African Bank preference shareholders may be outmanoeuvred on capital payback
Preference share investors in the holding company of the old African Bank, which renamed African Phoenix Investments Limited started trading again last week on the JSE , are in a pickle. The ordinary shareholders in the business have their hands tightly around their throats.
In better days, the preference shareholders had contributed R1.13bn of capital to what was then a bank holding company. Now, the decision on whether to pay that back is entirely in the hands of ordinary shareholders.
The company has value, providing some relief to the shareholders who thought they lost everything when the bank collapsed in September 2014. The ordinary shares traded on Friday at 45c, a premium on the 31c it last traded at before being suspended from the JSE — though a fraction of the R39 a share peak reached in 2012. That closing price gives the company a market capitalisation of R675m.
The preference shareholders, who would normally rank ahead of ordinary shareholders in a liquidation and therefore have first claim to the assets of the firm, seem less pleased.
The prefs closed on Friday at 33.5c. That is significantly ahead of the 7.8c that they were suspended at, but far below the 83.46c a share of equity that the pref shareholders technically have a claim to. That is also far below the implied value of dividends, set at 69% of prime, that they should be entitled to.
The problem is that the fine print of the instruments allowed them to be repaid in full if the bank were ever liquidated. But thanks to the Reserve Bank’s rescue of African Bank, that has not happened.
The crown jewel on the balance sheet of African Phoenix is Stangen Insurance, which holds the rights to a flow of premiums from all of African Bank’s loans made before the curator set up a new insurer within the bank.
ASSET VALUE
African Phoenix has a book value of R1.64bn and almost all the assets are cash. That value is more than the combined market caps of ordinary and preference shares in African Phoenix, which adds up to R1.1bn. It is likely also to have substantial tax assets from the losses incurred as the group crashed to earth.
The company has other assets currently valued at zero, including retail group Ellerines, and an interest in the “bad” book that was stripped out of African Bank during the curatorship.
There has been quite significant trade in the share already. That is in part due to short covering — the traders who shorted the stock in the run-up to curatorship now need to buy it back to cover their positions. I suspect a lot of the trade is from those smelling an opportunity.
The problem for the preference shareholders is that the decision to pay a dividend, or refund the capital, is now in the hands of the ordinary shareholders. And they can decide to simply hang on to the R1.13bn and use it to grow the business.
It is, in effect, a very cheap form of funding. The ordinary shareholders are not allowed to pay themselves a dividend without paying a dividend to the preference shareholders, but they can delay that indefinitely, building up the value of the firm and getting their returns via capital appreciation instead.
This is an unprecedented situation in the history of bank funding. At the very least, lawyers should be scrutinising the fine print of current preference share contracts to see what it implies for any future bank collapse. Since African Bank, the nature of funding has changed to comply with Basel 3 banking rules, and preference shareholders are treated somewhat differently than before.
But no one anticipated the current scenario when the African Bank preference share programme was first designed. It is not clear how the situation will be resolved.
I’m sure hedge funds are going to be flocking to the case to try and force an outcome.
There are various possible scenarios. One is to get a controlling stake in the equity, use it to pay a dividend to the preference shareholders to become current and then pay a massive dividend to ordinary shareholders. The company could then be put into liquidation, leaving whatever is left for the preference shareholders.
Another is for preference shareholders to gain enough of an interest in the equity to be able to force the board to resume preference share dividend payments. For anyone who got hold of all the prefs and ordinaries, there is, on paper at least, a R500m profit to be made from a R1.1bn investment. But because of the conflicted role players, that might not be feasible. It could well end up in the courts.
NEW BOARD
The new board has a strong investment banking pedigree. Newly appointed CEO Enos Banda has wrung value out of tricky situations before, including Super Group.
He has a strong investment banking background including Credit Suisse and HSBC.
Chairman Isaac Shongwe is former CEO of Barloworld Logistics Africa and has a strong investment pedigree of his own.
The other board members also have substantial investment experience. They look like the kind to identify value opportunities and make them materialise.
Preference share investors in the holding company of the old African Bank, which started trading again last week on the JSE-renamed African Phoenix Investments Limited, are in a pickle. The ordinary shareholders in the business have their hands tightly around their throats.