East Sydney Private Hospital: Adrenna CEO Ricky Fertig holds a minority interest in the hospital. Picture: Adrenna
East Sydney Private Hospital: Adrenna CEO Ricky Fertig holds a minority interest in the hospital. Picture: Adrenna

The effort by small-cap counter Adrenna to diversify away from its traditional real estate base is starting to look awfully messy.

Adrenna — which is a remnant of the old Quyn Group (later Colliers) that listed in 1999 — has endured a low-key tenure on the JSE since 2012, with its tiny Western Cape property portfolio not warranting much market attention.

Over the past three years, its share price has drifted 22% lower. It seemed listless: not paying dividends, nor seeking opportunities to build any scale. Finally, last year, Adrenna sprang into action: it shifted into health care, by backing a specialist day clinic business in Australia.

Its auditors RMS have now raised a "reportable irregularity" with Adrenna’s accounts, and slapped a qualified audit opinion on its financial statements to February.

In Adrenna’s 28-page annual report, RMS specifically flagged a transaction where Adrenna lent A$2m (R22m) to East Sydney Private Hospital (ESPH) in Australia, which bills itself as "one of Sydney’s finest boutique private hospitals". The catch is that Adrenna CEO Ricky Fertig holds a minority interest in the hospital.

Adrenna argued that the ESPH investment was motivated by the opportunity to "invest in a relatively strong currency and would enable the company to acquire the necessary skills to possibly replicate similar operations locally".

Notes in the financial statements show that Adrenna first advised shareholders in September 2018 of an agreement to advance ESPH R22m, "subject to shareholder approval".

But Adrenna went ahead and lent that A$2m, before it sent out the circular or got the green light from shareholders.

The way it was meant to work was that Adrenna would subscribe for 2-million convertible redeemable preference shares in ESPH. Then, on conversion, Adrenna would secure a 15% shareholding in the private hospital by February 2021.

But the preference share part of the deal was then terminated (by mutual consent). Adrenna said this was because of "the difficulty in obtaining the relevant historical financial information" for the shareholder circular.

It means the investment remains a loan, carrying interest at a rate of 12% interest a year. Adrenna still counts that "loan receivable" as an asset worth R21.5m in its books.

But what has irked the auditors is that Adrenna hasn’t impaired the loan — even though ESPH is now technically insolvent.

As RMS puts it: "We were unable to obtain sufficient appropriate audit evidence to satisfy ourselves that no adjustments to the carrying amount of the loan receivable were necessary in these circumstances."

It raises other governance questions too.

First, this transaction wasn’t put to a shareholder vote before the money was lent. And it’s worth pondering whether all shareholders would have approved a loan, equal to 40% of Adrenna’s market capitalisation, given the fact that it’s a related-party deal.

Cynical investors might see this as Adrenna’s resources being deployed to bail out the CEO from one of his struggling investments.

RMS’s "reportable irregularity", which has been sent to the Independent Regulatory Board for Auditors, relates to the advancing of loans to related parties as well as noncompliance with JSE rules around shareholder approvals.

Fascinatingly, however, Adrenna directors are not only disputing certain aspects of their own auditors’ "irregularity", but the group has also doubled down on the ESPH loan. After the year-end, it lent another A$300,000 (R4.1m at today’s rate) to ESPH. And it has also committed (subject to shareholder approval) to extend another R4.5m on loan account.

In defending why the ESPH loan should not be impaired, Adrenna said ESPH is confident of achieving earnings before interest and tax of A$2.5m in 2020 and A$5m in 2021. Adrenna suggests this recovery will value its original A$2.75m at A$3.75m-A$7.5m.

Next year it expects revenue to grow "significantly", due to the construction of a hybrid theatre extension, a new outsourced radiology department and extra hospital beds.

Adrenna directors argue the loan will be recoverable either way. "There is no basis to raise a provision for impairment," they say.

The company says a circular detailing the ESPH transaction, which will include a fairness opinion from an independent expert, is being prepared. Only then will shareholders be requested to approve the original A$2m loan to ESPH — after the fact.

While the health-care foray has proved immediately controversial, it was but the first step to diversifying Adrenna away from its property business. There is also a R2.6m loan made to a mining business, Adrenna Resources, which was exploring mineral reserves in Zambia and Zimbabwe.

However, this is yet another related-party transaction, since Adrenna directors Fertig and Bernard Kaiser also serve on Adrenna Resources’ board. It is 100% owned by a 61-year-old South African businessman, Ivan Whitehead.

The R2.6m loan was to give Adrenna Resources funding to complete a due diligence and do exploration work on the mines. The loan — which will also require a fairness opinion and shareholder approval — is unsecured, interest-free and carries no fixed terms of repayment. In return, Adrenna obtains the right to 70% of Adrenna Resources’ share capital.

But the hitch here is that changes to the tax rules and the exportation of mineral products to Zambia have, in the words of Adrenna’s directors, "resulted in this type of venture being unattractive to potential investors".

As a result, Adrenna has deemed it prudent to impair the entire loan.

And then there’s tourism. During the past financial year, Adrenna also invested in Safari News, a start-up conservation and ecotourism platform (in both digital and print media).

Adrenna has provided funding of R2m and given it two years to become self-sufficient; it gets the option to buy 50% of Safari News at a later date.

These scattershot diversification efforts should certainly make for an interesting discussion at Adrenna’s AGM in mid-September.

But perhaps more pressing for minority shareholders is an early-stage proposal to delist the company via a share buyback.

Considering the nature of the ongoing diversification effort – and the nature of the loan transactions – it might well be best for Adrenna to operate as a private company. There is one potential hitch: the share is wedged at 95c versus a NAV of 291c a share. This will make any buyout pitch very interesting.