Fairfax Media Limited (ASX: FXJ) is missing the point in a recent piece on the demise of the bankrupt Forge Group Limited (ASX: FGE). While Fairfax retains top talent and relevance, reading about its coverage of Forge Group in the Sydney Morning Herald and The Age over the weekend, I was reminded that we should all be sceptical of what we read: especially if it smells of spin. I welcome scepticism personally and am always happy to receive feedback over twitter or via email. On several occasions, readers have helped me refine my thought. Next time Fairfax reports sympathetically on Forge CEO David Simpson, the company's journalists might consider mentioning that he received over $2.9 million in remuneration in 2013, while shareholders have more than likely lost their entire investment.
"CEO David Simpson," Fairfax reports, "a former rugby player, was tripped by projects that cost him the game." However, the facts simply do not support the contention that CEO David Simpson was tripped. Rather, Simpson has been a well-remunerated beneficiary leading Forge to its doomed ending. It's worth noting that Simpson never bought a single Forge share on market. Personally, if I had made the terrible error of owning Forge shares into liquidation, I would find the reference to my loss as costing David Simpson "the game" as inappropriate. I hope the CEOs of companies I own shares in do a better job than Simpson.
Shareholders paid Simpson $750,000 to sign on as CEO in CY 2012, and he received a yearly salary of $1 million, together with long and short-term incentives. The short-term incentives were two tranches of $500,000 payable on achievement of an increase of 10% EPS from one period to another. One investor who saw the writing on the wall for Forge described the short-term incentive bonus as having "such a ridiculously low hurdle for such a huge payoff, it amounts to a joke." I couldn't agree more and the Fairfax portrayal of Mr Simpson as a victim of external circumstances strains credulity.
It's pretty easy to grow earnings by 10% if you simply take on more debt and make acquisitions that will boost earnings. That's exactly what happened with Forge's acquisition of Taggart, which the Fairfax article conveniently ignores. The acquisition was funded by debt, with subsequent equity payments not impacting the CEO's short-term bonus. If Simpson hadn't made the Taggart acquisition, the company would have had less debt and may have survived the writedowns associated with the prior purchase of CTEC in 2012.
Many of the individuals responsible for that decision left the company shortly thereafter, selling all their shares, along with the major shareholder, Clough Limited (ASX: CLO). I'd describe that as alarm bells ringing, although other commentators described the company's performance in FY 2013 as "kicking goals with both feet." I guess it's all subjective.
Fairfax reports that Simpson "had the ball firmly in hand and the finishing line in sight," and quotes Simpson claiming, "I was tripped!" In reality, Simpson was paid handsomely and oversaw massive destruction in shareholder value. Mercifully, The Australian has been providing a more rounded view of the situation. Journalist Paul Garvey reveals how Forge "splurged on executives".
"A lavish Christmas party for its staff," he writes, "was just one of several puzzling expenditures carried out in the group's final months." The company also relocated its executives from Perth to Sydney, despite opening an expensive new office in Perth in 2013. The company even paid stamp duty when one executive bought a new house in Sydney, according to The Australian. Forge executives continued to fly across the continent in business class seats until the company ran out of money, leaving 1,400 workers unpaid.
It seems clear that previous Forge management did not conduct the necessary due diligence on CTEC in particular, and thereafter did not have adequate risk management processes and systems in place. When it comes to contracting, being fully aware of potential risks and threats is absolutely vital to prevent situations such as those that crippled Forge.
Foolish takeaway
The demise of Forge is an important lesson on the importance of examining management. Long before the company entered liquidation I gave readers 10 reasons Forge was a poor investment. These 10 reasons related mostly to management selling shares and the poorly designed incentive structure for the CEO, which rewarded unwise expansion. Yet, I ignored the biggest reason to avoid the company: an unattractive business model. This is admittedly a subjective judgement and I know investors who achieve outperformance by investing in average or poor businesses at the right price.
Forge Group's business model were low margin projects to build gas-fired power plants in remote locations to support new or expanded mines. As if that wasn't risky enough, the company also took on high levels of debt to fund acquisitions. If that doesn't scream "unsustainable", I don't know what does. There are much safer businesses on the ASX, that's for sure.
