City Lodge’s bad BEE deal
SHARE OPTION: TRANSACTION COSTING OVER R900M
It would’ve been far cheaper to have simply gifted shares for free to these trusts and BEE partners.
It is hard to overstate just what a terrible deal City Lodge’s 2008 black economic empowerment (BEE) transaction has been, principally for shareholders. Just three weeks ago, the hotel group surprised the market with a request for the approval of a R1.2 billion rights issue. At that point in time, its entire market cap was just R1.3 billion. Since then, it has declined to R914 million.
Of course, the impact of Covid-19 and the lockdown since March has been brutal. City Lodge shares are down 70% this year, so it is tempting to imagine the group desperately needing funding for the market to sustain its currently limited operations.
The reasons disclosed in the rights offer circular include allowing the company to “repay corporate debt; provide for its obligation under the BEE funding arrangements; allow the company sufficient working capital to fund its cash flow shortfall as a result of the impact of the Covid-19 pandemic and the lockdown; and create debt capacity and a flexible capital structure to position the company for future growth”.
Remove the substantial burden of BEE funding from its balance sheet, and it would be hard to describe the level of debt as “high”, which the group does in the circular. In fact, shareholders are being asked to stump up R1.2 billion for the primary purpose of bailing out City Lodge’s BEE scheme.
In 2008, the group completed a BEE transaction with three entities who, together, would acquire 15% of the company. At that time, the value of the deal was R485 million.
Vuwa Investments would acquire 6%, the Injabulo staff trust a further 6% and an entity to be established by the University of Johannesburg, School for Tourism and Hospitality for the education of primarily black students of the tourism and hospitality industry would acquire 3%. The investments by the two latter entities are held via Newshelf 935 and Newshelf 892.
Funding for the acquisition of City Lodge shares by the various parties would be via preference share funding provided by Standard Bank. This funding would be guaranteed by the company.
These seven-year A preference shares would bear interest at 74% of prime, and the (rolled-up) cumulative zero-coupon five-year B preference shares at 75% of prime. With the scheme under water, the redemption date on both was extended to “no later than” 31 January 2021.
Today, the situation is dire. The June circular said: “The B-BBEE Transaction is unfortunately materially out of the money.” The total value of the BEE SPV shareholding on 15 June was R161 million. The amount outstanding in terms of transaction funding was R750 million.
The R50 million loan granted to Vuwa remains outstanding and has attracted total notional interest of R37.4 million, which has been converted to equity. It was not repaid at the original due date of 31 December 2017, as this was subject to the settlement of the BEE preference shares. Excluding lease liabilities, City Lodge’s long-term liabilities as at its interim results on 31 December 2019 were as follows:
Interest-bearing borrowings R660 million
BEE preference shares R353 million
BEE shareholder loan R50 million BEE B preference share dividend accrual R337.2 million Deferred taxation R210.9 million Hilton Tarrant works at YFM
City Lodge shares are down 70% this year