In 1998, a market crash in Asia heralded the end of the first phase of black economic empowerment (BEE) as JSE share prices tanked. Ten years later and another crash - this one due to poor investment decisions made thousands of kilometres away by American bankers - the second phase of empowerment deals hangs in the balance.
This second phase was also supported by a stock market in which it seemed - for a while - that share prices could only rise. But the JSE's 27% loss last year, coupled with a 4,3% loss for the first month of 2009, has thrust many empowerment deals into purgatory. Two years ago, for example, the average p:e ratio of all JSE listed companies was 15 ; now it is 9.
Considering the architects of most empowerment deals structured them so that the cash flows of the firms they were buying into would be used to repay the initial debt (mostly through dividends), the financial crisis spells bad news. As companies cut their dividends, there is less cash available for these empowerment investors to repay debt.
This creates the danger that the banks that funded the deals will call up the debt, forcing the black investors out of the companies.
Take Sasol, which launched a widely hailed empowerment deal to sell R7,5bn worth of its shares to more than 300 000 black South Africans for R366 (a discount on the R410 it was trading at before the announcement).
Since then, Sasol's stock has slid 27% to R267, due partly to a R4,1bn price-fixing fine in Europe and partly because the oil price lost ground. At Sasol's AGM in December, there were some angry investors. "Bryan", whose stokvel took up the Inzalo offer, fumed: "We expect you to protect our funds. If you are not able to do so, you should move over and let someone else, who can, lead the company."
There are other similar cases. Barloworld offered 10% of its shares to black investors at R83,31, but since then the stock has shed 60% of its value to R33. And these black shareholders would have been worse off had Barloworld not "repriced" the deal in October from its initial price of R103,87. Its rationale was that it would have created an "unsustainable deal" to keep prices artificially high.
There are many other examples of deals that are "under water" and, according to the press, "hours away from collapsing altogether". But James Formby, head of corporate finance at RMB, believes the reality doesn't justify the scaremongering.
"I don't see many deals falling over. For transactions done three years ago, the value of the shareholding is still marginally positive because markets grew so much in recent years before crashing in 2008," he says.
Most banks have a "default threshold", and if the empowerment borrower falls below that, then it can call up the loans. But the banks typically lend cash on the basis that they've got enough security (typically through the shares) to cover twice the level of the debt incurred. In most deals, a default occurs only if the collateral given to the banks falls below this ratio of two-times the debt.
"For this to happen, the shares would have to lose a third of their value at the purchase date before the bank even thinks of initiating a discussion. Though the JSE has lost a lot of value, most deals aren't at that stage," says Formby.
So for example, buyer X in 2005 bought shares at R100, and they rose to R150 by mid-2008. Even if those shares fall below the purchase price to R80, there is still a margin of comfort before things turn nasty. But even if the collateral drops to below a default level, this doesn't mean an empowerment deal is dead. Formby says in most cases, the company whose shares are being bought will then consider stepping in to help.
"It makes more sense for a board of directors to look at their empowerment deal and say it would be better for them to keep their empowerment credentials than to allow a deal to fail and then start from scratch. They could then decide to support a deal at a lower cost than letting it fail," he says. In this case, a company would provide additional collateral to the empowerment partners to prevent the deal falling below the "two-times collateral" requirement of a bank, and triggering a default. "But it's a minority of companies that have got to that stage. These empowerment companies are more resilient than people think," he says.
Ernst & Young, which provides an annual barometer of corporate activity, says the number of empowerment deals last year dropped. In 2007, there were 153 deals worth R96bn - up 71% from the previous year. Though its review for 2008 isn't complete, corporate finance director Dave Thayser says the number appears to have dropped sharply.
"It looks as though the value of BEE deals will be down, perhaps by as much as 40%, reflecting the general downturn in the market," he says.
Thayser says as far as 2009 is concerned, it doesn't seem as though this will be a good year to do deals either. "Management who believe their share prices are already below their long-term value will be reluctant to do BEE deals at a discount, thus further diluting existing shareholdings," he says.
There has been much talk about a government-bailout of BEE deals, but this seems unlikely. In December, trade & industry director-general Tshediso Matona said he was aware of flailing empowerment deals, and advised firms in trouble to call two state-owned entities, the National Empowerment Fund and the Industrial Development Corp. But it seems the most these two agencies can do is help the firms renegotiate the deals, presumably to make them repayable over a longer period. But this may not be enough assistance.
Some feel that any deal is about risk, and when things go bad, there can be no bailout. In December, Black Management Forum (BMF) president Jimmy Manyi told Business Report that "when those deals went north, they benefited. So they must also be able to take the strain when the deals go south".
The banks aren't likely to lose big on the loans to BEE companies, but they could still bruise. The security they have on these loans, usually shares, has now dropped to below the value of the loan, which means they will have to impair those loans.
Metropolitan Asset Management chief investment officer Johan de Kock says there isn't as much of a crisis as people think. But he says the most vulnerable are deals done in 1998 and 1999 with 10-year funding terms. "Even then, in most cases you'll find that shares in those companies have gained since 1998, despite what's happened in the past year. Even big companies like Mvelaphanda or Shanduka that have been in the game for a long time, and the markets haven't fallen significantly enough to [really hurt them]," he says. Of course, if markets continue to fall, and companies lose 80% of their value, as has happened to crippled sectors in the US, then you will see empowerment firms go bust.
But De Kock says banks have a big buffer still. "When the failure of deals begins to affect banks' capital, then it becomes serious. But I'm not convinced the problems will be so huge," he says.
Not that this will cheer Sasol's Inzalo shareholders, who're staring at a stock already 27% cheaper than the R366 they paid.
But De Kock says there's no need to panic, as the lock-in period expires years from now. "That's the nature of investment. Who knows, we could see another oil price bubble in the next 10 years," he says.
