Unavoidable truth is that empowerment stakes carry risk
The failure of the Sasol Inzalo black economic empowerment (BEE) deal to deliver value for most of its beneficiaries raises deep questions about such schemes.
In 2008, Inzalo shareholders paid a minimum of R457.50. Their investment was combined with funding to purchase Sasol preference shares that were meant to convert to ordinary shares in 10 years.
When the scheme officially winds up in 2018, the funding costs are going to be in excess of the value of the Sasol shares the scheme will hold. That is mostly the fault of the poor performance of the oil price. At present, the deficit is about R1.4bn.
As a result, Inzalo shareholders have lost their money. This is not the only scheme to have failed. Perhaps the worst case was the two schemes of African Bank, Hlumisa and Eyomhlaba, which collapsed when the bank went into curatorship. Those shareholders had contributed cash of at least R300 each.
In the Sasol and African Bank schemes, shareholders ranged from the very poor to the very well-off, who took larger exposures. Each company had many thousands of BEE shareholders.
These failures are few and far between. A study of the BEE deals by the JSE’s 100 largest companies undertaken by my firm Intellidex found that at the end of 2014, net value of R317bn had been created for black beneficiaries. Deals included that of banking group FirstRand, which delivered more than R23bn to beneficiaries, and insurance giant Sanlam, which delivered more than R14bn. The maturing Exxaro BEE scheme in 2016 netted investors in the mining company more than R10bn. Sasol and African Bank are the exception, not the rule.
There are many objectives of BEE schemes, some of which are inconsistent with each other. On the one hand, BEE schemes are meant to result in black ownership in companies. On the other hand, schemes are meant to create wealth in black hands. They are also sometimes seen as reparations for apartheid.
Ownership, by its very nature, implies risk. Owners are fully exposed to the value of their assets for both good and bad. Equity risk is usually understood in terms of price volatility — value can vary widely, but in the long run, the probabilities increase that the value will be positive.
That is why BEE deals tend to have long-term lock-ins of between seven and 10 years. The longer the lock-in, the greater the probability that the value of the equity net of funding will be positive.
The Intellidex study confirmed this. Shareholders were more likely to end up with positive value in 10-year schemes than in shorter-term ones. Of course, investors should be fully appraised of the risks and I don’t think BEE shareholders were.
The reparations ambition for deals could be achieved simply by writing a cheque to beneficiaries, but that would frustrate the ambition to diversify ownership. So, we have ended up with a compromise. BEE schemes are directed towards ownership, but the risks of that ownership are shifted. Reparation comes in the form of a transfer of risk from BEE shareholders to ordinary shareholders.
In the Sasol scheme, BEE shareholders got their shares at a discount to the market price. The smallest participants got shares for R18.30/ share when the ruling price was more than R400/share, while larger investors receivd shares at R366.
The capital they contributed was leveraged with debt that was provided at a discount to the prime rate. Given the discount and cheap funding terms, the probability that the Sasol scheme has ended up insolvent was very small.
Ordinary shareholders bore the cost of initiating the scheme, including a considerable dilution of their interest in the company, and now bear the cost of winding up the scheme including covering the financing deficit.
So, their risks have always been much higher than the Inzalo shareholders’. It is glib to say that shareholders, even BEE shareholders, should not have all their eggs in one basket. Portfolios spread the risks.
Had BEE shareholders participated in multiple schemes, the failure of some of them would not be a problem. However, diversification requires a certain scale that is out of reach of the poorest, given the minimum investment amounts. And the reparations motive of BEE deals is surely most important in the case of the poorest.
Much of the pain could have been avoided had BEE been done through portfolios from the start. However, the ownership objectives are frustrated when intermediaries are put in place between investors and the companies they are exposed to.
We want ordinary black South Africans to have direct interests in companies and to exercise the rights attached to those. Sasol has initiated a new scheme, Sasol Khanyiso, to which Inzalo shareholders will have preferential access. The new scheme is in Sasol SA, rather than the global company.
The specific terms of the Khanyiso deal have yet to be announced, but will probably include a pricing discount and subsidised funding. These will shift the probabilities further in favour of a positive payoff from the new scheme.
Once again, the prospects of positive returns will be good.
But, once again, they will not be guaranteed.