Where there's a will, there's a way, as some innovative funding mechanisms have shown in the past year
Akey to empowerment is the funding structures and mechanisms used for deals. When people have little capital, innovative funding is important for asset accumulation.
UBS SA corporate finance executive chairman Mxolisi Mbentse, writing in a recent BusinessMap report, agrees that innovation is needed in BEE funding.
Vendor financing - where the target company facilitates funding for the BEE buyer - is making a strong showing. Now it is common to tie the deals to option schemes in which the partners gain immediate economic participation in the company, but have full ownership only when an option to buy shares matures and is exercised some years down the line. The share price of the company will have to appreciate beyond the option strike price to make sense for the empowerment partner.
The advantage of this kind of financing, Mbentse argues, is that it aligns the interests of all parties to the deal.
The ability to access cash flows by buying into underlying assets is also gaining momentum, he says. This is normally cheaper than financing equity at holding level, partly because funders can secure the cash flows of the assets being financed. He says that unless shares are acquired at a substantial discount to fair value, funders are increasingly reluctant to accept them as security for funding BEE transactions.
The FM consulted a group of merchant bankers, financiers and deal-makers in an effort to establish which of last year's black economic empowerment (BEE) deals had been most innovative.
Those interviewed by the FM single out the ARMgold-Harmony merger as last year's most innovative deal. The deal was praised for its size (it was valued at R57bn) as well as for the financial technology used and the symbolic significance of the empowerment achieved. The deal also won the BusinessMap Foundation's top empowerment deal of the year award for 2003.
"The deal is impressive," says AMB Advisory Services executive director Zenzo Lusengo. The majority shareholder is a BEE company, which also has the chairmanship and the right to appoint other directors.
There was no reliance on a special-purpose vehicle because ARMgold paid for its stake through a share exchange.
Lusengo says the deal also gives the BEE shareholders a controlling interest in all the underlying assets.
"The deal is a scene setter and an empowerment champion," he says.
But Nivan Pillay, a deal-maker who operates through finance boutique Maia Capital, says the deal hinges on the gold price and is attached to the fortunes of the rand. Pillay says ARMgold chairman Patrice Motsepe is taking a significant risk because of this.
"The deal is confirmation of the fact that Motsepe is a committed miner who is in this sector for the long haul," Pillay says.
Itumeleng Kgaboeshele, CEO of Sphere Holdings, a strategic investment and private equity fund and management business, says: "A successful deal should have real economic value accruing to BEE partners, ideally upfront but also over time. Furthermore, the transaction should create unencumbered ownership over a reasonable period. The ARMgold-Harmony deal does this."
Also making a strong showing is the deal between Mvelaphanda Resources and Gold Fields, which involved the sale by Gold Fields of a 15% stake in its SA gold mining assets to Mvelaphanda for R4,1bn.
In an innovative funding deal Mvelaphanda will raise two loans (worth R1,4bn and R1,1bn) and new equity worth more than R1,6bn.
Mvela Gold will lend the R4,1bn to Gold Fields and the interest payments from the loan will settle the first R1,4bn loan.
"We are guaranteed to get R1,4bn of unencumbered equity. The only way this will not happen is if Gold Fields collapses," a director of Mvelaphanda Holdings says.
The Gold Fields transaction found a way for a BEE company to get close to a listed company's cash flow .
Previously the assumption was that a listed company could use only a funding model that depended on the performance of the share price. Direct proximity to cash flows could be achieved only with an unlisted company.
Most of the group of people approached by the FM agree that this deal is significant for many reasons, not least the way in which Mvela approached the international financial markets for the finance.
The deal, says Pillay, is also attractive for its broad-based participation, which is a hallmark of the Mvela empowerment legacy.
The R1,3bn Imperial/Ukhamba deal is also admired. Imperial sold 10,1% to Ukhamba in a deal that should benefit about 14 200 disadvantaged workers at Imperial.
Ukhamba earns shares every year if Imperial exceeds headline earnings growth of 13%. Ukhamba also gets full voting rights on the deferred shares upfront.
It is attractive, say some members of the group, because it empowers its own employees. Rand Merchant Bank corporate finance chief Herman Bosman says this deal ensures alignment of the interests of management, workers and shareholders. RMB advised on the deal.
The chief criticism of the deal is the valuation of BEE equity in the transaction because Imperial holds 49% of the shares in the trust created.
A notable innovation is the emergence of private equity funds as leading deal-makers. According to the recently released Ernst & Young Review of Mergers & Acquisitions Activity for 2003, the proportion of private equity-backed deals globally is also rising and now account for 10% of deals worldwide. In SA, private equity houses such as Ethos and Brait are positioning themselves to drive empowerment deals.
A deal in this mould that caught analysts' eyes is the R500m buyout of engineering group Ozz. Kagiso and Ethos Private Equity spearheaded this leveraged buyout, which resulted in Ozz being delisted.
This private equity structure is rarely used in empowerment, though it is ideal because the target company's own assets are used as the security for funding.
Last year's Bidvest/Dinatla deal came in for some criticism. Dinatla acquired 15% of Bidvest for R2,4bn. Dinatla has voting rights over the shares.
The sale involved existing shares rather than new ones. Those shares have an option attached to them that expires in 2006. If the share price reaches R60, Dinatla will acquire them at that price.
Between R42/share and R60/share, the empowerment consortium has an option to buy the shares at that market price. Below R42, the group will walk away. Bidvest is now trading at R52/share.
Dinatla struggled to raise funding and ended up using a much maligned option structure.
"We went to a number of financial institutions, but the interest rates were prohibitive. In addition, financial institutions demanded up to 40% of the equity upside, which would have been disempowering for us," says Dinatla director Lionel Jacobs.
The company has a three-year window to raise funding for its 15% option in the country's largest services and industrial group.
"With interest rates now at lower levels, we may be able to reach agreement with a financial institution," Jacobs says.
There is also concern that the deal is similar to those of the previous generation of BEE deals, which were too dependent on the share price. And some experts say Bidvest gave nothing in the deal.
Tiso's acquisition of a stake in Investec is considered opaque because of the lack of information and detail provided. Investec may want to protect the nature of the financing structure for reasons of competition, but some of the FM's sources say it created the suspicion that the middlemen benefited enormously.
Last year the following companies announced equity deals worth more than R1bn: Harmony, Avmin, Gold Fields, Afrox Health, Bidvest, Sanlam, Imperial and Investec. Ironically, the most talked-about transaction of the year did not involve a white group.
It was the sale of former empowerment giant Nail to a consortium led by Tiso Group and the subsequent unbundling of SA's first BEE company.
But on closer inspection, there are a number of disturbing trends to note. After the market crash of 1998, there was talk of new funding models but there has been little innovation in this area. Many deals still depend on an appreciation of the target company's share price to transfer ownership to BEE companies.
Transactions have consolidated around the few BEE companies with the balance sheets to bring resources to the table or the usual suspects with brand-name recognition.
ARM and Mvelaphanda Holdings participated in more than 50% of the transactions by value that were announced last year.
If you are black and do not have resources or a brand name, the chances of getting funding are slim.
Though Mvelaphanda managed to raise funds from a wide range of financial institutions, there are worrying signs that other BEE companies still struggle to raise funds outside quasi state institutions such as the Public Investment Commission (PIC) and the Industrial Development Corp (IDC) . The private sector has yet to come to the party in a big way.
Apart from the Gold Fields and Sanlam transactions, financial institutions do not appear to have provided funding for any of last year's deals of more than R1bn.
Under the financial sector charter, financial institutions have pledged R75bn for empowerment financing over the next five years. This is equivalent to R15bn/year, or 0,75% of the sector's R2 000bn asset base this year.
"It is still not clear how much of the R75bn will be for traditional BEE funding because there are other commitments to areas such as housing," says Brandon Doyle of Nedbank Corporate & Merchant Bank.
So there is likely to be a huge funding shortfall. The JSE has market capitalisation of more than R1 500bn. If it is assumed that traditional BEE funding will provide half of the R75bn empowerment financing commitment, BEE companies will get R7,5bn/year.
This year that will be less than 0,5% of the JSE's total market capitalisation. It will hardly make a dent in terms of changing ownership structures on the JSE.
Financial institutions will have to substantially exceed the minimum targets in the financial sector charter. The public sector could make a contribution, but the IDC is unlikely to participate in many BEE transactions of more than R1bn.
The mandate of the National Empowerment Commission is likely to emphasise investments in medium-sized unlisted companies.
It remains to be seen whether the PIC, which has provided more than R2bn for the MTN, Investec and Gold Fields transactions, will increase BEE funding.
The focus will therefore shift towards vendor financing models. To meet their equity targets, established companies will have to develop models that enable BEE companies to pay for their equity out of future cash flows.
This will be a challenge because many established companies still believe they can achieve BEE equity targets at no cost.
This year has kicked off with three of the country's main financial services companies - Absa, FirstRand and Nedcor - announcing that they would conclude equity transactions this year.
The three transactions will be worth about R10bn.
At the time of going to press, there had not been a single BEE transaction worth more than R500m concluded this year.
The likelihood is that future opportunities will consolidate around about 12 companies that managed to get unencumbered equity during the first wave of BEE transactions during the 1990s. Already HCI has made a cash offer of R270m for Golden Arrow, and Mineworkers' Investment Co will pay cash to increase its stake in Primedia to 7%.
The second wave of BEE has resulted in increased expectations that SA will succeed in transforming ownership of the economy. However, there is still a long way to go and there is a risk that the process could stall again.
So it is now up to the financial institutions and established companies to develop innovative funding models and identify a second generation of black entrepreneurs, many of whom have developed hard, technical skills, to take BEE to the next level.
From government, further amendments to the BEE Act will be required to make it more effective.
