How BBBEE shares have fared

Published Nov 11, 2015

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This article was first published in the third-quarter 2015 edition of Personal Finance magazine.

Opinion is divided on the merits of South Africa’s publicly traded broad-based black economic empowerment (BBBEE) share-purchase schemes. The schemes were introduced over the past decade to give previously disadvantaged members of the public the opportunity to invest and trade in the BBBEE shares of big, listed South African companies.

There were only nine publicly traded schemes at the time of writing, as distinct from numerous closed schemes offered by large, listed companies to qualifying staff and BEE partners.

Some say the public schemes are poorly understood by investors and misrepresented by vendors; others say information is hard to come by, or is pitched well over the heads of shareholders with no investment experience. What most people agree, however, is that the concept is a good one: to spread the wealth generated by the stock market to the section of the population who could otherwise not afford to own shares.

Riaz Gardee, a chartered accountant and investment principal at MMI Holdings, says there are about 800 000 direct shareholders in the nine public schemes, holding assets to the value of R20 billion. More than 95 percent of the shareholders are individuals. This transfer of wealth benefits South African society as a whole, he says. In a recent article on a business website, he said BBBEE schemes have “proved to be the most inclusive, broad-based and transparent economic empowerment mechanism used thus far. BBBEE still has a long way to go in achieving its stated objectives, but this is certainly a good start.”

All the schemes were launched between December 2005 and November 2013, and gains on the initial prices of shares in the schemes have varied between 5.1 percent and 1 352 percent, according to calculations by Gradidge Mahura Investments (see the table – link at the end of this article). Examples of companies that have done particularly well for their BBBEE shareholders are YeboYethu (Vodacom) and Phuthuma Nathi (MultiChoice). The YeboYethu share price increased from the issue price of R25 in November 2008 to R70.50 in May 2015, and the Phuthuma Nathi price rose from R10 in November 2006 to R145.20 over the same period.

Another BBBEE scheme that has richly rewarded its investors is Thembeka Capital (PSG Group). In June 2014, PSG announced the unwinding of the scheme to release value for investors, who would receive 1.7 shares in the PSG Group for every share held in Thembeka. At the time of writing in May 2015, the share price had increased by 118 percent, from R97 to R212. The main reason for the unwinding, according to a joint statement by Thembeka and PSG, was that Thembeka’s assets under management had grown to the point that very large amounts of capital would be needed to fund new investments in future, and the scheme’s capacity to raise such large amounts would be restricted by “scarcity of black capital and stringent bank funding requirements”. So it was seen to be the right time for shareholders to “receive a more liquid and tradable instrument [in the form of] new JSE-listed shares in PSG”.

At the other end of the reward scale are Eyomhlaba and Hlumisa, the two schemes linked to African Bank Investments Limited (Abil), which went under curatorship in August 2014 (see “Where to for Abil’s BBBEE investors?”, below).

Other schemes that have performed poorly are Sasol’s Solbe1 scheme, which has reflected the falling share price of Sasol itself, and Media24’s Welkom Yizani, launched in 2006, which made a zero-percent return for shareholders until recently, in line with the lacklustre performance of the issuing company. The moral of this story, Gardee says, is that success rests on the performance of the company behind the scheme; no publicly traded BBBEE scheme has failed because the structure was at fault.

Background to BBBEE schemes

BBBEE share-purchase schemes became a feature of the South African investment landscape as part of the response of South African companies to the requirements of the Broad-based Black Empowerment Act of 2003 and its Codes of Good Practice.

There are various routes to BBBEE compliance, one of which is ownership, and there are various ways that companies can achieve shared ownership. Many have brought in black partners and introduced share schemes for staff, but the “broad-based” principle requires companies to go beyond privileged partners and employees, and some have extended empowerment to the public by making it possible to buy the company’s shares through restricted BBBEE share-purchase schemes.

These publicly traded share schemes are open to black people exclusively (as defined in the BBBEE Act, people who are black, coloured or Indian and are South African citizens or permanent residents able to produce a birth certificate or identity document issued before April 27, 1994, or a naturalisation certificate signed before a Commissioner of Oaths).

The schemes are usually restricted during a so-called “empowerment” or “lock-in” period – usually between three and 10 years – during which shares may not be traded at all, or may be traded only among shareholders and qualifying BBBEE investors. This is to protect the scheme and shareholders by creating stability and ensuring investors take a long-term view and are not adversely affected by short-term volatility.

How the schemes work

The funding structures of empowerment schemes are complicated and vary from company to company, but the most common format is notional vendor funding. Typically, a special purpose vehicle (SPV: a legal entity created for a limited purpose) is set up with the sole purpose of facilitating the empowerment deal for the empowering company – for example, MTN Zakhele is the SPV for MTN and YeboYethu is the SPV for Vodacom. The SPV com-pany raises the money to buy shares in the empowering company, with the money taking the form of equity from the black public and a loan from a third party or the issuing company. Often, the empowering company will offer its shares at a discount to the SPV to help make the deal more affordable for the shareholder. The investors (the black public) receive shares in the SPV. The SPV is set up like any other company and has a board of directors and a management team. The sole asset in the SPV is the shares in the empowering company, and its liabilities are made up of the loan funding (debt) and often a capital gains tax (CGT) liability, which arises when the shares in the empowering company increase in value.

The debt is repaid via the dividends received from the issuing company, with the balance due at the end of the specified empowerment, or lock-in, period. During that period, if restricted trading is permitted, the shares may trade at a discount to the intrinsic value, reflecting the discount provided by the empowering company to the SPV when the deal was made.

During the empowerment period, debt increases with interest and decreases to the extent that dividends are generated by the shares. At the end of the empowerment period, shares of the empowering company are sold to settle any outstanding liabilities. The directors may then choose to unbundle the remaining shares to shareholders in the SPV (as in the case of Telkom), or the SPV can continue trading (as in the case of Phuthuma Nathi). When MTN Zakhele reaches the end of its empowerment period in November 2016, the directors will again have to decide whether to unbundle to shareholders, sell the shares and declare a special dividend, or list MTN Zakhele and continue to trade the shares.

Where a scheme is performing poorly, as in the case of Media24’s Welkom Yizani scheme, typically management would look to renegotiate terms with the funders, or seek assistance from the empowering company itself. This challenge has led to increased use of notional vendor funding in more recent deals, such as MTN Zakhele and Vodacom YeboYethu.

Craig Gradidge, an investment and retirement planning specialist at Gradidge Mahura Investments, explains notional vendor funding by way of the following simplified example. The shares of the empowering company, ABC Limited, are trading at a price of R100 a share, but the company sells them to the SPV at R1 a share. The rest of the buying price (R99) is a notional loan to the SPV (“notional” because no money has changed hands). Thus, for every 1 000 shares issued, ABC receives R1 000 and is owed R99 000. The company needs to perform well and pay enough in dividends during the empowerment period (when trading is restricted) to enable the investors to repay their debt.

If, during the lock-in period, the share price increases from the original R100 a share to R200 a share, and the company pays a total of R49 a share in dividends (R49 000 in all), the SPV will be left with a debt of R50 000 (R99 000 – R49 000) when the lock-in period is lifted. This means that they will need to sell 250 shares (R250 x R200 = R50 000) at maturity to settle the debt. This will leave the SPV with 750 shares, which will often be converted into ordinary shares. If this happens, shareholders will be in the money. This simplified example does not take into account interest rates, CGT and call options that also form part of the debt the SPV needs to repay.

MultiChoices’s Phuthuma Nathi scheme is one of the very successful schemes, in which the SPV was able to repay debt rapidly. In December 2006, Phuthuma Nathi shares were offered at R10 to qualifying investors, and since then the share price has increased to R143.51. Gradidge describes the scheme as a “cash cow” and suggests that shareholders hold on to their shares and collect what is expected to be a very generous dividend flow over the coming years.

At the other end of the scale are Eyomhlaba and Hlumisa, the two share schemes related to African Bank. Initially, the company did well and all the debt in the schemes was settled. However, before the bank’s collapse was in sight, the two schemes refinanced to allow the SPVs to take out new loans to buy more shares in the company. Post-collapse, the shares are now worth R0, while the SPV’s combined debt amounts to R177 million.

At the time of writing, the management of both schemes were in discussions with the curator of African Bank with a view to rescuing the deal somehow. If the schemes cannot be rescued, the individual shareholders will lose only the amount paid for the shares; the debt belongs to the SPV. As the debt was financed by third parties, the biggest losers will be the party or parties who stood surety for the debt, Gradidge says.

If the company decides to convert the BBBEE shares to its listed shares at the end of the period, the conversion ratio comes into play, Gradidge says. “The conversion ratio depends on a few factors: how much of the debt has been settled, and therefore the number of shares that have to be sold off to settle the outstanding debt, the impact of tax (CGT), and the other costs associated with winding up the SPV.”

He explains that the conversion ratio depends on a few factors. “If the scheme has repaid most of the debt by the time the lock-in is lifted, the conversion will result in a significant increase in value for shareholders. If the debt has not been repaid, the vendor company will have to settle the remaining debt by selling some of the shares. Only after that is the balance of the share value distributed among the BBBEE shareholders, which makes it very unlikely that the BBBEE shares will be converted into ordinary shares on the basis of one for one.”

Gardee says the best indication of a good final conversion ratio is a record of high, stable dividend payments during the lock-in period, because that allows the scheme to repay most or all of the debt.

However, the return for shareholders is determined, ultimately, by the share price, which in turn is driven by the underlying business dynamics of the issuing company. The same goes for any investment in shares.

The risk factor

The risk of holding shares in a BBBEE scheme is no different from holding shares in any other investment, Gradidge says. “As with all investments in shares, there is a risk that the share price will go down and the SPV will be unable to repay the debt,” he says. Since the debt belongs to the SPV company, the shareholders are protected to some extent. The risk of losing their initial investment is mitigated by the fact that the shares in the structure were originally sold at a discount to the fair value of the ordinary shares,” says Gradidge.

The bigger risk in any BBBEE scheme is the debt structure that is used to fund the scheme, because the shareholders will lose some of their shareholding if there is debt outstanding at the end of the lock-in period. The discount at which the shares are issued is designed to take this into account, but it must also compensate for the limitations on trading during the empowerment period, when it may be difficult to sell the shares, and the fact that, in some instances, the assets in the BBBEE scheme are not the same as the assets that an ordinary shareholder would buy into on the JSE.

Examples of BBBEE schemes that do not hold the same assets as the issuing company are YeboYethu, which has a stake in the South African business of Vodacom, and Phuthuma Nathi, which gives investors shares in a limited portion of MultiChoice’s operations. At the other end of the spectrum is MTN Zakhele, which gives BBBEE shareholders a stake in all the operations of the company.

Invest or not?

The question of whether to invest in BBBEE schemes for the first time – or remain invested – is always going to be hard to answer. In the past year, the schemes have been in the news for two reasons, neither of them good. First, there was the announcement by the Financial Services Board (FSB) that the unregulated over-the-counter (OTC) trading platforms on which most empowerment schemes trade must apply for licences as regulated exchanges or cease trading.

OTC platforms offer an alternative to the JSE for unlisted companies and share-trading schemes that do not meet the stringent listing and trading rules of the JSE – for example, that trading must be open to all. After the FSB’s directive, all the companies or empowerment schemes applied successfully for the deadline for registration to be extended while a solution was found. This bought them some breathing space and, at the time of writing, the likely solution was a new exchange, to be called 4Africa Exchange (4AX). A consortium of multinational companies applied to the FSB to register as an exchange and hope to have a licence by August and to be able to begin trading in October. If it is granted a licence, it will provide services and infrastructure to all entities that impose restrictions on the trading of shares, such as BBBEE share schemes.

However, the concern remains that regulation of the OTC market will make it difficult for shareholders to trade their shares, which, in turn, will make it impossible to achieve a market-related price.

Then, soon after the FSB issued its ultimatum in respect of OTC trading, came the news that Abil had been put into curatorship, with the implications already discussed for its BBBEE shareholders (see “Where to for Abil’s BBBEE investors?” below).

Although investors cannot hope to foresee such exceptional events as these, they can make sure that the company behind the scheme has good prospects. As Gardee points out, no scheme has failed because its structure was at fault, and the success or otherwise of a scheme is inseparable from the success of the issuing company.

Gradidge agrees, urging prospective BBBEE investors to scrutinise the empowering company’s results and the scheme’s prospectus, which will provide details of the funding structure and an indication of the price of the shares. The empowerment or lock-in period is a critical risk factor, too, he says, because it affects the value that will eventually be created. “This principle would apply in normal markets, like the bond market,” he explains.

“Bonds with a longer term to maturity are considered riskier than bonds with a shorter term to maturity. The higher term to maturity therefore attracts a bigger discount, as investors demand to be compensated for the additional risk. Over time, this higher risk leads to higher returns.”

As always, the decision to invest depends on individual circumstances, Gradidge says. “There is no point in having 1 000 Sasol Inzalo shares, but you have young kids and no life or disability insurance. It is important to understand the financial planning context for these and any other investments.”

Gardee advises shareholders to speak to a financial adviser before making any investment decision, because “each person’s financial situation is unique and the schemes are quite complex”.

WHERE TO FOR ABIL’S BBBEE INVESTORS?

“In general, shareholders in broad-based black economic empowerment (BBBEE) schemes have been rewarded – the outlier is African Bank,” Riaz Gardee, the investment principal at MMI Holdings, says.

Two empowerment schemes, Eyomhlaba and Hlumisa, were created in 2005 to give about 14 000 BBBEE shareholders and employees a meaningful shareholding in African Bank Investments Limited (Abil). The shares were offered at R4 and R8 respectively, with the target of the schemes having a combined 10-percent holding in the assets of the bank by 2015.

At first, all was well. By 2012, the initial debt had been repaid and shareholders were sitting pretty; it made sense to take on more debt to increase the schemes’ shareholding in the bank.

On Friday, August 8, 2014, the combined market value of the two schemes was R99.2 million. By Monday, August 10, the market value of their combined 4.97-percent stake in Abil (underlying value: R23.3 million) had crashed to zero. Or, more accurately, minus R177 million-worth of debt.

Far from owning 10 percent of Abil by 2015, Eyomhlaba currently owns only 3.2 percent, with a debt of R112 million. Hlumisa owns about 1.7 percent of the bank’s assets with a debt of R65 million. The value of these shareholdings is impossible to determine because of the uncertain future of the bank itself.

At the time of writing, the managements of both schemes were in negotiations with the curator of African Bank and funders with a view to restructuring the schemes and potentially positioning them as BEE partners for the “good bank”, which will house the “good” loans of Abil and is expected to be launched in September 2015.

WHAT IS OVER-THE-COUNTER TRADING?

The difference between trading on a stock exchange and over-the-counter (OTC) trading is that a stock exchange acts as a regulated, transparent central clearing house for buy/sell share transactions and communicates the prices achieved in all transactions to the entire market. The result, as the International Monetary Fund explains it, is “a level playing field that allows any market participant to buy as low, or sell as high, as anyone else, as long as the trader follows exchange rules”. In South Africa, exchanges must be licensed in terms of the Financial Markets Act (FMA) of 2012, which protects investors against market abuses such as insider trading and price manipulation.

OTC trading is unregulated and much less transparent, although much of it is automated and the boundaries between the two systems are becoming more and more blurred. About 12 companies in South Africa, including the broad-based black economic empowerment (BBBEE) share-purchase schemes, trade their shares over the counter via their own online trading platforms or dedicated OTC trading platforms such as Equity Express. The Financial Services Board (FSB) is concerned that these platforms, however well managed, are operating within the definition of exchanges, but without the investor protections provided by the FMA.

That trading in the empowerment share schemes is well managed is generally accepted. As MTN Zakhele states on its online trading platform: “Even though the trading platform is not a licensed exchange, MTN Zakhele has nevertheless implemented extensive measures to prevent fraud and other abuses through, among other things, insider trading and price manipulation.” But the FSB’s directive points out that “price manipulation and other market abuses are generally only identified through proper surveillance. If these exchanges are regulated, there will be market surveillance to ensure that abuses such as insider trading and price manipulation do not happen. The FSB would then also be able to act against … offenders. The other objects of the FMA licensing requirements include the reduction of systemic risks in the markets and the maintenance of a fair, efficient and transparent market.”

The JSE did launch a BEE board in 2011, but so far, only Sasol’s BEE ordinary shares (Solbe1) are listed on it. This may change, now that MTN Zakhele has applied for a listing, rather than register its own platform as an exchange. The JSE confirmed in March that it was reviewing its BEE trading model with a view to accommodating the empowerment schemes, possibly by altering its listing and trading rules.

WHERE IS THE NEXT BBBEE SCHEME?

The last public broad-based black economic empowerment (BBBEE) transactions were Imperial’s Ukhamba scheme in November 2013 and, before that, MTN Zakhele in September 2010. According to Riaz Gardee, the investment principal at MMI Holdings, the global financial crisis of 2007/9 is largely responsible for the drought of schemes, because it became more difficult to obtain debt financing and share prices fell. “It was not a favourable environment for large debt-funded public BBBEE transactions,” he says.

However, one new scheme is on the way: earlier in 2015, ArcelorMittal South Africa, the country’s largest steel-maker, announced that it had received a mandate from its largest shareholder in London to embark on a BBBEE deal.

Paul O’Flaherty, the chief executive of ArcelorMittal SA, said this would allow the company to boost its BBBEE status to level five under the amended codes.

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