It is not often that an empowerment deal is hailed as “profound” — the term applied to Dimension Data SA’s (DDSA) recently announced agreement.
Though it may not be as unique as the praise suggests, it has touched a chord among empowerment analysts.
Its outstanding feature is that it goes beyond a simple equity deal, building in a defence against the “enrichment” criticism by insisting on specific value-add.
The black economic empowerment (BEE) consortium partners are expected to earn their shares by helping the local subsidiary of Dimension Data fulfil the company’s transformation charter, which, once finalised, is likely to comply with the national information and communications technology charter.
Complying with the charter will enable DDSA to qualify for procurement from the government, parastatals and other corporations that subscribe to their own sector charters.
The consortium will comprise Andile Ngcaba’s Ngcaba Holdings, Saki Macozoma’s Safika Holdings, broad-based empowerment groupings and DDSA’s black staff.
Ngcaba Holdings will have 12,71% of DDSA (though this includes 2,9% for broad-based BEE participants); Safika 5%; and other broad-based BEE participants 7,3%. In total, the broad-based beneficial interest is 10,2%.
Ngcaba is not one of the big names that usually crops up in BEE deals. Brought on board as chairperson-designate in April, the former director general in the Department of Communications can contribute much to DDSA’s strategy. The company will draw from Safika the expertise of executive chairperson Moss Ngoasheng, long associated with the company.
So the operational involvement of the BEE partners will not be nominal, creating more genuine empowerment than in many deals.
The equity part of the transaction has novel elements, along with what are becoming standard features.
Following a well-established trend among corporations, it is “vendor-financed” — rather than raising money from banks, the BEE partners are being helped to buy shares by DDSA itself.
“Buy” is perhaps not accurate, as this is “notional” finance. No money changes hands, except for the R23-million down-payment by Ngcaba and Safika, equal to 1,51% of DDSA’s shares.
The percentage of DDSA set aside is 25,01%, which enables the company to be called a “black-empowered” entity in terms of the government’s broad-based BEE strategy. The percentage is becoming standard, except in financial services where the target has been set at 10%.
The deal has a broad-based element, but is led by two high-profile BEE entities. Again this is standard, though Ngcaba Holdings is synonymous with Ngcaba himself. As usual, the BEE consortium will vote 25,01% of the company, though it will only own the full 25,01% in five years at the earliest, the time it is “locked into” the transaction.
Also different is the use of two classes of ordinary shares rather than preference shares, and the concept of “notional” vendor financing.
One model has been that shares acquired by the BEE partners entitle them to dividends from the company. These pay in time for ordinary shares making up, say, 25% of the company.
In the DDSA deal, a different share class, A shares, have been issued to the BEE consortium equal to 23,5% of the company. On final payment — between 2009 and 2011 — these will convert to ordinary shares.
Instead of dividends, the BEE consortium will be entitled to 23,5% of the company’s headline earnings.
The catch is that the “notional interest rate” on the R357-million outstanding to pay for the 23,5% is rather high, at 18% annually. This is the putative interest rate the BEE consortium would pay in the market to raise from a bank.
The details of the finance structure are fairly complex, and entail a maximum of 5% of DDSA a year “vesting” in the BEE consortium. Simply put, the aim is that by year five the BEE consortium will have paid off the notional finance and have a real 25,01% of the company worth far more than R380-million.
To do this the BEE partners must help DDSA raise headline earnings substantially. The DDSA announcement says pre-tax profit for the year to end-September 2003 was R60-million. The higher the earnings, the greater the profit when, after five to seven years, the BEE partners cash in at least some of that stake.
DDSA CEO Alan Cawood reckons the transaction is neutral for shareholders, but empowerment transactions tend to have some cost.
I believe shareholders will bear it in two ways: by giving up part of the 23,5% of the headline earnings that goes to the BEE consortium, and through dilution of the share base when the A shares convert to ordinaries. New ordinaries will have to be issued at the end of the lock-in period. Balancing this out will be the obvious benefit to shareholders of higher earnings, leading to an improved DDSA share price.
Anyway, without BEE credentials, DDSA will not get very far. If this deal works, black and white managers will score from bonuses.
A significant feature of vendor-financed deals is that self-interest becomes the glue between the partners. This was absent in BEE’s “first wave”, characterised by third-party-financed deals that fell apart.
Sceptics might point to the high hurdle rate and other potential pitfalls, but it is in the interest of neither party that it dissolves. Should the deal fall apart, DDSA would have to find a new empowerment partner.
Cawood confirms renegotiation would come before dissolution of the deal. “This is a partnership, not just a buy-and-sell deal.”