Wiphold puts women centre stage | Private equity and BEE
THE PHILOSOPHY OF the South African policy of Black Economic Empowerment (BEE) is simple. Execution is not so straightforward. Working out how best to get equity in businesses of all shapes and sizes into the hands of blacks, women and the republic’s other historically disadvantaged groups is part of the broader BEE process of giving them the capital, jobs, and skills to take part in entrepreneurship and wealth creation. But this equity transfer is the single biggest preoccupation for South Africa’s M&A advisors and corporate financiers.
According to Ernst & Young’s annual South African M&A survey, there were 244 BEE deals worth a total of R52.9 billion ($7.8 billion) in 2004. That’s an increase in BEE deal activity of nearly one-third by volume and over one-quarter by value on the previous year.
“BEE is keeping every corporate financier in the country busy,” says Tim Thackwray, head of corporate finance at Standard Bank in Johannesburg.
The figures for 2005 should be just as impressive. In the fourth quarter alone De Beers announced its BEE deal – a R3.6 billion ($533 million) sale of 26% of its South African operations – and Anglo American, Kumba Resources and Eyesizwe Mining established a new empowered mining company with an enterprise value of R16 billion.
They are following in the footsteps of Old Mutual, which announced its empowerment deal back in April, and Deutsche Bank, which in February announced that it was selling 25% of its South African securities and corporate finance businesses to a BEE group and its black South African staff in February. Deutsche’s deal was eye-catching – although international banks with South African branches had signed up to the Financial Sector Charter (FSC), one of the industry charters that outlines how to achieve and measure BEE, they had negotiated an opt-out from the FSC’s ownership provisions. Meanwhile, a host of mid-market and unlisted companies are announcing their own smaller BEE deals.
No two deals are the same. But, fundamentally, advisors on all of them have to tackle the same problem. When you are transferring property to groups that have been excluded from mainstream economic activity, those groups cannot fund the transfer out of their own pockets.
“There is a willing buyer and a willing seller,” says Thackwray. “But the willing buyer doesn’t have the necessary capital.”
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“Companies have amended their dividend policy to service BEE debt.”
Fradreck Shoko, JP Morgan |
It helps that the seller wants to do the deal. Indeed, vendor support is almost a pre-condition of doing a BEE deal. “No-one is going to help the buyer buy except the seller,” says Thackwray. The question is how, and at what cost to the seller’s existing shareholders, who will generally agree to sell at a discount.
“On recent deals, the potential cost to existing shareholders has been around 1.5% to 3% of market cap,” says Shaun Rosenthal, head of specialized funds management at Wipcapital, the financial services business wholly owned by BEE company Wiphold [see Wiphold puts women centre stage, this issue]. “That’s generally thought of as the acceptable figure.”
Although they are harder to quantify, the costs of not doing a BEE deal are much higher. In some regulated industries, for example, licenses will only be granted to empowered companies. And when two banks pitch for a deal, an empowered bank has an advantage. “If there’s nothing to chose on price and quality and one bank’s empowered and one isn’t, it’s a slam dunk,” says Deutsche Bank South Africa’s chief country officer, Martin Kingston. That’s explicitly true as far as the public sector is concerned. In November, senior officials at South Africa’s Public Investment Commissioners (PIC), which invests public sector pension funds, were quoted in the local business press as saying that they would regard 25% black ownership as a minimum qualification when awarding mandates. Increasingly, private sector clients take a similar view.
Are options still an option?
The simplest BEE deals use options. These are the lowest-cost deals for existing shareholders, particularly in a cyclical industry like mining, where volatility tends to make options cheap.
But they are going out of fashion. “There is a significant move away from the original deals where you gave the BEE partner a put or call option through which it could get 15% of the company and that was its cut,” says Mark Currie, who as a member of Investec’s treasury and specialized finance division has helped structure numerous BEE deals.
The South African government feels that holding an option does not always guarantee a transfer of real economic interest. For example, a BEE company that holds options doesn’t necessarily get the same voting rights as other shareholders. “The charters don’t like to see the word ‘option’ and the FSC specifically says that options don’t count,” says one banker.
Secondly, there is an element of chance in any options-based deal. “Options structures are a much more conscious bet on your share price,” says Jacques Fourie, director, corporate finance, at Standard Bank.
There is still an element of market performance in many BEE deals. Some rely on dividends to service interest on debt borrowed to finance the deal. “More and more, people set dividends at levels to enable the BEE group to service its debt,” says Fradreck Shoko, vice-president, investment banking, at JPMorgan. “Some companies have amended their dividend policy to achieve that.” When Standard Bank did its own BEE deal in 2004, it was based around a 20-year funding structure that is highly dependent on dividend generation. Incwala Resources, an empowered mining company, also structured its BEE deal with dividends as a major driver of debt repayment.