It's not all milk and honey

Once again it strikes me how the headlines on the big black economic empowerment deals mislead. You can almost sympathise with Julius Malema when he says of BEE: “We are free to buy shares, with what?”

A deal transferring 25% over five or 10 years will most probably mean that 10% or less actually ends up in the hands of the BEE beneficiaries at the end of the period.

The Tiger Brands’s second-phase BEE deal, recently approved in a modified form by shareholders, is an example.

I asked the company why special purpose vehicles (SPV) were used for the BEE deal. These legal entities, created to get the deal makers from point A to point B, have had a bad name for a while, because of the collapse of BEE deals after the Asian crisis.

But according to Clive Vaux of Tiger Brands, it is unusual for funding arrangements of BEE transactions not to use SPV structures.

SPVs are used to make it easier for the company to provide finance for the BEE beneficiaries to buy shares.
The “ring-fenced” nature of the SPVs makes it possible to isolate the share purchase transaction within the SPV. The SPV mechanism also provides security to the financiers, he says.

My observation is that what this has meant in other BEE deals is that if things don’t work out the BEE partners walk away without being asked for more money and the financiers have access to the shares in the SPV, rather than having to pursue companies or individuals.

SPVs and funding structures are complex enough, but in the Tiger Brands deal an added complexity is that there are two types of funding structures, as Vaux points out:
o The “notional” funding structure that applies to Brimstone Investment Corporation and the Black Managers Trust (BMT II); and
o A preference share funding structure that applies to the two perpetual trusts, namely The Thusani Trust and the Tiger Brands Foundation Trust.

Preference shares are also often used in BEE deals, because they are a handy mix of a share and a loan.

The preference share deal for the trusts lasts 20 years, which seems long enough for the preference shares to be paid off. Few BEE parties would want to wait that long for the deal to be done.

The notional funding structure is the more usual BEE deal.

Notional here means what’s on paper, as opposed to the reality.

Why it’s notional rather than real financing is that without the financial engineering Tiger Brands would simply lend the money to the BEE beneficiaries to buy the company’s shares.

The BEE participants would then have to pay interest on a loan over the period they are “locked in” to the deal and cannot sell their shares. They would get dividends, but they would have to borrow the money to buy the shares, hence the loan.

At the end of the period the BEE participants would take full ownership of the agreed number of shares. This is often 25% of the company. But to settle this interest and repay the loan, the BEE parties would then have to sell some of the shares they own to pay off the loan and the interest built up on the loan, which would far exceed the dividends received.

The BEE participants would be left with a certain number of shares after paying off the loan, but nothing like the full 25% allocated, unless the share performed exceptionally well.

The notional structure replicates this funding structure, says Vaux. But no actual money is lent on day one. Instead, at any point during the period of the agreement, a formula is used to determine the net value the BEE participants have earned.

This is calculated as if a loan or preference share arrangement had been in place from the beginning of the transaction.

So at the end of the eight-year transaction period, Tiger Brands will buy back a number of shares from the BEE participants, determined by the formula, at the same nominal price for which the BEE participants were allowed to buy them, to settle the notional funding outstanding.

The nominal price is R7.40 a Tiger share for Brimstone’s shareholding and R0.10 a Tiger share for the BMT II’s shareholding.

The idea is that at the end of the period, each BEE participant will be left with the same shareholding as it would have been left with in a typical funding structure.

Vaux admits that in the notional funding structure (which has an eight-year lock-in period), “it is most improbable that a participant will end up owning the entire number of ordinary shares that have been allocated.”

The reason is that the notional funding amount that has to be repaid at the end of the eight-year lock-in period is dependent on variable factors, such as interest rates and dividend flows.

These, he says, cannot be predicted with any degree of certainty.

“Realistically though, it is anticipated that a major portion of the shares allocated will have to be sold back to Tiger at the end of the eight-year term to settle the outstanding notional amount.

This is because dividends over the eight-year period would be insufficient to liquidate the capital amount plus financing charges.”

The situation with the trusts is different, though. The Thusani Trust SPV and the Tiger Brands Foundation SPV have full ownership of all the allocated shares from day one of the agreement.

It is the preference share debt that will be serviced over the 20-year funding term out of the dividend flows received on the Tiger Brands ordinary shares. Once the debt is fully repaid, Vaux says, the trust gets the full dividend flow from the Tiger Brands shares held.

The BEE participants could end up with zero at the end of the period, depending both on the price of the Tiger shares at the end of the lock-in period and the level of notional funding outstanding at the time, though this is not likely.

If the company hits hard times and doesn’t pay a dividend, the notional finance charges on the notional debt rise. But, Vaux says: “Tiger has a proud history of consistently paying dividends to its shareholders on an uninterrupted basis.”

It is also in Tiger’s interest to continue to pay dividends so that the BEE deal doesn’t come apart. Indeed, with vendor-financed deals like this the company has an interest in their not failing. When they were externally financed it mattered more to the financiers than the target company.

Still, even the vendor-financed deals have risk attached. It is not a gift, despite what the headlines might lead one to believe. No wonder Julius is puzzled.

When BEE attracts the wrong attention
Once upon a time it was enough for a company to announce a BEE deal to attract favourable comment. Times have changed.

Now BEE deals can attract the wrong sort of attention and that is what has happened to the second phase of the Tiger Brands BEE deal, which was supposed to allot 10% of the company’s shares to BEE participants.

First the union representing the company’s workforce, the Food and Allied Workers’ Union, criticised the deal for favouring management.

Then the Public Investment Corporation, which manages the billions of rands of government pension funds, led a shareholder revolt to exclude black non-executive directors from the deal.

The result of this shareholder activism, unusual for South Africa, is that the 10% of Tiger that was the deal target is now around 9%.

The reason given was that non-executive directors are supposed to be independent and this allocation of shares would affect their independence.

At the annual general meeting the company could not muster the 75% of the votes needed for the Mapitso Consortium part of the BEE deal to go through.

As far as favouring management goes, the deal did and still does, though that is not unusual. The percentage allocated to the general staff share trust was 0.44% and that remains unchanged.

The other participants have fractions of a percentage point added to their notional stakes. Black management gets 1,58% compared with 1,56% previously, and so on (see table). It must be remembered, however, that in 2005 each staff member, black or white, who did not get shares allotted in the black managers’ trust or get share options, was given 50 shares.

Also, the Thusani Trust helps provide university education to the immediate families of Tiger Brands’s black employees and it has now been allotted around 2% of the company in total.

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