I get a really uneasy feeling when a CEO's opinion and promises start to become moving targets with shifting goal posts. Investing in shares is really investing in the management team running the underlying company. And, investing in a management team is really built on trust. Trust is built by sticking to ones word.

Changing opinions and shifting goals does not foster much trust.

Any listed company with growth ambitions should have a strategy in place to achieve this growth. Not just is this strategy important as a guideline for management to execute, but it also becomes the intangible object that investors are investing in: the future cash flows of the company.

What is an investor's most common starting point in trying to forecast the future? Always management. And what management will always tell investors is what the company's strategy is and how they plan to execute it.

Any corporate growth strategy has three main variables:

1. Quality: Is it a good growth strategy? Does it 'work on paper'?
2. Execution: Even if the growth strategy is a good one, does management execute it correctly? No matter how great it looks on paper, does it work in reality?
3. Reality: Is the strategy even being executed at all, or is management doing something else entirely?

The last point is perhaps the most important, as a director of a company is in a position of immense trust. A minority investor invests in a company based on the promises of a CEO asserting what the said company's strategy is. This minority investor then comes to a conclusion of the company's future based on this strategy and its expected execution. That same investor would feel pretty betrayed if the CEO does not then execute what he has promised to execute.

For example, let's say that a company comes to the market promising to construct private schools at a rate of three to four new schools a year. The CEO promises certain targets of learners and certain cash flows and profits at certain points along the way.

Now, the first part of that scenario is a strategy, while the second part is really just management guidance.

Management guidance will never be perfect, as profits and cash flows are variable. Still, any quality management guidance should at least be pretty close to what the company eventually reports. If not, questions have to asked why management guided to those figures at all in the first place?

So, this private schooling company's strategy is to grow by constructing a couple new schools a year. There are a couple aspects to this sentence, of which I am going to focus on just one: constructing schools.

Organic growth tends to be slower, but safer than acquisitive risk. Hence, if the company's strategy is basically to attack the private schooling market by growing organically, I can build this into my investment decision, my time horizons, my models and my overall assessment of the risk of the investment and final decision to buy the shares or not to.

And then the private schooling company starts aggressively acquiring other private school businesses.

And misses its stated profit targets.

In this example, as a market analyst, I would start to grow increasingly uneasy of management. I return again to the element of trust and how, arguably, in this situation it has been broken or, at least, very much strained.

In the above example, the company is Curro (COH) and I am growing increasingly uneasy of management. For some background on Curro, have a glance at the article I wrote shortly after it listed: COH: Enthusiasm could be expensive.

Now, let me run you through the course of events surrounding Curro:

1. Curro publishes its pre-listing statement, noting that a competitive advantage Curro's is that its school fees are some 20% to 40% less than other role players in the private education market. The reason for these lower school fees is because Curro constructs its own schools and can do so cheaper than other players (who tend to contract an outsider to construct the schools). (Clause 1.3.2.3 of Curro's prelisting statement. Also have a look at Clause 1.1.8 where Curro uses the very specific phrase "By building schools in middle to affluent areas, Curro frees up valuable Government resources that can be spent in less affluent areas.")
2. Curro lists and raises over R322m via a rights issue in its script and ear-marks this capital for the execution of its stated strategy.
3. Curro's CEO, Chris van der Merwe, reiterates its profit promises to the market by indicating that they are expecting a R1m profits at the end of 2011. (See here where vd Merwe says "...we promised the marketplace a profit after tax of R1m at December 31 this year. According to our cash flow and business forecast, we will easily strike that target.")
4. Curro's CEO, Chris van der Merwe, goes on record talking to Moneyweb as reiterating this strategy of building schools and identifies the target as constructing between 3 and 5 news schools a year. (See here where vd Merwe specifically says that "The business vision, Hilton, is to construct anything between three to five schools per year.")
5. Curro then buys Woodhill College for R185m (over 10% of Curro's market cap at that stage.) on 22 November 2011, just about five months after being listed. CEO, vd Merwe, talks to Moneyweb about the acquisition and goes on record saying the following: "...we have two different growth divisions in our company. The one is by naturally enrolling children and the other one is by acquiring schools ...  Alec, unfortunately I can’t share our new vision with you, we can do that after December."
6. Curro CEO, vd Merwe, then goes on record again a couple days after this when talking to Summit TV by saying that Curro's "...integral strategy is always to build."
7. Curro then buys three more private schools in late February and, while talking to Moneyweb again, CEO vd Merwe states how "...we have revisited our vision and in terms of our strategic intent we now focus on three key words. So we are spreading our wings to go for acquisitions of schools similar to Woodhill, so that is a change in vision. Obviously we are going ahead with the developing of Curro original schools because that seems very, very popular, and now we see an even bigger market in terms of entering the school market similar to the Meridian concept."
8. A day later, Curro then releases a revised trading statement indicating how "Shareholders are hereby advised that a reasonable degree of certainty exists that the Company will report an attributable and headline loss of between 5.6 cents and 6.6 cents per share for the year ended 31 December 2011, opposed to a profit of 0,7 cents per share published in the Profit Forecast."

So basically, Curro came to the market to build private schools and promises some targets, which included a break-even / small profit position by the end of 2011. And Curro then has gone around buying schools and will not make a profit in 2011.

If your competitive advantage is low school fees and these schools fees are low because you have the ability to build cheaper schools than competitors, then how exactly are you achieving this if you are buying schools other businesses built?

So, basically, Curro's competitive advantage comes from building, but they are now buying.

But Curro's "...integral strategy is always to build."?

But, oh, wait... Now Curro has "...revisited [their] vision and in terms of [their] strategic intent [they] now focus on ... acquisitions of schools similar to Woodhill ...[and]  developing of Curro original schools ... [and] ... entering the school market similar to the Meridian concept."

And forget about the 2011 profit, now Curro's going to report a loss because it has "...subsequently built additional capacity and seized more opportunities than initially anticipated. The costs associated with same have consequently had a negative impact on earnings during the current reporting period."

Wow, sounds fantastic... Fantastic for everyone, except those minority shareholders who put their hard earned cash into Curro stock based on its pre-listing statement and related strategy.

In the meantime, "Curro's prospects remain positive and the financial benefits associated with the expansion of the Company's footprint are expected to come to fruition in upcoming reporting periods."

So a lot of what you previously said has not come to pass, but because you tell us that everything is great we must be happy with that..?

The problem with Curro's growing divergence between its promises and reality is that it has not even been listed for a full year! So with such early stage divergence, it is anyone's guess what Curro will be doing in five or ten years time?

If I make a long-term investment into Curro, then I have to be certain that what I am investing in, is actually what will be there in five or ten years time.

At this rate and within a reasonable margin of forecast error, I am just not convinced anymore that I know what Curro will look like in five or ten years time.

• < Prev
• Next >