Adcock’s BEE deal

Adcock Ingram’s recently approv ed R1.3-billion BEE deal brings into focus the growing absurdity of using direct JSE ownership as a measure of the success of black economic empowerment.

What the deal serves to illustrate is how far BEE has moved towards corporate social responsibility in which the lion’s share goes to a development trust and a non-governmental organisation (NGO).

More and more deals involve foundations or trusts and workers. But this raises several questions: Who are the ultimate owners of the shares — the trustees or foundation board members? The real beneficiaries — the people the trusts and foundations give aid to? And if all the trustees are white but the beneficiaries black, would that still be empowerment?

In the Adcock deal the two main members of the ‘ BEE companies” to be allotted shares are Kagiso Trust Investments, investment arm of the respected development agency Kagiso Trust (6.13%), and the Kurisani Youth Development Trust, investment arm of loveLife, the national HIV/Aids prevention campaign (2.6%).

Black employees are also allotted a stake (3.25%) and the Mookodi Pharma Trust gets 1%. Overall, 13% of shares are allotted. In this light the recent ‘debate” between trade union Solidarity and the department of trade and industry over measuring black ownership on the JSE looks silly.

Ownership by trusts, NGOs and other such groups with charitable intent are not the kind of ‘black ownership” that people usually think of when discussing BEE. They think either of narrow-based ownership (such as the likes of Patrice Motsepe and Cyril Ramaphosa) or of broad-based ownership by many black individuals, each with a small stake.

Adcock’s deal does include workers — but unusually for an employeeshare ownership scheme, only black workers. Dr Jonathan Louw, Adcock’s chief executive, says: ‘Only black [black, coloured, Indian and Chinese pre-1994 as defined in the BEE codes] employees appointed permanently by Adcock Ingram qualify to participate” in the transaction — and white workers do not seem to mind the discrimination.

‘We value all our employees, irrespective of their race, and have briefed them about the rationale and principles behind the transaction. In all the sessions we have held with all our employees, we have not experienced any sign of discontent.”

One feature of the deal that will be applauded is that the deal does not include black executives, thus maintaining the independence of the board. Louw points out that this is consistent with the King III codes of corporate governance.

Otherwise, many features of the deal are standard, such as the beneficiaries getting shares at a discount, although they have to make a small down-payment. This is a vendor-financed deal, which means that it mimics a deal in which black buyers borrow money to buy shares , then use dividends from the shares to pay off part of the debt. Usually there is a lock-in period .

After that black partners can sell some or all of the shares and pay off any debts that might have accrued. But if the shares perform well, they might not have to sell many of the shares to settle the debt. The worst case scenario would be that they walk away with nothing.

With vendor-financing the deal is consummated at the end of the period according to a formula that uses a ‘notional” interest rate to calculate what the BEE partners owe the company. This is subtracted from the value of the shares and the result is what the BEE partner gets.

So for the transaction period, usually five to 10 years, the target company has a black ownership of, say, 25%. At the end of the period, this could drop to, say, 15% or less if the black beneficiaries sell 10% or more of their shares to finance the cost of financing the purchase of the 25%.

What was the realistic expectation of the final percentage of shares Adcock’s black strategic partners would get?

The company says that the ‘effective black ownership” when the transaction period starts will be 25%, as required by the Broad-based BEE Codes of Good Practice. That excludes foreign holdings and ‘mandated investments”, that is indirect shareholding, including pension funds and unit trusts. The actual size of the stake is 13%.

Louw says that the eventual share ownership in Adcock after seven years for its black employees and 10 years for the BEE strategic partners is ‘dependent on a variety of factors, primarily the performance of the Adcock Ingram share price over the period. It would therefore be speculative to forecast a share price that far into the future.”

He says that the interest rate on the notional loan to the BEE partners (at 9.5% a year) is ‘well below” what they could have got in the market . ‘Adcock Ingram is also donating approximately R650 000 to the employee trust to facilitate the scheme. In addition, the shares were issued to both the Staff Trust and the BEE partners at a 5% discount, equating to an upfront value of R66- million, thus immediately ensuring that the participants are in the money.”

Meanwhile, since the deal price was first agreed on, Adcock’s share price has risen by 13%. The R650 000 is part of the total R372-million cost of the deal and includes the cost of advisers (R11.4- million) and a R360-million ‘economic cost”, which will be recorded in the company’s income statement, but will not result in an outflow of cash. That cost is 3.7% of Adcock’s April 10 market worth, which, again, is standard.

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