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Ridley: ?We effectively arrange funding for the participants. The new shareholders get their shares on day one and the dividend flow is used to repay the debt. It’s quite a simple structure? |
South African banks are working out how to structure and finance the Black Economic Empowerment (BEE) deals that are altering the ownership structure of the country’s financial services industry. Under South Africa’s voluntary Financial Sector Charter, direct black ownership in financial institutions should reach 10% by 2010.
In July, Standard Bank Group announced plans to sell a 10% interest in its South African banking operations to three BEE groups. The deal is worth about R4.3 billion ($645 million).
Standard Bank’s sale follows deals by Absa and Investec, as well as BEE deals in other sectors such as mining and telecoms. The country’s total requirement for BEE financing could exceed R75 billion.
There is no regulation BEE template for South African companies to follow. Different deals use different combinations of options structures, equity and debt. In mining sector deals, for example, third-party lenders to BEE groups often take a view on future commodity prices and provide project finance-style debt. Banks have used quasi-vendor finance structures to help pay for their BEE deals.
“In any empowerment deal, for repayment of debt used by BEE groups to acquire shares, one of two things needs to happen,” says Prince Ngcobo, vice-president, Citigroup Global Capital Structuring, who has advised on various BEE deals. “Either the lenders to the BEE group rely on operating cashflows from the target company for repayment of their debt. Or where there is no recourse to the target’s balance sheet, they rely on the BEE group’s proportionate share of the target’s ordinary dividends and the target’s share price appreciation, with lenders relying on the BEE group selling enough of its shares in the target for redemption of outstanding debt.”
Standard Bank has three BEE investors. A consortium formed by investment companies Shanduka Group, co-founded by former ANC secretary general Cyril Ramaphosa, and Safika, which is the largest new shareholder. Standard Bank’s 2,500 black managers will own 2.9% of this second group. The third BEE group comprises regional business and community organizations.
“Our deal is a funded transaction rather than an options deal,” says Standard Bank CFO Simon Ridley. “The new shareholders get their shares on day one and the dividend flow is used to repay the debt. It’s quite a simple structure.”
Standard Bank’s is a two-stage deal. First, Standard Bank creates three subsidiary companies and capitalizes them using preference shares while they are still owned by the bank. The subsidiaries can buy shares from Standard Bank shareholders. Standard Bank then sells ordinary equity in the subsidiaries to its BEE partners. Neither of those steps contravenes the South African Companies Act, which prohibits one company helping another buy its shares.
High-cost funding
The deal allows the BEE shareholders 20 years to pay for their stake, although Ridley says they should clear their debts sooner. “We expect the redemptions to occur in about 17 years, although that assumes there is no appreciation in the share price, which is conservative,” he says.
At the end of 2010, the performance of financial services institutions in South Africa will be reviewed under the Financial Sector Charter. After this, if Standard Bank’s share price has risen, the BEE shareholders can sell some shares and use the proceeds to pay back part of their debt.
The interest rate charged on the preference share funding is 8.5%, which is relatively high even by current South African standards. “That’s why we asked our shareholders to sell their shares into the new subsidiaries at a discount,” says Ridley.
Nobody doubts the worthy motives behind BEE transactions. However, individual deals have been criticized, either for not delivering the true benefits of share ownership to blacks, or for saddling BEE groups with long-term debt.
Absa’s deal, which was unveiled in April. also involves the subscription of 10% of the group’s enlarged share capital by broad-based BEE groups and black employees. The black shareholders’ interests are held by a special purpose investment vehicle, Newco, which has to raise R146.3 million to fund its share subscription.
But the new shares are option-holding preference shares. Holders can subscribe for ordinary Absa shares between three and five years after getting their options.
Options with votes
“Our transaction has been criticized for not offering real ownership from day one,” says Leslie Maasdorp, one of the BEE promoters on the Absa deal. “We believe that is not so. It provides for full voting and economic rights for the options holders from day one. Although it is an options structure, it has the key features of real ownership. If there’s a rights issue we can increase our stake.”
Critics of Absa’s deal also say that delivering empowerment depends on a significant rise in Absa’s share price. If the share price falls, an options deal unwinds. “We recognize that that is a risk we run,” says Maasdorp. In practice, when the deal was first negotiated, the Absa share price stood at around R37. By the time it was signed, the strike price was already below the market price. “We have looked at analysts’ reports and are very confident of where the share price will be in the three- to five-year window,” says Maasdorp. “On day one, the option was in the money, bringing real material benefits.”
The other big challenge is to keep diluted shareholders happy that they are not losing out to the new empowerment shareholders. To do this, Absa came up with an options formula. If the share price is between R48 and R70, the option strike price is at the lower limit ” R48. If the share price is between R70 and R100, the strike price is R70. “Effectively our upside is capped,” says Maasdorp.
Investec announced its BEE deal in May last year, with black investors buying over 25% of the lender in a deal funded by the issue of 5.6 million new shares.
FirstRand Group and Nedcor are the two large banking groups that have yet to announce details of their BEE programmes. Deals from leading insurers and asset managers ? in particular Old Mutual ? are also keenly awaited.
Although the Financial Sector Charter is voluntary, any banks that chose not to sign up would risk missing out on lucrative public sector mandates, including future privatizations.
?The South African market is dominated by government-owned institutions that are more likely to procure services from empowered banks,? says Citigroup’s Ngcobo.
