Adapt IT CEO Sbu Shabalala’s property deal raises questions

There are a number of Adapt IT shareholders who do not think it is good for CEO Sbu Shabalala to own the building his company uses for its head office as the tenant’s interests are secondary to the landlord’s interests.

This is the view of Huge Group CEO James Herbst, who has made an offer to shareholders to acquire Adapt IT through a share swop.

To fully understand the deal and the concerns from Herbst, it is of value to go back a few years.

In 2015 Adapt IT initiated the project to develop a new Johannesburg campus and merge its eight legacy offices into one.

Building of the new Adapt IT campus started in November 2016 and the company signed a long term lease agreement with Inyosi Ross on 19 December 2016.

Adapt IT moved into the first phase of their new office in February 2018 and occupied the second phase in August 2018.

Six months later, on 1 March 2019, Mshengu Property Holdings acquired Adapt IT’s Johannesburg campus from Inyosi Ross.

The lease agreement signed by Adapt IT in 2016 was automatically ceded from Inyosi Ross to Mshengu Property Holdings.

Over the last financial year, which ended 30 June 2020, Mshengu Property Holdings earned lease rentals of R34.62 million from Adapt IT.

Mshengu Property Holdings is 100% owned by the Mshengu Family Trust, of which Shabalala is a beneficiary and trustee. Shabalala is also the sole director of Mshengu Property Holdings.

Adapt IT campus
Adapt IT campus in Johannesburg

In response to questions from MyBroadband, Adapt IT said there is nothing untoward regarding the deal.

The company said the sale of the property was strictly between Mshengu Property Holdings and Inyosi Ross.

“The sale of the Johannesburg campus was concluded independent of the company and it has had no adverse effect on the lease terms,” Adapt IT said.

“The terms are still exactly the same as when it was entered into with Inyosi Ross, save that the landlord has changed.”

To avoid a conflict of interest, Shabalala recused himself from the decision regarding the property.

“Shabalala fully disclosed and completed the notice of directors’ personal financial interest along with recusing himself from all of the company’s decisions pertaining to the lease since Mshengu Property Holdings effectively became the landlord,” Adapt IT said.

“At the time of entering into the lease agreement, the board of the company was comfortable with the term of the lease which is in line with the company’s facilities strategy.”

Adapt IT said its board remains comfortable with the terms of the lease agreement.

Sbu Shabalala
Sbu Shabalala

Having a CEO of a company which owns, or partly owns, the property which the company uses as its campus raises questions about a potential conflict of interest.

Higher rent, for example, is good news for the CEO, but bad news for the company which must pay this rent.

There are also concerns that the executives may want to satisfy the CEO’s needs when they deal with issues related to the property.

Commenting on this scenario, the Institute of Directors in South Africa (IoDSA) said conflicts typically involve tension between multiple competing interests, be these personal or financial.

This often manifests in the entanglement of the private and professional interests of an individual.

The existence of a conflict is, however, not necessarily an indication that an impropriety has occurred.

“Some conflicts are pervasive and should be avoided, while others can be managed,” the IoDSA said.

In assessing whether the conflict is material, and therefore must be avoided, the board needs to consider the pervasiveness and the period over which the conflict will occur. This will often involve judgement.

“The onus is thus on the board to adequately assess this, including the various multi-faceted risks and attendant opportunities, and what ultimately is in the best interests of the company,” it said.

Huge Group CEO James Herbst
Huge Group CEO James Herbst

Herbst told MyBroadband he is certain Adapt IT’s directors and Shabalala would have followed a process to deal with “what was clearly a conflict of interest for Shabalala as a conflicted director”.

“We are unsure with which Adapt IT Holdings associated company the Lease was concluded so we are unable to make reference to the designated Adapt IT Holdings’ tenant,” Herbst said.

The Huge Group CEO said where companies often fall short in dealing with conflicts of interest is understanding that it does not only present itself at one moment in time, but rather across time.

“Most boards think that the conflict of interest arises once. In this example, it is at the time of considering the conclusion of the lease,” Herbst explained.

“However, this is not correct. What boards should do is consider other times that might arise in the future when the conflict of interest might manifest.”

If Shabalala recused himself from the deliberations which took place before concluding the lease, this would have been an example of good corporate governance.

However, Herbst said, the other directors should have asked additional questions at the time of considering the conclusion of the lease.

Herbst provided the questions to consider, and where relevant his comments below the question.

  • What is the term of the lease and is the term normal?

In this example, we understand that the lease had an initial term of 13 years. We are of the view that a 13-year lease is not normal in South Africa. Long leases are normally 5 years but no more than 10 years.

  • What is the cost of the lease and is the cost normal?
  • Is there an ability to terminate the lease early?
  • What is the value of the lease to the landlord and Shabalala?

It appears that the lease’s lease rentals of about R34 million per annum with annual escalations probably approximates a present value of R500 million, and in all likelihood equals the cost of the building.

  • What circumstances could arise in the future where the interests of the landlord and the tenant are not aligned?

Example 1: The world has changed because of Covid and in all probability the Adapt IT head office is probably not fully occupied. The ability to downscale should have been contemplated at the time of deciding to conclude the lease and the interests of the landlord versus the tenant should have been considered.

Example 2: Mergers and acquisitions are often viable because of cost cutting opportunities. The interests of the landlord versus the tenant in a merger or acquisition of Adapt IT Holdings should have been contemplated at the time of deciding to conclude the lease and which interests would outweigh the other and which party would be in control of the respective interests. In this case, the Conflicted Director is in control of the interests of the landlord and the tenant but he has more to gain if he looks after the interests of the Landlord ahead of the interests of the Tenant.

  • If a matter arises in the future involving the Landlord and the Tenant, will Shabalala act in the best interests of the landlord or the tenant?

Shabalala’s interest in the tenant probably have a value today of about R100 million, whereas his interests in the landlord likely have a present value of R500 million.

This, Herbst said, is why they agree with the view that it is not good for Shabalala, as CEO, to own the building Adapt IT uses for its head office.

MyBroadband asked Adapt IT why Shabalala decided to acquire the Adapt IT Johannesburg Campus, but the company did not answer this question.

They would also not address questions about the potential conflict of interest, which other properties Mshengu Property Holdings owns, or whether the property deal influenced his support of the Volaris offer to acquire the company.

Instead, Adapt IT said the document embedded below addressed all the issues regarding the Adapt IT property in Johannesburg.

Now read: Large group of Adapt IT shareholders support Volaris acquisition offer

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Adapt IT CEO Sbu Shabalala’s property deal raises questions