Economic crisis - BEE transactions under threat?
14 July 2009
Are BEE transactions faced with a sub-prime scenario?
Black economic empowerment (BEE) is an important strategy in the process of transforming the economy in post-apartheid South Africa. Transactions designed to transfer significant ownership in South African companies to previously disadvantaged persons have been financed by major financial institutions and vendors. The ability of the new owners to service the financing arrangements in these transactions depends principally on the profitability of the entities in which they are investors. The economic crisis which has developed over the past year raises questions concerning the viability of the BEE transactions.
Are BEE transactions faced with a sub-prime scenario?
While the global economic crisis will have had a significant effect on BEE transactions in South Africa, the issues faced are unique and cannot be likened to the subprime issue facing the banking sector. BEE structures were tailored to the specific requirements of the transaction and were not designed for mass on-selling. In addition, the debt servicing was linked to the cash flows projected to be generated by the underlying company.
Remedies for BEE deals under water
BEE deals may be under threat as the underlying company share prices have plummeted in conformity with international markets. The prolonged economic downturn is also likely to have a negative impact on the cash flows in the companies concerned. This will have a knock-on effect on the dividends which BEE investors may expect to receive, and place them at risk of non-performance on their contracts with the financiers. Remedial restructuring, including extension of repayment periods for the BEE partner, may place pressure on the score achieved for the net equity element of the BEE ownership scorecard.
Given the commercial benefits that empowered companies have over companies without BEE ownership, it is in the interests of all parties, being the underlying company, the banks and the BEE shareholders, to keep these deals intact. This may require one or a combination of the following steps:
Restructuring the funding structure in order to align with the changed economic conditions and the outlook for the underlying company;
Engaging with financially robust BEE groups to effectively merge or consolidate, which will enable the facilitation of sustainable BEE structures; and
Obtaining State-sponsored finance solutions to bridge any funding gaps on a temporary basis.
Accounting, tax and valuation considerations
While these remedies may assist in rescuing BEE transactions that are under water, the accounting and tax implications, if any, should be considered, as well as the market reaction to such rescue packages. For example, a share disposal in respect of a share held for a continuous period of not less than three years will be deemed to be of a capital nature. Earlier disposals may carry a risk of taxation as a trading transaction. It may be possible to merge operations without triggering adverse current tax exposures using group relief provisions in the Income Tax Act. In addition, mergers of BEE groups should only be undertaken once detailed valuations and due diligences have been concluded. A detailed valuation will prevent companies from overvaluing investments and serve as a safeguard against the unexpected future erosion of profits as a result of impairment charges.
Preventative measures
BEE transactions that do not appear to be under immediate threat may come under threat due to difficulties faced by their customers or suppliers. BEE companies would be advised to examine their current trading arrangements carefully and take preventive measures to avert unnecessary risk. Internally, they may also consider whether they may implement strategies to optimise their cash flows in a slowing economy, such as streamlining processes and implementing controls designed to reduce and manage costs. Difficult circumstances demand difficult decisions. BEE companies that successfully manage the risks that may affect their status stand to gain enormously.