For Every Door that Closes, Another Opens for BEE - 20 March 2009

Disclaimer: Please note that this article is at least 12 months old.
Any information herein was accurate when published on 20 March 2009

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Roughly R41 billion worth of potential BEE deals have been wiped out due to unfavorable trading conditions in the past two years, according to statistics sourced from BEE rating agency Empowerdex. Last year alone the total value of BEE deals sealed on the JSE declined fivefold to R13 billion (from R66 billion in 2007). But the real threat is that deals already struck may begin to unwind.

A solution, according to Morné van der Merwe, Werksmans senior director in the corporate and commercial department, with special focus on M&A, would be for government to consider a bail-out package to ensure no BEE deals fail, and the country remains on target to meet DTI objectives.

Van der Merwe says that a number of BEE deals will undoubtedly be under threat during the current economic slowdown, especially those deals struck in the mining sector at the top of the cycle, as many were last year, to meet the Mining Charter deadline.

“However, I'm confident a large portion of the deals should be safein light of the fact that a significant number of the latest waive of BEE deals were struck on a vendor-finance basis, using less bank finance than was the case under the model that collapsed during the Nineties market correction.

“We will not see anything like that this time round,” adds Van der Merwe. “Vendors tend to be a lot more sympathetic and would rather renegotiate the deal to save it than see it collapse.”

However, many deals (especially the large value deals) were structured using bank and private equity funding.

Paul Austin, Head of Corporate Finance at BDO, says that where bank finance is present in a deal, the structure may be under stress, not so much because of the share price collapse, but due to falling company earnings in an economic slowdown.

“A lot of BEE deals are still financed with debt, and bankers the world over are under pressure to find more security and reduce their exposure to risk.

“Although banks have a substantial exposure to BEE finance, we have not yet seen a flood of actual collapses, because there is a degree of robustness in many of the older deals. Even if a share price has collapsed from, say, R500 to R300, if the deal was done in 2005 it is likely to still be in the money. For instance, the original share price might have been R100,” says Austin.

“It would only affect deals either done at the peak of the cycle last year, or where the share price collapse has been of spectacular proportion,” he adds. However, there have been some such spectacular collapses in share price of as much as 94 percent in the case of Super Group. Austin says many of these deals still have a long time horizon in which to recover, and BEE partners are therefore no worse off than other shareholders.

In most deals involving bank finance, a certain rigour was introduced by the banks' process of due diligence. Austin says although banks have been heavily involved in funding BEE deals, “they never gave anything away, and every deal had to be bankable with their loan capital well secured”.

In the few cases where deals have to be renegotiated, both Van der Merwe and Austin see a positive aspect to it: only last September were the Codes of Good Practice finally published, and only in February this year was the final piece of the jigsaw put in place when a verification system was authorised.

Therefore, says Austin, only now can broad-based BEE fully get under way. This means all the earlier deals, while in most cases perfectly valid, may not fully comply with the Codes.

Van der Merwe says any renegotiation therefore offers the opportunity to strike new fully-compliant deals which offer maximum scorecard points, and create the opportunity for more broad-based partners to be brought into any deal.

Van der Merwe says this would align with a financial role by government agencies in supporting vulnerable deals.

“Government has charged agencies such as the Industrial Development Corporation and National Empowerment Fund with supporting BEE, and they could play a role – especially if there was now the opportunity to make them more broad-based – to provide finance or guarantees to such deals, and even facilitate the introduction of specific BBBEE groups,” he says.

“Banks aren't lending, and government has funds for BBBEE as well as the infrastructure to accomplish it through its development finance institutions. Government really needs to step in here to ensure all the good work achieved in BEE is not undone by factors which started beyond our borders, as well as helping preserving the good parts while improving those aspects deserving of criticism,” says Van der Merwe.

Austin says in the absence of a government bailout or renegotiation, there are few alternatives still open to BEE groups: “It's very difficult to raise new finance in this market to replace debt, and if you can do so it will most likely be expensive.”

Should the worst happen and some deals collapse, companies might even view this as a benefit, as it would give them the opportunity to negotiate a new deal from scratch – one that complies with the DTI Codes and can now be verified as such by one of the accredited BEE verification agencies, says Austin.

Disclaimer: Please note that this article is at least 12 months old.
Any information herein was accurate when published on 20 March 2009