different outcome.

For the first time in almost five to ten years, I think EOH may be worth looking into again, if only from a qualitative perspective.

Notice how I have not touched on any numbers or valuation metrics above? This is simply because we do not know what the “new” EOH will ultimately look like.

Sure, R1.2bn of suspicious transactions were found, but how much business did that bring in? What future revenue is at risk? What legal contingent liabilities are lurking out there now? What margin or volume of work will EOH win on a level playing field? What proportion of the quality staff are left after the last couple of years versus what proportion of quality staff can they still attract? What extra costs and what margins will all these extra controls and procedures cost the Group? Having sold off a chunk of the Group and in trying to pay down debt, what is left and how much is that worth?

While the above narrative hopefully provides context for what I believe may be a structural improvement in EOH going-forward, the latter numerical, financial and valuation questions are both harder to answer and more pertinent for investors considering their share price.

In reality, I do not know the answers here, but I thought there may be value in providing the narrative.

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