This year there will be a radical shift in the financing of BEE deals, thanks to an amendment to the Companies Act which will make it possible for companies to play a much greater role in financing their BEE partner's acquisition of a stake. Much of the advanced financial engineering that investment bankers have cooked up in the past few years will be cast aside.
That will be the dominant issue for empowerment dealmakers in 2007. But their attention will also be caught by two other trends.
First, the strong performance of many companies' shares, which has left BEE partners in a much stronger financial position. Consequently, many are looking to refinance their empowerment deals to bring down the cost of funding.
Second, a new stage of BEE dealmaking has arrived - a second phase, in which BEE investors are trading stakes between themselves, requiring new financing in the process.
The legislative amendment, which was imminent at the time of going to press, will amend section 38 of the Companies Act to allow for companies to directly finance the acquisition of stakes in their businesses by BEE consortiums.
Until now, transactions have been financed by external parties - usually the banks - on a non-recourse basis. Section 38 has forbidden companies from lending or guaranteeing loans to be used to purchase their own shares.
The section, adopted from English law, is intended to protect creditors. However, allowing companies to finance purchases of their equity can improve the value of the company by effectively increasing leverage. It has been recognised that banning such financing is a blunt instrument. If companies are solvent and liquid, there is no reason it should be prevented.
In SA, the section has been particularly irksome because of the pressure on companies to introduce black shareholders. So the amendment, which comes as part of an amendment bill affecting various sections of the Companies Act, both brings SA into line with the rest of the world and smoothes a big wrinkle in the financing of empowerment shareholders.
It will mean big changes in the way such deals are done, though exactly how it will work remains to be ironed out. "The board must be satisfied at the time the financial assistance takes place that subsequent to the transaction the company will be solvent and the company will be liquid. That to me is quite a difficult test," says Rudolph du Plessis, corporate law partner at Bowman Gilfillan.
He points out that the liquidity and solvency wording applies throughout the lifetime of the transaction - which could be many years. Du Plessis says the new Companies Bill, published recently for comment, has a lesser burden on directors - to reasonably foresee consequences of the transaction at the time it is implemented.
Until now, the majority of deals were financed by funders, usually banks, on a nonrecourse basis. So an investment in a company was financed by a bank, the costs of that finance was borne by dividend flows from the investment, and the empowerment partner was the technical owner.
In practice, the restriction on financing by the vending company was skirted through various complex structures, usually involving subsidiary companies and preference-share funding.
These structures depended on two things for their sustainability: sufficient cash flow from the investment, and appreciation in the value of the underlying equity, so giving the empowerment partner a genuine asset after the capital is repaid.
It was often a tall hurdle: when cash flows did not materialise or the shares performed poorly, such deals fell apart. The banks were left holding the shares - the only security they usually had.
In practice, though, the banks usually also had a claim on the vendor company, usually via its holding company in order to skirt section 38.
With section 38 amended, however, two things become possible. One is that vending companies will be able to finance empowerment shareholders directly. That leaves the banks out of the picture - which can cut the cost of finance to the empowerment partner. It also aligns the incentives of all the parties. The company needs to deliver a dividend cash flow to maintain its own financing. But a more likely alternative is for the vending company to issue guarantees to a bank which will still be the lender.
This lessens the cash strain on the vending company but also cuts the risk faced by the bank. Both strategies will have one major benefit over previous nonrecourse funding models: they will lower the cost of the financing. This will make it easier to conclude empowerment deals and will make more of them sustainable (all else being equal).
That is good news for those sectors which have lagged in empowerment dealmaking, such as the retail sector. But for those which have gone well down the road in transferring ownership, it offers a cheap refinancing option.
Thanks to the stellar performance of most JSE-listed counters, many empowerment investors have hit paydirt. With their assets having performed strongly, the way is now open for original funding structures to be recast, recognising the improvement in the value of underlying security.
Deals done with various tiered structures can now be refinanced to eliminate more expensive funding. One investment banker says riskier deals have been done with financing at an effective cost of 17%. Now they can be done for around 10%. Plus the vending company can be introduced as one of the funders. It adds up to a significant boon for existing empowerment investors who now have the opportunity to restructure the funding of their investments, cutting finance costs along the way.
While they're doing that, though, empowerment investors have taken advantage of other opportunities made possible by the accumulation of genuine assets - the rationalisation of their investment portfolios into focused competences. If empowerment investment firms went on an asset grab during the first phase of empowerment, they are now developing themselves into focused value-adding firms.
"It's like what SA went through in the mid-1990s when all the conglomerates unbundled and focused on core areas. Now you'll see the BEE companies focusing," says Rob Wessels, joint head of corporate finance at Nedbank Capital.
This is helped by a strong mergers and acquisitions environment generally. Wessels predicts empowerment firms will swap assets among themselves as they choose to focus on particular sectors - for example, Mvelaphanda in resources, Sekunjalo in medical and foods, HCI in gaming and leisure.
Though many such investors are tied up in terms and conditions by the vending company, such as lock-in periods, they can be loosened if the transaction involves a sale by one empowerment company to another. From the perspective of vendors, it will be worth doing if they gain a value-adding specialist rather than a general empowerment investor.
