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Barloworld’s new BEE scheme could have a fighting chance

It’s underpinned by properties as assets and not share price movements.

Black economic empowerment (BEE) schemes that are underpinned by volatile share price movements, which is how JSE-listed companies usually structure their schemes, cannot guarantee consistent returns for investors.

This is according to Tshepisho Makofane, MD of advisory firm Tamela Holdings, which has advised some of the largest BEE deals in SA – including MTN’s R9 billion Zakhele scheme, which was lauded for creating value for about 124 000 black investors in 2017.

“Equity [or shares] by its nature cannot guarantee returns, even on BEE schemes,” Makofane tells Moneyweb.

Some JSE-listed companies in recent years have failed to deliver attractive returns to black investors because the success of their BEE schemes, which are financed by large debt, depended on a rise in share prices and volatile commodities. 

Welkom Yizani, the BEE scheme of technology company Naspers that invested in its media business Media24, didn’t deliver on its promises. Investors in Inzalo, the BEE scheme of oil and chemicals group Sasol, almost walked away with nothing until its share price recovered just months before the scheme expired in 2018. The 2008 BEE scheme of JSE-listed industrials group Barloworld also didn’t live up to expectations.

New Barloworld scheme

Barloworld – the South African distributor of brands such as Caterpillar, BMW, Mercedes-Benz, Toyota and Ford – is taking another stab at delivering value to investors with its newly launched R2.9 billion Khula Sizwe Property Holdings, a BEE vehicle.

Unlike Barloworld’s previous BEE scheme, value creation in Khula Sizwe is not based on share price movements, but on properties.

Read: Barloworld launches Khula Sizwe public BEE offer

Barloworld sold properties worth R2.9 billion from its portfolio to Khula Sizwe, but at a 5% discount – meaning the sale value was R2.7 billion. The properties include Barloworld’s motor retail (dealerships) and industrial properties across South Africa.

Barloworld has invited black South Africans to, until May 31, buy 16.3 million ordinary shares in Khula Sizwe, with a minimum R2 500 investment, or 250 shares at R10 per share – raising R163 million if all shares are taken up. If Barloworld raises less than R120 million, Khula Sizwe will have failed and Barloworld would own it in its entirety.

Makofane, who is acting as an advisor on Barloworld’s Khula Sizwe deal, didn’t disclose the level of commitment so far, saying only that the response from the public “has been positive”.

He says the company has learned a lesson about the hazards of share price-based BEE schemes, which is why it chose property as the new scheme’s underlying asset.

“Other similar equity schemes haven’t been successful. Past lessons with previous schemes helped us structure this transaction in order to reduce the risk of the scheme not being successful.”

The properties that are sold to Khula Sizwe will be occupied by Barloworld for 10 years, with the rentals paid by the company escalating at 8% per annum on a triple net lease. A triple net lease means that all the upkeep costs of the properties will be carried by Barloworld, the tenant.

Having Barloworld as a rent-paying tenant means there will be predictability in Khula Sizwe’s income stream instead of leaving it to market forces, says Makofane.

Income and debt

In the first year of the lease agreement with Barloworld, Khula Sizwe has pencilled in rental income of R278 million, escalating by 8% per annum for the next 10 years. This income is important as it will repay the debt tied to Khula Sizwe.

The purchase by Khula Sizwe of Barloworld’s properties was 80% debt-funded (R2.2 billion), with the remaining 20% (R544 million) to be funded by equity. The equity portion will be raised from the potential R163 million from the public offer, with the balance from a management trust (R207 million) and the Barloworld Employees Trust (R174 million).

Risk element

BEE analyst Riaz Gardee says Khula Sizwe’s debt load is high and its ability to repay it might be impacted by a drastic increase in interest rates and taxes over the next 10 years.

Khula Sizwe’s debt is not guaranteed by Barloworld – meaning that in the event of a default, the debt won’t be taken up by the company or its shareholders. Makofane says the rental income that Khula Sizwe will achieve from its agreement with Barloworld will be enough to repay the debt.

Khula Sizwe and its debt provider, Nedbank, expect a reduction in the debt from R2 billion to about R900 million in the next 10 years. “Our numbers indicate that the debt will go lower than this number [R900 million],” says Makofane. “But we don’t know what the interest rate and tax regime will be.”

Other measures taken to minimise the risk of adverse interest rates include the hedging of debt, with the Barloworld board imposing an obligation for “50% of the debt to be hedged”.

The debt obligation means Khula Sizwe won’t pay dividends anytime soon.

“Khula Sizwe will consider dividends when the debt has been retired,” says Makofane.

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Ray, your article does not cover political and business risk the scheme faces i.e. nationalization, expropriation without compensation,and what happens if Barloworld fails to renew the leases after 10 years of occupation. Will Barloworld buy the properties back on the expiry of the scheme?

Also, can you establish if the interest rate of the loan is fixed or is it linked to prime. The scheme will be much more attractive if the loan is secured on a reasonable fixed interest rate basis over the loan period.

And ,if the properties were properly valued. Me thinks the properties are over valued,and a bigger discount should have been offered to the investors.

with any investment that is made there is a risk, normally the higher the risk, the higher the income – here it looks like sitting on 2 seats at the same time – if i put my money into a scheme, i take a risk -the onus of the decision to make that investment is on myself – along with it comes the risk that i take – stop dreaming about a risk free investment in what ever form and with immediate high returns thereon – the real financial world is rough and rude – no smooth ride seats available at this stage

It would be interesting to find out where the initial value of the properties come from, i.e. book value or market value, etc?
In a big transaction like this, 5% discount is low in my opinion. This is based on the believe that there must not have been competition (market) to buy the properties and hence the “spread” would have been wider leading to a bigger discount to valuation.

2cent

25 years later and we are still trying to prove BEE works………..?????

Investing in the share of company shouldn’t be “a free call option.” If you want equity exposure: do your valuation work and prepare for the ride of markets going up and down and individual share prices going up and down. BBBEE schemes never feel the same pain as ordinary shareholders when prices go down. When the out-of-the-money scheme is dissolved BBBEE holders walk away from both the liability (usually loans) and the asset (the shares). This isn’t equity investment, this is a type of dilutive derivative and ultimately cost to the company. Ultimately the funding of BBBEE is another tax on the savings wealth of the economy.

This “sale and leasback” model very rarely work, after +_ 7 years , the rate increases on “rental” become so high that the business become marginal, especially in a market with growth are lackluster/increase form consumers for cars/cats/spares.

Whilst you are growing it is easy to hide the inefficiency’s…when growth halts all teh gremlins surface

What happen next is a good business under pressure…or the landlord take over the business.. and viola a whole business captured like em zupta’s

Some dud properties with an over burden loan in a struggling economy mixed with political uncertainty, and with exposure to one tenant/one company makes it a dubious investment.

Yet another BEE scheme. What a jip… What do you call a deliberate exclusion of a group based on race again? You say we live in a democracy? On our menu today some Affirmative Action with a side order of BEE. BEE = Government enforced economic apartheid anyone? Government exclusionary policies doesn’t wash BEE policies clean you know. Two wrongs don’t make a right. Almost 3 decades later and we’re told that now this one will work? Also the following elicited a sick giggle from myself “Some JSE-listed companies in recent years have failed to deliver attractive returns to black investors…” Which should also read that some of JSE-listed companies in recent years have failed to deliver attractive returns to ALL investors. We (the paler part of the the demographic) are constantly reminded not to make race and colour such an issue. Appears we have double standards here though? Were BEE investors supposed to receive preferential ownership of shares AND preferential returns that differs from the others holding those self same shares? Now how does that not smell like a dog’s rosebud?

As others have noted, the 5% discount is dubious in the current property market. I’d want to know how the properties were valued these past few years, and if, for example, they followed the general trend of listed property and shed around 20-30% in value in the last year.

Also, it’s worth noting that Barloworld announced on 10April that the R2.9bn BEE property disposal was coming (freeing up maybe 10% of the balance sheet), and a day later on the 11Apr a cautionary note that they were planning a material acquisition (with those funds?).

What’s that for? BEE brownie points? Dumping overpriced property with debt on unsuspecting BEE sods? Preparing facilities for the next evolution of vehicles? Getting funds out of SA? Tying down long-term property costs at less than market escalations? Nothing against what Barloworld is doing, but right now I’d rather buy the share than the property scheme.

This is a little like voting for the DA. “We”, some obscure proportion of SA citizens, know that BEE is wrong and racist in principal. But, in order to do business, or lure voters, companies and political parties need to subscribe to it. For companies, I happen to believe it is a short term, self interested choice. Some companies (Anglo) will seem to comply but actually move out of SA, others (SASOL, Vodacom, maybe BW) will comply and just pass on the cost to the SA economy, adding another parasite to the already wobbling host. In most cases, the decision makers (the directors) do personally very well out of the companies, and the deals, as applicable. You be the judge.

This is a joke. 80% debt? They should have had more equity than this. I’d never invest.

“Black Economic Empowerment”. Thought State Capture has now made this irrelevant?

If you’re black just buy.
Sasol via Inzalo
Multichoice via Phuthuma
Vodacom
So yea ignore the naysayers. In fact approach them and most of the will be willing to borrow you the money and use you as a front.

Barloworld is hedging against EWC. Property in SA is not a good bet for the next 10 years or maybe even the next 100 years. The 2.7 bn can be safely re-invested overseas.

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