Q2 2021 - (released August 2021)
SA's quarterly Private Equity & Venture Capital magazine
Perspectives on Burger King decision
An unbalanced approach to assessing public interest
by David Holland and Cesaire Tobias
Unlocking shareholder value often requires hard decisions and decisive action.
Grand Parade Investments (GPI), a Cape Town-based empowerment investment holding company, is diligently trying to restore shareholder value by reducing debt and closing the discount at which it trades. The South African Competition Commission has made matters worse for GPI.
GPI acquired the master franchise rights for the Burger King South Africa (BKSA) brand in 2012 and has grown BKSA annual turnover to over R1bn. Profitability has been slow to materialise and cash flow negative to fund the expansion. GPI’s debt grew to a dangerous level, dividends were cut, and its share price underperformed due to disappointing results. As part of a value-based strategy to reduce the discount at which GPI’s share price trades, relative to its intrinsic net asset value (iNAV), GPI made the strategic decision to sell BKSA. GPI accepted an attractive bid of R670m (revised down to R570m post COVID-19) from the US private equity firm Emerging Capital Partners (ECP) Africa to acquire BKSA. The proposed acquisition was unexpectedly blocked by the Competition Commission on “substantial public interest grounds”.
“The Commission is concerned that the proposed merger will have a substantial negative effect on the promotion of greater spread of ownership, in particular to increase the levels of ownership by historically disadvantaged persons in firms in the market as contemplated in section 12A(3)(e) of the Competition Act. Thus, the proposed merger cannot be justified on substantial public interest grounds.”
On 18 February 2020, GPI announced that it had entered a binding offer with ECP Africa for the sale of BKSA as a major step in unlocking share-holder value. The market reacted favourably, with GPI’s share price jumping from R3.25 (Feb 17, 2020) to R3.70 (Feb 20, 2020), a 14% improvement. Shareholders were rewarded as a direct result of a sound strategic decision on GPI’s part. The COVID-19 pandemic slowed the deal, but both parties pressed ahead after agreeing to a lower price.
In a decision that has baffled all but itself, the Competition Commission reversed the momentum of GPI’s strategy by slamming the brakes on the deal. On 1 June 2021, the Commission released a media statement prohibiting the proposed acquisition of BKSA by ECP Africa, causing GPI’s share price to drop 17% overnight, from R3.10 to R2.57. Shareholders were markedly poorer after this unexpected announcement. To most, the Competition Commission is mandated to assess the equity, efficiency, and fairness of M&A activity in South Africa. The Commission, however, has a dual mandate, the second part of which includes the protection of public interests. It is this second part of their mandate which was the deciding factor in prohibiting the acquisition.
“The Commission found that the proposed transaction is unlikely to result in a substantial prevention or lessening of competition in any relevant markets. With respect to public interest considerations, the Commission found that the Target Firms are ultimately controlled by an empowerment entity wherein historically disadvantaged persons (HDPs) hold an ownership stake of more than 68%. The Acquiring Firms have no ownership by HDPs. Thus, as a direct result of the proposed merger, the merged entity will have no ownership by HDPs and workers.”
This dogmatic interpretation of the law can be argued to have a net negative public interest effect, rather than a positive one which the Commission aims to promote. To assess the public interest impact, a scorecard can be used. The table below, illustrates such an approach.
Quite simply, the economic pie grows for South Africa if the deal is approved. Our high-level scorecard demonstrates that the deal is positive for the public interest. Although the Commission made mention of a scorecard, it did not release one. We can only surmise that the Commission used an unbalanced scorecard weighted exclusively on a single factor.
The Commission placed an emphasis on HDP shareholding to support their public interest claim. While B-BBEE is indeed a matter of great importance in South Africa, black shareholders have not been aided by the Commission’s decision. The Southern African Venture Capital and Private Equity Association (SAVCA) has said that “blocking the deal hurts the ability of black investors to optimise returns on their investments.” GPI’s historically disadvantaged shareholders have been hurt by their shares losing value, and black-owned businesses in general because of more onerous requirements for M&A activity to be successful. One need only look at the immense discount that publicly listed black-owned holding companies trade at to quantify the penalty.
“At some point any investor wants to realise value and by limiting black shareholders’ options on who they can sell to, you’re effectively blocking them from optimising their returns and restricting them to only local sources of capital. Inasmuch as greater ownership by black shareholders is important, it is also equally important that viable exit options are available for these shareholders and therefore a balanced approach is required.” - Sthembile Nkabinde, SAVCA director and CEO of Khulasande Capital.
The dual mandate of the Commission is understandable. The myopic interpretation of the public interest matter is not. The decision benefits a narrow interest, not the public interest, and is based on an unbalanced approach. The implications of this decision set a disconcerting precedent.
Foreign investors will be more reluctant to invest or simply unable to invest.
Those who are willing and able to invest will require a higher return proportional to the increased policy risk, thereby raising the cost of capital and decreasing valuations.
Optimal deals will be forfeited for suboptimal ones (or none) because of a lack of options available to shareholders.
Inefficiency of capital markets is a natural result of (artificial) suboptimal decisions. This invariably leads to a concentration of power in the hands of the politically connected.
Loss in tax revenue due to lower M&A activity, higher unemployment, and decreased competitiveness.
Economic growth is impeded and, as a result, so are employment opportunities.These are government’s top two priorities.
One of South Africa’s best attributes is the strength and resilience of its capital markets. The historical decision to block the Burger King acquisition threatens this. While it is imperative that business activity is aligned with the broader social good, businesses need to have the freedom to express how that social good is realised. Narrow interpretations of rules and regulations cause frictions in markets, which limits opportunities and stifles enterprise. In a country so desperate for jobs, investment and economic progress, the Commission’s decision is a harmful one, not only to Grand Parade and its shareholders, but to South Africa.
Holland and Tobias are directors of Fractal Value Advisors www.fractalva.com