“To move forward with purpose requires that we extricate the public and private sectors from the current comfort zones,” president Nelson Mandela told the South African parliament at the opening of its 1996 session in Cape Town early last month.
The sentiment is keenly endorsed by the burgeoning black business sector. What is more, the vast majority of brokers on the Johannesburg Stock Exchange (JSE) appreciate the importance of the radical shake-up it demands. Yet beneath this apparent consensus, the legacy of apartheid is writ large across South African business. Nowhere is it more conspicuous than on the JSE’s listings board.
Twelve black-owned companies are listed but, as of January 31, their combined market value was R7 billion ($1.92 billion), slightly less than 0.6% of the total market capitalization of R1.2 trillion. This is easily explained, says Jonty Sandler, CEO of New Africa Investments, by far the largest black-owned conglomerate and, in August 1994, the first to be listed: “It is very difficult for black business to raise capital.”
Much of South Africa’s political transition has been exemplary, but the real test of liberation will be played out on the stock exchange. Without a more equitable distribution of economic power, the process could still come off the rails. As the principal mechanism for raising risk capital in sub-Saharan Africa, the JSE will play a critical role in the development of the new nation. As Mandela put it: “We cannot build or heal if we continue with business as usual.”
Economic empowerment
It’s a tall order for an exchange whose brokers are white, but it’s one that has long preoccupied the JSE’s governing committee. In last year’s annual report, JSE president, Roy Anderson, noted that the exchange “is now being used as a vehicle for widening economic empowerment”. His optimism may be premature, given that black-owned business is characterized by the same types of tightly controlled corporate structure that were developed by white-owned big business before liberation, and were, for decades, the butt of the criticism from exiled liberation movements. Nevertheless, a number of recent initiatives at the 108-year-old bourse testify to its attempts to attract more black-owned business.
Particular attention has been paid to junior markets. The development capital market, the oldest of these, plummeted during the global stock market crash of 1987 and has not recovered. Its fundamental problem is size. With only nine listings, it is thinly traded and it is poorly understood. Improved research would revive interest, but would require investment that brokers will avoid as long as returns in bigger and more complex equity markets are buoyant.
The JSE’s second attempt to find a new vehicle for development funds was the venture capital market, which was founded in 1992 to raise capital on a project-by-project basis. Although fundamentally different in purpose, the new market’s design is an improvement on the company-based older board. Companies seeking a listing on the development capital market are, for example, required to submit a two-year profit history and command at least R1 million in subscribed capital. Less stringent conditions were attached to the venture capital market. These were further relaxed last year to attract businesses with capital needs beyond the R500,000 ceiling of the government’s Small Business Development Corporation. The profit-history requirement can be waived altogether at the discretion of the board.
In addition, what is known as a redevelopment sector has been launched on the JSE for companies whose objective, says the listings guide, is to provide “assistance to socioeconomic development”. The sector is listed with other financial stocks on the JSE’s main board, but some of the listing requirements may be waived by the listings committee which has “sole, unfettered discretion” over the admission of new applicants. By contrast, other sectors on the main board have a minimum listing requirement of R2 million in subscribed capital and a three-year profit history.
Notwithstanding the good intentions of the JSE committee, the junior boards have failed to capture the imagination of managers with no experience of the stock market. The redevelopment sector boasts only three listings, all for Umbono, a private-sector funding and management agency which went to the market this January. The most successful of the juniors has been the venture capital market, with 10 listings including M-Cell, the cellular-telephone venture of the Multichoice pay-television group, and several other technology stocks.
JSE operations director Neil Carter is aware that the creation of junior boards with relaxed entry criteria does not address the latent divisions between the JSE and black business. “We are still saddled with the image that the stock exchange is a casino for rich whites,” he says. “We have not gone out in a systematic way to identify black entrepreneurs”.
The JSE has launched a new marketing drive targeting black leaders of medium-sized businesses. But these are thin on the ground despite the rapid growth of this sector – which is perhaps why the JSE’s search for a black marketing specialist to spearhead its campaign has so far proved fruitless.
There may also be more profound reasons for the JSE’s scant appeal among black entrepreneurs. The legacy of exchange controls, designed to prevent capital outflows during the sanctions era, is a labyrinthine network of cross-holdings among local companies forced to invest their profits at home. More than 70% of the JSE is controlled by four corporations: mining and industrial group Anglo American, insurance group Sanlam, tobacco and luxury goods group Rembrandt, and insurance and financial services group SA Mutual. All are tightly controlled empires built on multi-tier pyramid structures that vest ultimate control in their founding families. The Oppenheimers of Anglo American and Rembrandt’s Rupert family are the best-known examples.
Such concentration of economic power has long been a grievance for those outside the inner sanctum and continues to attract fierce criticism from the African National Congress (ANC). It is an indication of the low esteem in which the new government’s majority party holds these structures that justice Richard Goldstone, the country’s most eminent judge, has been appointed to head a new committee charged with reviewing corporate governance and reforming company law. (Goldstone spearheaded inquiries into the so-called “third force” activities of apartheid’s security forces during the 1980s.)
The creation of new multi-tiered pyramids has for decades been banned on the JSE, unless they are the “demonstrably fortuitous” out-come of mergers or acquisitions approved by shareholders in all operating companies. That issue, and the concomitant question of “unbundling” the existing corporates in the interests of diversifying economic control, has gained a new lease of life from South Africa’s return to the global economy.
Ironically, black empowerment has revived pyramid structures, whose staunchest defenders are none other than the black business leaders formerly involved in the anti-apartheid struggle. The best known of these is Nthato Motlana, chairman of New Africa Investments, who was once Mandela’s personal physician and who was frequently detained by police during the 1980s state of emergency.
Through Corporate Africa, a first-tier holding company, Motlana, and several other prominent black business leaders, control New Africa Investments, an empire that counts at least 20,000 individual shareholders and trade unions representing more than 500,000 people. Similarly, Real Africa Holdings, the JSE’s second-biggest black-owned listing, is controlled by a first-tier parent, Real Africa Investments. Its founder, Don Ncube, learned about the workings of pyramid structures during a 20-year career at Anglo American. He eventually earned directorships on the boards of several Anglo American group companies.
Both conglomerates derive their moral standing from the hundreds of thousands of blacks who have direct or indirect stakes in their operating companies. However, at holding company level, control is vested in a much narrower array of shareholders.
The standard justification for the new pyramids is that they help to balance the concentration of power in white-owned business. Without them, it is argued, black investors would still be at the starting blocks in the race to wrest meaningful economic control from the hands of established conglomerates. By contrast, though, with the white families that have dominated South African business and once enjoyed the freedom to create multi-tiered pyramids, the ultimate influence of Motlana and Ncube is curtailed by the Companies Act, which forbids new pyramid structures of more than one tier.
In pursuit of similar goals, the JSE has allowed black investors to list so-called N shares which carry diminished voting rights. Thus African Life is controlled by Real Africa Holdings, whose shareholding is 47%, via weighted shares. Critics of weighted shares argue that the loss of voting rights defeats the essential principle of share ownership, undermining the principle of “one share, one vote”. To date, the market has taken little note: N shares generally trade at the same price, or only fractionally lower, than ordinary voting shares. Pragmatists point out that while the principle of N shares is deplored by stockbrokers everywhere, N shares listed in London, for example, are traded in a similar way.
The consequences of intervention have so far deterred the overloaded new government from tackling the issue. Ministers are mindful that New Africa Investments was floated after Sanlam responded to political pressures by unbundling Metropolitan Life to New Africa Investments, and that Johannesburg Consolidated Investments, the R7 billion holding company owned by Anglo American, is also up for sale this year. In the long term, it is unlikely that these voluntary disposals will avert pressure to reform the oldest of the multi-tier pyramids. The disposals may, however, be sufficient to deter forced restructuring – a policy which the government knows could interrupt the influx of foreign capital to the JSE.
As the volume of black-owned capital increases, the influence of those who oppose pyramids and N shares on principle could find an unlikely ally in the rank-and-file members of the former liberation movements. Community leaders have already expressed concern that the banner of black empowerment has been something that a new economic elite could shelter behind. The partial privatization of state-owned assets later this year will further fan the flames of controversy, as a substantial portion of the sales will be to black interests.
Telecommunications operator Telkom, electricity generator Eskom and South African Airways are among the state assets earmarked for “restructuring”. If, as predicted, the initial phases of privatization win political acceptance, the subsequent sale of larger stakes will drastically alter the profile of the JSE.
The biggest-market-cap companies on the JSE have been insulated from the pressures of the global economy by exchange controls. Once restrictions on the outflow of domestic capital are lifted, the dominant conglomerates will invest heavily overseas in a bid to export long-contained expertise into new markets. An improvement in liquidity is inevitable, clearing the way for an unprecedented level of trading on the JSE and heralding a new era of opportunity for black investors currently frustrated by the scarcity of saleable stock.
President Mandela’s speech to parliament left no doubt that the next phase of South Africa’s revolution will be played out on the JSE’s trading screens. Commenting on the prospects for abolition of exchange controls, Mandela prompted a spate of gambling among stockbrokers eager to predict the decline of controls. “For us,” he said, “it is not a matter of whether, but of when these controls will be phased out.” n
Thirsty for liquidity
Brokers on the Johannesburg Stock Exchange (JSE) are prepared to give up everything, including their city-centre offices, to satisfy the international institutions whose capital inflows have propelled the market to record highs. In the first five weeks of 1996, market capitalization increased by 15% to R1.2 billion ($330 million). As recently as last December, analysts had forecast that it would take a whole year to achieve that level.
This month, the JSE will get its first taste of electronic trading, which is intended to make the exchange more attractive to international players. Although life on the trading floor has survived the shift to screen-based trading in other countries, local firms are considering leaving the city in favour of suburban office parks. “We will have more of a banking culture – more electronic, more international, a lot of faceless people behind screens,” says Neil Carter, JSE’s head of operations.
If the introduction of electronic trading is on schedule, the Diagonal Street tower block that houses his office in downtown Johannesburg could be up for sale by the end of the year. Chemicals sector listings are expected to be screen-traded on March 8, with other sectors due to follow by June.
Roy Anderson, executive president of the JSE and architect of the changes, has a straightforward ambition: “To create the best medium-sized stock exchange in the world.” His vision won the support of more than 75% of brokers when the proposals were put to a vote last year. Technological change was backed up by deregulation last November, when the JSE opened its doors to banks and other institutions, allowing them to operate on their own account for the first time. The next steps are designed to create a market more efficient, transparent and secure than its predecessor.
There are three key aspects of the reforms. Automated trading on the JET (Johannesburg equities trading) system will replace open outcry, continuous auction on the trading floor. Buyers and sellers will enter orders from their computer workstations, JET will match the orders and complete the transactions automatically.
Second, brokers will be allowed to take on a dual role after electronic listing, trading as agents on behalf of clients, or as principals on their own account. They will, however, be obliged to disclose the capacity in which they want to trade.
Third, banks and other institutions may join the exchange as full members where previously they had been confined to a maximum 30% stake in existing firms. Some banks, such as BOE NatWest Securities and Baring ING, have chosen to launch new operations, while others, such as Rand Merchant Bank, have entered the market on their own account. Brokerage fees are now fully negotiable; competition could bring them down by as much as 45%.
Amid the general enthusiasm for change, fears have been expressed that, under a more liberal regime, the most lucrative trade could shift to London. Of the 641 companies listed on the JSE, 154 are also listed on overseas exchanges, 81 of them in London. Although orders will be processed chronologically on the automated system – it won’t be possible for bigger orders to receive preferential treatment from brokers – Carter says there has been “no real sign” of a shift of business to London.
Before considering the possibility of shifting business, institutions are probably waiting to see how the JSE adapts to the abolition of exchange controls, widely expected later this year. Initial steps towards abolition could come as early as the March 13 government budget statement. When completed, they will precipitate a huge rise in trade volumes as local conglomerates rationalize their assets and begin to invest and expand overseas. The success of such a move, which has been widely touted by business as a panacea for the JSE, will be measured by its effect on the exchange’s stubbornly low liquidity.
Illiquidity, rather than political risk, is now the biggest deterrent to international investors considering South Africa. While analysts admit the wider world is waiting to see how South Africa’s democratic transition fares under a successor to 77-year-old president Nelson Mandela, there is widespread agreement in financial circles that Johannesburg is a relatively secure market, lying somewhere between Asia, with its higher P/E ratios, and the debt-laden Latin American bourses. “This is the least emerging of the emerging markets,” says Nicholas Banszky, head of corporate finance at Smith New Court.
Liquidity, based on annual turnover as a proportion of market capitalization, has remained flat this year at 7% – on a par with the annualized 1995 figure, but down 0.6% on 1994. For as long as exchange controls survive, the 60% to 70% annual liquidity ratio of London or New York will remain a brokers’ dream.
Other obstacles to improved liquidity include the marketable securities tax and stamp duty, both pegged at 1%. These are earmarked for review and most brokers are confident they will be brought down to 0.5%, in line with London, at the next budget. “This is an issue of revenue, not of principle,” says Carter. “Everyone knows it’s a bad tax.”
Reforms to capital gains tax, currently collected at the discretion of the tax receiver, would also be welcomed. The knowledge that share deals are liable for full taxation encourages players to sit on stock that would otherwise be saleable.
The controversy of the moment is the recommendation by the government-appointed Katz Commission that, as part of a broader overhaul of the tax system, interest on pension funds should be taxed at 30%. Last month, finance minister Chris Liebenberg reaffirmed his support for the proposal in the face of angry protests from pension fund managers reluctant to invest in the tightly held equities market. Joss Gerson, a director at brokers Smith Borkum Hare, speaks for most brokers when he brands the tax an anathema: “The big local institutions are up to their eyeballs in equities,” he says, “which leaves little room for anyone else.” – MA
Turnover on the Johannesburg equities market
Equity capital raised on the Johannesburg Stock Exchange
1991 1992 1993 1994 1995
Acquisition of assets 1846 2839 3632 2986 1664
Rights issue 6529 7403 7263 2881 6834
Scrip dividend 192 1141 697 2272 5370
Share incentive 233 677 590 1091 681
Via prospectus 692 239 578 341 942
Waiver of pre-emptive rights 0 0 318 120 1538
Other 145 5 480 297 2700
Total 9637 12304 13558 9988 19729
Source: Johannesburg Stock Exchange
