Poor corporate governance practices in a target company are not something investors should take lightly as a lack of due diligence can jeopardise exit plans and valuations. This assumes greater significance amid the ongoing COVID-19 pandemic as investors can ill afford risky, reckless bets.
Here is the second in a short series of stories that DealStreetAsia is producing on the issues plaguing Vietnam’s startup industry.
Vietnam may be the destination of choice for private equity investors (PEs) looking for pandemic-resilient markets, but they must be cautious of companies with poor corporate governance issues. Two recent public spats between investors and their investee companies bring to the fore the gravity of this risk.
The first instance is that of restaurant chain Huy Vietnam, where Chinese and Singapore investors sued the founder Huy Nhat in May for allegedly embezzling $25 million.
In a similar instance, in June, Singapore-based strategic investor Kusto Group asked the top management of Coteccons to resign, accusing the construction firm of misappropriating its funds to group companies. Kusto holds a 17.55 per cent stake in Coteccons and invested eight years ago as part of its $100 million-plus Vietnam portfolio.
It is being supported by Singapore-based hedge fund Vahoca Pte in its push against the Vietnamese firm.
The result in both cases was an erosion in investment value and diminished chances of an exit for investors. “Good standards [in accounting and governance] and other management practices are key to creating value and selling stake further down the line,” said Andy Ho, chief investment officer of asset management firm VinaCapital.
Huy Vietnam: When faith is eroded
The tussle between Nhat and his investors goes back a long way.
In October 2019, investors ADV Partners, AIF Capital, F&H Fenghe, Fortress Investments, Gryphus Capital, and Welkin Capital filed a lawsuit against the restaurant chain founder in the Ho Chi Minh City People’s Court. They claimed that the entrepreneur siphoned off large amounts of cash and assets from Huy Vietnam.
After a month of silence, Nhat finally spoke to the local media claiming he was being forced by the investors to leave his own company. He could not be reached for comment after a second lawsuit was filed against him in May.
Huy Vietnam operates the restaurant chain Mon Hue and several other brands.
Investors accused Nhat of pitching a resort development project, Horizon Langco, in central Vietnam to them in 2018, along with the mainstay restaurant business. They said they had disbursed $25 million for Horizon Langco, but it turned out to be a “bogus real estate project.”
It was “a great failure,” law firm YKVN that represents the overseas investors said in a letter in May. “This is going to be a case to refer to whenever an investment consideration is taken,” it said.
Coteccons’ value erosion
In the case of Coteccons, investor Kusto Group claims the company used its resources and reputation for the benefit of other firms in the “Coteccons Group,” in which Kusto had no interest.
“The conflict of interest among the companies within Coteccons Group by Coteccons’ executive management team have caused significant damages to our investment due to a reduction in Coteccons share prices and serious violation of our shareholders’ rights,” Kusto said in a statement in June.
Coteccons’ share price on the Ho Chi Minh City Stock Exchange has plummeted from the 150,000 dong ($6.5) range since the start of 2019 to around 45,000 dong in early April 2020 before a rally to the current price of 78,000 dong.
Despite being the single-largest shareholder, Kusto says its request to the Coteccons management to organise an extraordinary shareholder meeting was rejected.
“All legal attempts to perform an independent audit by the board of supervisors on Coteccons’ business activities have not received any cooperation from the board of directors and board of management,” Kusto said in June, adding that it had no faith in the management of Coteccons, especially the chairman, CEO, and deputy CEO.
“Having the current management team in charge poses existential risks to Coteccons and could potentially destroy all Coteccons’ shareholder value,” it added.
In its defence, Coteccons’s management issued a statement saying that as part of its business it partners with sub-contractors (known as “units” in the Coteccons Group). The units include Ricons, Unicons Newtecons, BM Windows, and Dcons, which are also in the real estate and construction sectors. The management added that it is willing to work with shareholders on management issues, but accused Kusto of trying to take over its business.
On August 6, Coteccons finally announced significant changes in its top executive team, with a new CEO as well as board seats for representatives from Kusto and another foreign investor.
While the management dispute seems to be sorted, it involved “many years of unsuccessful attempts in dialogue with Coteccons’ board of directors,” according to Kusto.
The Singapore investor claimed that the businesses under the Coteccons Group had cannibalised Coteccons’s profitability. The Vietnamese company’s net profit declined sharply from around 1.5-1.6 trillion dong ($64.5-68.8 million) in the 2016-18 period to 710 billion dong in 2019.
Its management, however, attributed the declines to the “lengthier than expected” timeline of several large construction projects that resulted in increased costs.
Important lessons for investors
“A lot of founders still think they are the owners of their businesses and do not treat PE investors as partners. They think they can bully investors, as in the case with Coteccons and Huy Vietnam,” an investment advisor told DealStreetAsia. “The investors should have done checks and balances to decrease the centralisation of power.”
A fundamental way to avoid fraud or wrongdoing in an investee company is to bring in professionals, especially at the CFO, CEO and chief HR officer positions. “A fish rots from the head,” said Chris Freund, a partner at Mekong Capital, suggesting that governance issues usually stem at the founder/CEO level. “Due diligence isn’t difficult; it just requires effort and discipline,” he added.
Companies in Vietnam are usually controlled by the founders who are also principal owners, highlights Reshmi Khurana, managing director and head of Southeast Asia at risk consulting firm Kroll.
“They control not only the operations of the companies but also the quality of the financial information that is made available to investors, external auditors, regulators, and other stakeholders,” she said.
Meanwhile, the board rarely challenges the management owners.
VinaCapital’s Ho acknowledged that privately-owned businesses, who know what they need to do in terms of managing finances and corporate governance, tend to be in the minority. “While you want to trust the executives of companies in which you invest a lot of capital, you have an obligation to your investors to continually monitor what’s going on,” he opined.
“We always insist on an audit by a Big-4 accounting company before our investment. Further, we do mystery shopping and collect some performance data ourselves and compare it to the data presented by the company,” Mekong Capital’s Freund added.
Don’t rely on the law
Experts agree that given the inefficiencies in the legal processes in Vietnam, taking legal action does not necessarily help investors resolve disputes. It took eight months for the Ho Chi Minh City People’s Court to accept the case filed by Huy Vietnam investors, and the lawsuits have not been settled yet.
Litigation proceedings could drag on for years, while legal professionals might not be fully independent and founders could manipulate proceedings, said Khurana. Adding to that, the execution against assets in Vietnam is also challenging for overseas investors. “In our experience, the red flags are usually present even before an investment is made,” noted Khurana.
Going forward, COVID-19 is projected to dampen deal activities in the second half of 2020, partly due to the difficulties in conducting onsite due diligence. Yet, diligence is something investors should not ignore.