DealMakers - Q3 2019
Crystallising value in B-BEE deals
by Zondi Nduli and Greg Rowan
When the Broad-Based Black Economic Empowerment (B-BBEE) Act, 2003 was promulgated, its primary intentions were to encourage and enable meaningful participation by black people in the South African economy, drive structural change within the senior management of organisations and facilitate equitable ownership of those organisations.
While these were all noble intentions, it is important to reflect on the successes and failures of B-BBEE deals. 25 years after South Africa's first democratic election, and 11 years after the publication of the first DTI Codes, we explore the value B-BBEE investors have been able to realise and the tangible impact that these deals have been able to deliver to the B-BBEE participants.
The 100 largest JSE-listed companies have succeeded in generating approximately R317bn in value for B-BBEE participants since the turn of the millennium. However, of the R317bn in value generated, some R208bn in value is still locked in shares and is yet to be monetised. From the above, the country's private sector appears to be taking significant steps towards fostering the transformation required for truly inclusive growth and participation in the South African economy.
While there have been many successes, there are as many shortcomings, the most notable of which is a failure of B-BBEE deals to crystallise and deliver the value generated to B-BBEE participants through monetisation of their equity interests. There is certainly a lot that can be learned from these failures, many of which share similar characteristics.
For example, a key mistake in the early phases of B-BBEE (before the emphasis was placed on broad-based ownership) is that B-BBEE deals were structured by simply providing strategic, black-owned equity partners with third party funding to acquire B-BBEE interests in companies. While some of these leveraged B-BBEE deals resulted in a few individuals amassing huge wealth, the limitations of this approach soon became evident. There were examples noted where the company in which the B-BBEE equity interest was acquired realised minimal capital appreciation and declared insufficient dividends to service the acquisition finance costs, and the B-BBEE participants were unable to cover the cost of repaying the funding they received, and many exited the B-BBEE deal without realising any value.
There have been some attempts to address these challenges after a number of high profile B-BBEE transactions all but collapsed in 2003 and 2004 due to the market decline at that time. Following the introduction of Nedbank’s innovative notional vendor funding structure for its own B-BBEE deal in 2005, many organisations followed suit by vendor financing B-BBEE deals to create more flexibility by utilising a combination of cash flows and share price appreciation to grow and deliver value.
Another impediment in realising value in B-BBEE deals is the complexity for B-BBEE participants to exit their interests. Even relatively successful B-BBEE deals have faced these value delivery difficulties. Monetisation of B-BBEE equity interests is typically achieved through the sale of shares to either general market participants or other B-BBEE parties to the extent required.
While the sale of shares to general market participants upon the lapsing of a B-BBEE deal is beneficial to B-BBEE participants, the disadvantage to the business is that the company has to structure a new B-BBEE deal when the associated DTI scorecard points are no longer applicable. This naturally presents a conflict of interest between shareholders who will be required to incur further economic costs of completing a new B-BBEE deal and the ability of B-BBEE participants to monetise their interests at market value.
Potential solutions to the above are that upon the lapsing of a B-BBEE deal, in a scenario where the sale of the shares is restricted to black parties, the shares could be sold to other B-BBEE parties or the equity interest could be listed on an empowerment segment of an appropriate exchange. This would allow a company to retain its B-BBEE status and ensure shareholders would not incur the economic cost of structuring a new B-BBEE deal. However, both solutions mentioned above are typically executed at deep liquidity discounts due to limited capital availability within the black investment community and the high costs associated with obtaining funding. B-BBEE participants are thus not able to realise the full value of their shares upon monetisation.
Given the limited success that has been achieved in terms of monetising value and transforming ownership to make historically disenfranchised people active participants in the economy, it is essential that both the private and public sectors return to the drawing board to ensure that future B-BBEE transactions do achieve true empowerment, and crystallise the value that they were initially intended to do.
Nduli and Rowan are Analysts in Corporate Finance at Nedbank CIB.
 Source: Intellidex: The value of BEE deals (June 15, 2015)