Grindrod has asked shareholders for approval to bail out its failed black economic empowerment (BEE) scheme by ‘buying back’ shares issued to a special purpose vehicle (SPV) in 2014.
Shareholders will vote on this early next month.
Though not quite a City Lodge-level of disaster, the logistics company has been faced with this large headache for some time and while IFRS accounting will make the problem simply go away, it’s not as if shareholders haven’t had to pay up.
The original plan in 2014 seemed elegant enough: BEE shareholdings at various operating companies would be replaced by a direct stake at the listed (holding) company level. How Grindrod would get there is another matter entirely.
It raised R4 billion in capital by issuing new shares. A total of R560 million of this was spent buying out BEE stakes in its various subsidiaries from Calulo and Solethu. These same partners (Calulo and Solethu) together with Brimstone and two other parties (Safika and the Adopt-a-School Foundation) then subscribed for R1.6 billion in shares during the capital raise.
This gave BEE shareholders an 8.39% stake in the overall business. Funding for the SPV was provided by Grindrod through the issue of R400 million in vendor preference shares, as well as Absa through a further R450 million in senior preference shares.
The funding agreement with Absa came to an end in July last year and Grindrod Holdings was at that point forced into the first bailout of the BEE SPV. The SPV issued Class C preference shares to the logistics group and the proceeds were used to repay Absa.
Grindrod, however, points out that a share covenant for the preference share agreement was breached as early as 2016 and “several times thereafter”.
To support the funding structure, Grindrod has had to provide numerous guarantees and cash collateral to “remedy the share cover ratio breach”.
Fast forward to 2018, and Grindrod unbundled its shipping business (Grindrod Shipping) to shareholders.
This led to the BEE SPV owning 8.39% of a shipping business that didn’t want or need empowerment shareholders.
By December 2018 the situation had deteriorated to such an extent that Grindrod had to consolidate the BEE SPV in its own accounts. Effectively, it has treated these shares as treasury shares since that point.
This, then, is where Grindrod finds itself: It says “due to the significant decline in the Grindrod share price over the past two years”, the effective debt in the scheme (R1.4 billion) far outweighs the market value of the shares (R300 million). It cannot quite bring itself to use the word ‘debt’ though, preferring to instead refer to the “aggregate redemption value of accrued, unpaid dividends in respect of the Vendor Preference Shares and the Class C Preference Shares”.
Just how bad things are …
Brimstone, which is majority shareholder in the BEE SPV, shows just how bad things are. At the end of 2019, it held 6.1% (in aggregate) of Grindrod and Grindrod Shipping shares and valued this stake at R345 million. But it also disclosed a total of R960 million in debt related to these shares. With the limited recourse nature of the BEE funding structure, however, it notes its “investment is shown at a minimum value of zero”.
While the “repurchase price” is set at R209.8 million by Grindrod, because the SPV is already consolidated, the transaction will have no material financial effect on the company.
In a peculiar defence, Grindrod says “shareholders have been appraised of [these] developments … over the years as per the disclosures contained in Grindrod’s annual financial statements”. In the August circular, it argues “the administrative process to unwind the 2014 BEE transaction has therefore already commenced”.
But in the 2018 financials (when Grindrod consolidated the SPV), shareholders are provided with the most limited of “disclosures”, with the group saying only (repeatedly) that “due to the additional security [provided], the group’s rights have changed from protective to substantive and the consortium is now controlled by the group in terms of IFRS 10”.
The R4bn capital raise in perspective
One wonders whether the R4 billion capital raise in 2014 would’ve been necessary at all, were it not for the BEE deal. It’s not as if Grindrod had any other pressing uses for the money, aside from the R1 billion needed to buy out the empowerment partners and fund a portion of their new stake. In fact, one could easily argue that shareholders have paid the R1 billion price for this empowerment mess through that rights issue.
If shareholders approve the transaction in September, Grindrod will cancel 64 million shares (8.39%) it holds in itself and will also end up with an 8.39% shareholding in the shipping business it unbundled two years ago.
Lawyers, auditors and other experts will be paid R3.38 million for their efforts on this “transaction”.
Despite the artificial earnings boost created by the “buyback” and cancellation of shares, Grindrod will find itself worse off than in 2014. At least then its various operating businesses had empowerment credentials. Its current Level Two Contributor status is under obvious threat.
Any bets against another BEE transaction being announced in the next 12 to 18 months?