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How Barloworld’s Khula Sizwe BEE scheme could create value

Three main variables factor into its value creation.

Barloworld’s recently launched Khula Sizwe public black economic empowerment (BEE) scheme offer comes to a close in less than two weeks, on May 31. The scheme is unique in that it is underpinned by a property portfolio occupied by JSE-listed industrial conglomerate Barloworld as a tenant and guarantor.

Read: Barloworld launches Khula Sizwe public BEE offer

Barloworld has a R28 billion market capitalisation.

The scheme can be likened to buying a house with 80% debt, with Barloworld as the tenant who has signed a 10-year lease with 8% annual escalations – and has also effectively guaranteed the debt to the banks. These factors provide significant downside protection to prospective BEE shareholders. Conversely, the upside is limited to the maximum rise in the property values over the term. Given these variables, investors want to know how much value the scheme can create.

Key variables

The three main variables in the value creation of this scheme are:

  1. The future value of the property portfolio
  2. Outstanding debt after five years and thereafter, and
  3. Any illiquidity discount for restrictions on BEE shares.

The 8% annual rental escalation for the next 10 years will underpin the future value of the property and allow for the debt repayments to be serviced. The debt of R2.2 billion, on an average interest rate of 9.5%, has been structured as interest only in the first year and thereafter amortising to R900 million at the end of year 10.

Based on these assumptions, as detailed in the prospectus, and an estimated 5% per annum escalation in property values over the period the following scenarios* unfold:

R’000m

 

Current

Year 5

Year 10

Market vlue

 

 2 856

 3 645

4 652

Debt

 

(2 200)

(1 820)

(900)

Net value

 

 656

 1 825

 3 752

BEE shareholders

@30%

197

547

1 126

Shares

Millions

16

16

16

Value

R/share

12

34

69

Less: Illiquidity discount

 

17%

25%

25%

Value

R/share

10

25

52

Based on the above assumptions, the value of the share should be around R25 after five years and in the region of R50 after 10 years, assuming a 25% illiquidity discount due to the envisaged BEE trading restrictions. As there will be trading restrictions after five years, some illiquidity discount should be applied. After 10 years the value should increase even further as the debt is repaid, leaving the shareholders with the full value of the property portfolio. Assuming a 7% per annum escalation in the property value, no debt and no trading restrictions, the value should be around R100 per share in 15 years, excluding any dividends paid. Hence shareholders are urged to remain invested for 15 years to obtain maximum benefit of the deal structure.

Read: Barloworld’s new BEE scheme could have a fighting chance

Any change to the property value growth, positive or negative, will have a corresponding impact on the value. The above is referencing the value and not the price as the price will be determined by buyers and sellers in the market in five years’ time. However, it is critical for any investor to assess the underlying value of any purchase. This is succinctly summarised in Oscar Wilde’s definition of a cynic as “one who knows the price of everything and the value of nothing”.

Dividends 

Another important consideration for shareholders is how much they will receive in dividends. As there is significant debt upfront, 80% loan-to-value, the dividends are only likely to increase after five years as follows:

Years 1-5: It is unlikely that there will be a significant surplus, and any surplus would be used for expenses or to repay the debt. Shareholders should not anticipate any significant dividends.

Years 5- 10: It is likely that some of the excess cash will be used to pay dividends. Depending on the company’s strategy at this point it may use the excess cash to repay debt, pay dividends, acquire new properties, or a combination thereof.

Year 10 and beyond: The company should have cash surpluses at this time and is therefore likely to pay dividends and settle any outstanding debt or make further acquisitions.

Therefore, meaningful dividends should not be anticipated before year five.

For a further explanation on the above, watch the video below:

Value will be created through the combination of any increase in the property values and the use of financial leverage, which is effectively guaranteed by Barloworld.

Launching a public BEE scheme is commendable as it truly gives broad-based BEE shareholders the opportunity to create value over time, inculcate an investment culture and integrate into the mainstream economy. The only negative of the scheme is its small size at only R163 million. It is therefore likely to be allocated in smaller amounts across many shareholders even though there is no maximum subscription limit.

This is certainly no get-rich-quick scheme. It is designed for long-term capital value uplift which is typical of any highly leveraged property transaction. Patience is the hallmark of a seasoned investor. When Warren Buffett was asked why many people don’t just copy his simple investment thesis, he replied: “Because nobody wants to get rich slowly.”

Riaz Gardee is a mergers and acquisitions specialist and financial writer.

* The views and opinions shared in this article belong to their author, cannot be construed as financial advice, and do not necessarily mirror the views and opinions of Moneyweb.

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In the boardroom at Barloworld head office: “Guys, the economic policies of this pathetic ANC government has a detrimental impact on the performance of our properties. The talk about EWC killed the property market. The market value of these properties declined by between 30% to 50% over the past few years. There is no market for them. These properties are a drag on our financial performance ratios. We have to get rid of them or our shareholders will give us the boot. How do we get rid of them under these terrible market conditions?”

The young secretary answers:” Sir, may I make a suggestion? At secretary school, they taught us to turn your weaknesses into strengths and your threats into opportunities. So how about this – the ANC is a weakness in the financial system, so we use it to our advantage? The BEE law is a threat, so we turn it into an opportunity. We sell our properties to a BEE company, at a price that is determined by us, we keep the properties as collateral, we keep on using the properties as usual but it is off balance sheet. We sign long-term lease agreements at a rental cost determined by us, so we have certainty. Our financial ratios improve, we get rid of nonperforming assets and we comply with BEE laws. We lose nothing and we win everything. Our shareholders will love us!”

Chairperson: Ms Secratary, that is exactly what I thought. Thank you for reminding me of my brilliant idea. Can I have a cup of tea, please?

I don’t know heyy!! I believe it is in Barloworld’s interest that this succeeds … they will be managing and maintaining these properties out of their own pockets, at no cost to the BEE scheme.

Anyway my daughter is 13 yrs old now so I will buy for her (with money I can afford to lose as there is risk) so she can at least participate in the economy somehow as she will be in a position to make her own decisions when lock-in period ends…something my parents couldn’t afford to do for me. I will continue to encourage her to read all financial materials she can find in the meantime, such that she is not lost when she has to make those decisions.

I will continue trusting the professional with the money I can’t afford to lose though …

Good for you sir. You have to realise however that these kind of convoluted BEE schemes are all artificial and forced upon business by the corrupt ANC who has destroyed the property market for one. So good luck and especially with trusting the “professionals”.

BEE policies and initiatives are racist and divisive and should no longer be part of the South African economic formula – especially after 25 years.
Every South African company has already built in a BEE component…it’s called Corporate Tax.

Believe me the ANC are just getting started !!!
Until all wealth has been “expropriated ” from the Pale society , the plundering will continue .

Nitpicking I know but I don’t think the ANC big men really care who wealth and property is removed from as long as they end up with it. Look at Maraikana or Life Esidimeni; no one cared that lives were lost in the pursuit of filthy lucre with no less that the current ANC and SA president playing a prominent role.

Such is my read of BEE. It is not at all “broad based” unless you count Khulubuse Zuma as having a broad based. It is manipulated for the ANC cadres and their chums to score. Look no further than Cyril – his wealth does not go any further down the poverty chain than him; it stops there.

*lol* “…counting Khulubuse Zuma as broad based”. Not only that…he’s certainly a heavyweight when it comes to empowerment deals.

Still forgetting the first two B’s in BBBEE.

There is no BEE, it is supposed to be BBBEE.

Government wields a lot of power. You underestimate it at your peril. Tiger brands and construction sector come to mind.

What construction sector would that be? In SA – dream on.

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