Pinnacle Holdings CEO Arnold Fourie talks to Biznews.com’s Alec Hogg about the once highly rated company’s three big issues – its R300m debt-funded investment into fellow JSE-listed tech stock Datacentrix; the hangover from allegations that it bribed SAPS to land a contract; and his decision to appoint a successor after 22 years at the helm.
Alec Hogg sat down with Pinnacle’s chief executive, Arnold Fourie following the release of the company’s interim results. He started by asking him about the bribery allegations from last year, which affected investor perceptions of the company. Let’s take a look. To see the full 8 minute interview on CNBCAfrica.com, click here.
It was a shock to us when it first surfaced. The timing wasn’t great because we’d brought out interims last year, which also showed that the company was flat year-on-year (and there were some reasons for that). I think that the investment communities felt that we’d slowed down. For 10/12 years, we had tremendous growth. We grew at an average of 38% per year and they felt that these allegations might have caused some of the slow down, which obviously was not true.
Well, the big question was that you’d always had superior margins to everybody else in your industry and the immediate assumption was ‘well, then you guys must have been doing something a little strange to get those higher margins’. Maybe you can unpack that for us.
Again, it’s not accurate. If we look at our competitors, they’ve been able to achieve the same margins. What we always did really well is run our business in a very cost-effective way. If you look at our operating costs, we’ve always been very proud of the fact that sub-10, sub-9, and even sometimes, sub-8%.
What does that mean?
Operating costs as a percentage of revenue, where our competitors were running 10% to 12%.
That would account for the margins.
That accounted for the high operating profit margins. However, if you look at the gross profit margins, we were always in line with everybody else.
When one looks at these results that were released today; this is for the first half of the 2015 financial year. Headline earnings are down again. As you’ve said, you have a proud record, which went off the rails in 2014 and now we’re seeing another decline. I guess that would be raising flags amongst investors. Is there not some overhang from the allegations
Alec, at first glance, when you look at the numbers then operating profit is down 17%. HEPS down 16%. If you look at the revenue growth, we’re up 14%. If there were cases of us losing business or people turning away from us, the revenue would have declined first. Again, it’s a perfect storm. We started our financial year in July, with a month-long strike at our Midrand premises. That took roughly five cents of headline earnings away from us.
Five cents. Was that the Numsa strike?
Yes. We lost our entire operation in Midrand for that entire month. The big issue in our numbers at the moment, is our margins. Our margins are under tremendous pressure. We told the market before, that the margins would be under pressure but not to the extent that we’ve seen the decline now. That’s because of the product mix that we’ve had. We’ve embarked on new business areas – advanced technologies – and the margins in those areas have always been fairly thin. In addition, when you enter a new market, you have to be aggressive. I think that combination and some of the product mix have caused the margin to be down.
On the product mix, you were selling a lot more laptops/notebooks and desktops in the past, than you are now. Certainly, in 2014 we saw a dip. Has that decline continued in this half of the financial year?.
That accounted for the high operating profit margins. However, if you look at the gross profit margins, we were always in line with everybody else.
When one looks at these results that were released today; this is for the first half of the 2015 financial year. Headline earnings are down again. As you’ve said, you have a proud record, which went off the rails in 2014 and now we’re seeing another decline. I guess that would be raising flags amongst investors. Is there not some overhang from the allegations
Alec, at first glance, when you look at the numbers then operating profit is down 17%. HEPS down 16%. If you look at the revenue growth, we’re up 14%. If there were cases of us losing business or people turning away from us, the revenue would have declined first. Again, it’s a perfect storm. We started our financial year in July, with a month-long strike at our Midrand premises. That took roughly five cents of headline earnings away from us.
Five cents. Was that the NUMSA strike?
Yes. We lost our entire operation in Midrand for that entire month. The big issue in our numbers at the moment, is our margins. Our margins are under tremendous pressure. We told the market before, that the margins would be under pressure but not to the extent that we’ve seen the decline now. That’s because of the product mix that we’ve had. We’ve embarked on new business areas – advanced technologies – and the margins in those areas have always been fairly thin. In addition, when you enter a new market, you have to be aggressive. I think that combination and some of the product mix have caused the margin to be down.
On the product mix, you were selling a lot more laptops/notebooks and desktops in the past, than you are now. Certainly, in 2014 we saw a dip. Has that decline continued in this half of the financial year?
When we started the business, we were a basic PC distributor. We sold a lot of components and our own Proline brand. With those types of products, you can earn a much better margin. It’s not an easy comparison. If you have a good product, you can get a fair margin out of that. Over the years, we’ve started to adapt to market conditions. We’ve taken on tier-1 brands. A tier-1 brand commands a lower margin. You need to accept the fact that it’s an easier sell. You don’t have to do all the hard yards yourself. When you sell a Proline product, you have to do the marketing. You have to tell the market why they should take it. We were one of the first proudly South African partners. All of that takes a lot of effort. You get the margin for that. With tier-1, you don’t and as the tier-1 business grew in our life, our margins came under pressure.
Tier-1 would be Acer, Dell, and Lenovo etcetera. Are they becoming an increasing part of your pot?
They’re a big part of our business today. Sometimes you migrate to the path of least resistance. Your people start selling what’s easy to sell and you don’t sell your own product. What we’ve said is ‘that’s not on'; we have to make sure that our own traditional product/our components business/our own brand gets the recognition and the attention, and that should boost the markets.
Okay, so that’s the operational side. The strategic side, your acquisition/investing of nearly R300m into Datacentrix has given you a big debt burden – something you’re going to have to sort out in the near future and you’ve said that in this set of results. Why is it so important that you get Datacentrix at this point?
Again, when you look at the whole IT ecosystem, selling the product is a portion of the big picture, but it’s certainly not the total picture. Especially as technology becomes more complicated you need more and more, clever people to make that product work. In my slides today, I showed that things such as infrastructure and software as a service has become a much bigger part of the IT ecosystem. If we ignore that part, we effectively lock ourselves out of a big part of the industry, which we should be in.
Did you see Datacentrix as a juicy opportunity with good value?
They’re a fantastic company. They build fantastic solutions. They’re a bunch of clever guys whom we believe, can participate in that part of the business.
You’re having to do things that you wouldn’t have wanted to do though, such as selling your property portfolios. It’s nice to have your own properties. For example, Wind Down – one of your managed print businesses – all because you’ve taken this debt out in Datacentrix. With hindsight, was there perhaps a different way?
With hindsight, the only change I would have made, would have been to use shares instead of paying cash. The acquisition of Datacentrix is the right strategy for the group, though. We have to do it. If we want to grow this business for the sake of the investors, we have to participate in that space.
You’d rather have used shares.
Certainly.
Presumably, at the old share price and not the new one.
Yes.
Despite having this debt burden, you’re still doing share buy-backs. That’s an interesting conundrum.
We did one share buy-back right at the beginning of the allegations. At that point, we believed it was the right action to take.
To support the shares?
Well, it wasn’t really to support the shares. We never thought the share price would be this cheap because today, it is really cheap relative to our peers and other companies. We thought that it’s a good buy for us. It’s not really to support the share, but to buy the share. Let me go back to the Datacentrix acquisitions. Sometimes pressure forces you to do things that you should have done before. For 17 years, we grew at an incredible pace. Sometimes, you think you’re bulletproof. You buy companies, which you maybe shouldn’t have bought. You don’t take action fast enough in underperforming divisions. The Datacentrix acquisition has certainly focused our minds to question whether we should be in property. Can we take that money? Our financial services business is giving a 40-odd percent return on capital. If I go and take property at nine percent yield, it’s a no-brainer. I must do this. I can use that capital much better in the Group. We’re a growing Group. We need cash. For me, it’s the right thing to do.
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