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Classic Business’s Michael Avery invites insights from Soria Hay on the anticipated trends going into the ‘4th’ wave of B-BBEE transactions in 2019, touching on the lessons learned on sustainable structures; considerations when empowering at company or measured entity level; multinationals and equity equivalent deals; and the future of B-BBEE deal-making for unlisted companies. Read the transcription below:

Michael Avery: Broad-based black economic empowerment continues to divide opinion in South Africa some 25 years after democracy. I facilitated an empowerment-focused event late last year and conducted a quick thought experiment with the audience; a word association game, and the following words were standouts and were a reflection of the audience’s thoughts on BEE: fairness, complicated, opportunities, more or less inequality, controversial, sustainability and redress.

Jacob Maputo who is Chief Director at the Department of Trade and Industry (dti) for BEE said at the event that the government will require BEE as long as inequality persists, but it does hear concerns from industry asking for more policy certainty and ensuring consistent application of the policy across all sectors of the business community.

When it comes to BEE deal-making what are the trends that we are seeing against that BEE backdrop. I am joined on the line by Soria Hay, Head of Corporate Finance at Bravura.

Michael Avery: We started the year on an interesting footing with the majority of the shareholders in JSE-listed Texton property fund voting against buying back shares in the group from the PIC after we saw a BEE consortium that was funded by the PIC, default on its load. Are we seeing perhaps a hardening of attitude towards BEE by shareholders?

Soria Hay: I think there may be an element of that, but I also think the Companies Act we have now had for a some years gives shareholders a bigger say, so for these kinds of resolutions where shareholders need to pass a resolution, shareholders have more power than previously.

Michael Avery: When you look at the fact that shareholders have more power than previously, the one issue has always been dilution and at what cost BEE becomes a real drag on the investment case for SA Inc.-focused companies. Are shareholders still fundamentally supportive of BEE as a transformative tool? We’ve seen a wave of, let’s call them, the first and second wave of empowerment transactions where some worked and some ended under water, depending on how they were structured. And to go to the market again with a third wave is starting to really dilute shareholders. What impact is that having on the way shareholders tend to approach BEE?

Soria Hay: I believe shareholders are fundamentally supportive of transformation and ownership. I think they are fed up with the unsustainable transactions that have been put on the books, and then when these transactions are underwater they have to be restructured and shareholders have to foot the bill. Specifically, you mentioned Texton, the unsustainability there is that the PIC loan in November had an outstanding value of R670 million and the value of the Texton shares at the time was R213 million. So not only do shareholders have to pick up on the PUT option that PIC wanted to issue against Texton, but also they would have to fork out and dilute again for an affordable BEE transaction, as you say.

Michael Avery: What have we learned from some of these past failures where schemes were based on trickle dividends, and a raising the share price and some of those expectations were not met. We saw those schemes under water or needing to be refinanced. How do we fund empowerment deals in 2019?

Soria Hay: What we’ve learnt is the first and most important thing is to look at the funding structure that be put in place and that must be sustainable against many different sensitivities that must be modelled. Things like the Sasol transaction which had a wild swing, where a year earlier it was completely out of money and then the oil price rested and then it was slightly in the money is a very good example of where completely outside factors then influence your share price and then has an unsustainable outcome.

I think what has been learnt is that it’s better not to do externally funded transactions. The Texton transaction was an externally funded transaction. The PIC funded the BEE consortium and that is another example of where it went wrong.

More and more we see different kinds of funded transactions, so internally leveraged or internally funded. The new Sasol restructure transaction is an example of that. I think that is the first really big lesson. I think in some of the other transactions, the other lesson that was learned was, do we go directly as the operational cashflows of the measured entity, so of the entity that needs to be empowerment? So again, Sasol’s previous BEE transaction was on the listed company level including all of the offshore developments and assets. Obviously, with the development in the US and the huge Capex cheques there it means that your BEE in the South African operation really needed to dilute. So again, the restructured Sasol transaction was done in the South African operational entity. I think that is a wise decision.

Michael Avery: If we had to look at where we likely to see the bulk of BEE deals, many of the listed companies in South Africa were early adopters across the sectors. Do you suspect that we might see smaller or mid-sized deals happening in the unlisted space as the third and fourth waves?

Soria Hay: Yes, I think that’s right. I think that for all companies, whether listed on unlisted, to achieve an acceptable BEE level – let’s say you want to achieve level 4 where companies who do business with you get recognition of R1 for every R1 spent with you, companies cannot get there anymore without an ownership solution. Not only private companies in South Africa but the multinational companies doing business in South Africa have adopted ownership transactions to cater for that.

Michael Avery: The multinationals have wanted to do equity equivalent deals because very often at the multinational HQ level they are hesitant or reluctant to cede ownership. Are we likely to see that becoming an interesting factor in the BEE deal-making; more innovation around equity equivalent type transactions to help secure those point on the codes?

Soria Hay: Michael, it’s interesting. So yes, especially the American multinationals have done equity equivalent transactions. We have had comments from people who thereafter have appointed us to do BEE ownership transactions for them because they say that they find it quite unwieldy and very difficult to get through the ministerial consent on an ongoing basis, and they struggle to actually get the equivalent points. So I do think it is a jurisdictional thing where I think some jurisdictions are less likely to embark on ownership. But what I see currently is that many of the multinationals in South Africa are actually embarking on ownership transactions as opposed to equity equivalents.

Michael Avery: When it comes to employee share ownership components to these transactions, we’ve seen two different approaches to go back to your Sasol example. Sasol made headlines for excluding white employees from its initial ESOP, whereas Barloworld towards the end of last year took a different approach and opened its ESOP to all of its staff based on the demographics of the country. Which way are you likely to see ESOPs go following those two examples and the public outcry? It seems that the Sasol example wouldn’t be favoured?

Soria Hay: No, I don’t think it will be favoured. Very few companies want to be in the news for political reasons and it’s interesting that government’s stance, if you look at the Mining Charter that was adopted at the end of last year, seems to include employees save for employees that have been included in other incentive schemes. So typically that would be your senior management level where they would participate in those share incentivisation schemes. It seems that even the Mining Charter as well as through the Codes of Good Practice allow for up to 15% of white people to be included and for the scheme to still count as the Broad-based Black share ownership scheme.

Listen here: Soria Hay – Classic Business