Not really a buyback
PSG Group says it has significant support among shareholders for a plan to refinance its hitherto successful funding structure by buying back its perpetual preference shares at a cost of R1.4bn. With interest rates drifting down over the past 18 months, i
ýPSG Group, the Stellenboschbased investment group, has unexpectedly opted to refinance its “expensive” funding structure by buying back its perpetual preference shares (prefs) for R1.4bn.
The issuing of perpetual prefs to raise fresh capital was initially seen as the most appropriate funding model for PSG — essentially ensuring permanent capital without refinancing risk.
Funds raised by perpetual pref issues over the years helped build a highly successful investment portfolio that included investments in Capitec Bank, Pioneer Foods (via agribusiness investor Zeder), financial services hub PSG Konsult and private education businesses Curro and Stadio.
But with local interest rates drifting down over the past 18 months, PSG reckons a perpetual pref structure is no longer the most effective funding arrangement.
This naturally raised questions around whether PSG still has an appetite to pursue new deals to build out its investment portfolio. The group is hamstrung in its ability to issue new shares for cash as the PSG share price discounts the sum of the parts value of the portfolio by more than 30%.
CEO Piet Mouton says PSG can still evaluate new opportunities by refinancing its balance sheet at significantly lower interest rates via bank funding.
If PSG redeems all its perpetual prefs it will have a cash balance of between R400m and R650m.
But it still retains 1.4-million shares in Capitec worth about R1.8bn that might also be considered as deal-making currency. The mechanics of the repurchase will see PSG offering pref shareholders R81 a pref — a roughly 23% premium to the pref share price on April 8 of R65.88. The prefs were issued at R100.
The buyback is a “clean” offer, which means the price and premium are calculated without any accrued dividend.
Mouton says that though the market might regard the pref deal as a buyback, it is in reality a refinancing of the group’s funding. “We can, if suitable investment opportunities arise, replace that debt on our balance sheet.”
He estimates PSG could gear up to a level equivalent to the current market cap of the perpetual prefs. With traditional bank funding it could save up to R30m a year in interest.
Mouton says it is an opportune time for PSG, which has surplus cash available (after receiving a huge special dividend from Zeder), to pursue the pref share buyback.
There is also unlikely to be a call for funding by PSG’s investee companies, with Mouton noting that “all our underlying businesses are well capitalised”.
Significantly, PSG already has irrevocable undertakings and letters of support from shareholders representing about 40% of the perpetual prefs in issue.
Mouton argues that the share price of the perpetual prefs is not likely to increase from current levels for the foreseeable future. This creates an opportunity for the pref shareholders to enhance their returns by reinvesting the cash received from the scheme. He adds that if the prefs are repurchased at R81 each, the shareholders can enhance their yield from the current 9.3% to about 11.7% by reinvesting in other JSE pref shares.
Other listed perpetual pref shares include Absa (historic yield of 8.4%), FirstRand (8.4%), Standard Bank (8.8%), Discovery (10.2%), Grindrod (10.4%) and Investec (10.5%). Whether there will be resistance from a significant number of PSG perpetual pref holders remains to be seen.
One thing’s for sure, the pref market has changed considerably.
Mouton says the change in tax legislation from secondary tax on companies (STC) — which entailed a 10% tax on a company declaring a dividend — to dividend withholding tax has been very negative for holders of perpetual prefs.
He says initially most of the issuers gave the perpetual pref shareholders the tax saving relief in the form of the 10% STC saving for the company. PSG upped its pref dividend rate from 75% of prime to 83.33% of prime.
Mouton estimates that after these changes, holders of perpetual prefs are worse off by 11%.
He says that when perpetual prefs were initially issued, many holders might have viewed the product as equity with a higher dividend payout ratio.
“With the global financial crisis [in 2008/2009] the market started to understand the product better and the prices dropped significantly, thereby increasing the yield. The market now understands that perpetual prefs rank behind senior debt, but ahead of equity.”
Mouton says perpetual pref holders are also not totally in control of the level of gearing a company can introduce — over and above the gearing associated with the perpetual prefs — which could introduce additional risk.
“One can argue it several ways, but ultimately a perpetual pref structure is sub-debt or mezzanine debt,” he says. “There is merely one advantage … if the company has a very bad year with severe cash flow constraints, it does not automatically put the company into default if it is unable to service the dividend.”