Black-chip companies are the belles of the business ball, but Mike Metelits warns that a bearish hangover is looming
To borrow from the fashion world, the new blue is black. Blue as in blue chips, companies which are considered the aristocrats of the financial markets because of their good returns and reliability. Black as in black chips, the empowerment version of blue chips which in 1997 outperformed the rest of the Johannesburg Stock Exchange’s (JSE)main indices.
Businesses are eager to convert the political changes of recent years into meaningful economic benefits. It’s open to debate whether this is due to moral concerns, government influence, anticipation of future legislation or a hardheaded business recognition of where the new potential markets lie. In many cases this has translated into the creation of, and tie-ups with, black-chip companies.
Everyone knows black chips exist, but it’s sometimes less clear what companies fit these criteria, not to mention how they stand in relation to competitors and what potential they have. Jarrod Cahn, of Cahn Shapiro brokers, defines black chips as firms which are “fully or majority black- owned and controlled”, with commitments to black ownership, management, and employment. Such firms have two yardsticks: like any other company, they must make money and survive in the marketplace. A tougher measure to gauge is how a firm meets social goals like “black economic empowerment”.
ING Barings analyst Phumzile Mamjezi says the investment bank no longer treats the black chips separately, but analyses them simply as part of their sectors, like financial services and industrial holdings.
Mamjezi points out that the top five black chip groups by market capitalisation (the number of outstanding shares multiplied by the share price) are all in these two sectors.
This concentration in industrial holdings and financial services means the firms are well positioned to win government tenders in a number of areas.
Cahn, along with many other analysts, identifies this as a major strength of the black chips. The government’s efforts to redress past economic imbalances mean empowerment firms get preference in the tender process, and this political advantage is a major market asset.
Black chips are seen as attractive merger partners by established white-controlled firms. This trend emerged in January 1997, when it was revealed that black-controlled firms had outperformed the JSE as a whole in the previous year. Having an empowerment partner became an important part of doing business.
But the concentration in the financial and industrial sectors of the JSE may have disadvantages. The value of shares across the JSE has plummeted in the past five months. The financial index has lost almost 50% of its value since May and industrials about 40%.
The RAD-Nomura empowerment index, which is a weighted index of the black chips, fell by 40%, in line with overall share losses, says Bongi Masinga of Real Africa Durolink (RAD) Securities.
Masinga feels that recovery among black chips will follow from strong fundamentals like earnings not derived from acquisitions. Substantial cash holdings may also make some of the black chips attractive investments.
But the fall in share prices means market capitalisation has dropped, and it becomes difficult for companies to raise funds.
The situation is exacerbated by high domestic interest rates which also make it difficult to borrow capital, and the gyrations of the bond market add to the risks of using other people’s money for projects. These economic conditions may make even existing deals problematic, comments Attlee Masuku of RAD.
But while black chips are positioned to take advantage of the lucrative government tender market, and thus have enormous potential, there are some problems. The black chips seem to have strongly overlapping ownership, reminiscent of the kind of industrial concentration of power seen in South Africa in the pre-empowerment days. This raises questions about exactly who is being empowered, and how successful the firms are at their stated social goals.
Further, none of the major firms has declared a dividend, leaving investors dependent on rising share prices to register any return on their investment.
Given the decline in share prices in South Africa, these returns may be hard to find. Also, relying on price increases for rewards exposes investors to capital gains taxes.
Capital is hard to come by, and may have been raised in less than preferable ways, for example offering more shares to existing owners (rights issues) and straight borrowing.
Such methods of getting money may have set the black chips up to be squeezed by merchant banks when their deals need to be restructured due to the worldwide and domestic credit crisis.
Masuku suggests that even for listed company deals, funding will be more difficult in future as many traditional financial institutions see no reason to hold their interest through a pyramid black chip rather than directly.
Jarrod Cahn also points out that a number of these firms have strong connections to more established white capital, in the form of significant holdings by bank nominee companies as well as direct holdings. While Sankorp’s stake in New Africa Investments Limited is non-voting, for example, it does represent a significant capital infusion.
The trade-off of shaky capital structures and merger profits versus anticipated profits from tenders and operations is the key question for investors. Given the scramble of many white-controlled firms in South Africa for “empowerment partners”, and the equity price of acquiring them, the verdict in the markets is that these are the dominant firms of the future.