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Mar 2003 - BEE

BEE – Is the market over-reacting?

At the Indaba Conference in Cape Town from 18-20 February 2003, a very sobering perspective of the expected unrecoverable discount impact of BEE (Black Economic Empowerment) on share prices was given by a number of brokers.

Figure 1 shows that shares were expected to initially target 65% to 75% of their original shareholder values, or up to 83% to 86% if a discounted empowerment stake was included.

Figure 1. The Empowerment Life Cycle (source : Deutsche Bank)GDNmar03-1

This presentation was preceded by a comment from CIBC that the discount impact of BEE on shares could be clearly shown by the performance of Anglo American compared to RIO, in which Anglo American’s share price had fallen by 25% and RIO was unchanged.

While it is true that the South African exposed shares did collapse in the week ended 26 July during which the first BEE proposals were leaked on miningweb, the great majority of the shares shown in Table 1 had already slipped from a peak around 30 May 2002. Despite an outpouring of net financial flows from South Africa in both shares and bonds until January 2003, a number of the shares had recouped their losses from 19 July 2002 to 24 January 2003. Also, as far as the gold shares are concerned, Anglogold (despite BEE) has been outperforming Newmont, and in the platinum shares, Zimplats (despite Zimbabwe) has been outstripping its peers. Aquarius’ relatively weak performance has been partly blamed on a perceived Australian misunderstanding of BEE.

Table 1. Share Price Comparisons (30 May 2002 – 5 March 2003)GDNmar03-2

BEE (which has as yet to be fully enacted to give it a starting reference point) has been referred to as being based on four “planks”, namely : Equity, Employment, Social Upliftment, and Procurement of which the “equity” component has received the most publicity. It should be noted that there are a few new abbreviations being used in the BEE text, such as NEPAD (New Programme for African Development), and HDSA (Historically Disadvantaged South Africans – being non-white SA citizens such as Indian, Coloured and Black people – [Black people from other parts of Africa are not classified as HDSA, they are non-white non-SA citizens]).

The “equity” component refers to 15% of a South African (mining) company needing to be HDSA owned within 5 years (although empowerments have so far only been Black, the SA Minister of Mines stated HDSAs in her speech at Indaba) and 26% HDSA owned within 10 years. This is required for the old MLs to be converted to new MLs. The “equity” component has been widely interpreted as having to become a “hand-out” “based on a R110bn requirement for 15% of the SA mining sector compared to the SA banking sector’s total market cap of about R50bn, so international banking finance is required and they are likely to demand a discount”.

While it is expected that the companies may have to aid in providing lines of finance for a black empowerment group or person to attain a holding at current market prices, with the repayment possibly linked to dividends or cashflow, it is not that simple since investment in profitable companies is likely to be desired, with marginal companies shunned. There is also the difficulty of trading a large parcel of shares from one black empowerment group to another (if the first deems itself to have made a sufficient profit) or the risks of insider trading where a group knows in advance that its investment is likely to decrease in value.

However, there is expected to be a system of credits where existing shareholders who are HDSAs or companies that hold a sizeable amount of another company are themselves partly owned. For example it was hinted in the Royal Bafokeng Resources presentation at Indaba that it could swap its 22% Implats royalty for an Impala shareholding which could occur if Implats bought back its Gencor holding (when it becomes available in 2003) and swapped it. Since RBR already owns 1.5% IMP shares, that could result in RBR owning 23.5% of Implats with no change in the existing number of issued shares. Now, since IMP has 25% of Aquarius’ operations and 9% of the AQP parent, if that occurred, AQP’s SA operations could effectively become almost 7.5% HDSA-owned, again without any change in the number of issued shares.

AQP and some of the other SA companies in fact welcome HDSA ownership since it would provide finance to reduce debt funding for capex programmes. In AQP’s case for more HDSA ownership, it is more complex because AQP is not listed in South Africa and SA Reserve Bank approval would be required to buy a shareholding outside of South Africa.

The “employment” component relates to the fact that the SA Govt wants to reduce its SA citizen unemployment levels. Consequently 40% of management positions are supposed to be held by HDSA within 5 years, and 10% are to be HDSA women. AQP has 4 Black people amongst its 31 employees, but 2 of them are non-SA citizens – so they do not count because they are not HDSA – which highlights the difficulty that some companies may have in attaining their targets and why the “pool” may be able to name their salaries. However, there are expected to be credits, because AQP outsource most of their operations amongst contractors it is up to AQP to encourage such contractors to increase their HDSA employees.

Although new mines are expected to require the 26% ownership and 40% management positioning (ideally) upfront in order to attain an ML, the SA Govt has stated that it will not halt economic progress, so some old order MLs are expected to be temporarily granted for smaller operations if they result in providing employment.

The “social upliftment” component relates to assisting and engaging in local communities. This is a common requirement for mines throughout the world to put something back into their local community (apart from caring for the environment), such as funding schools, medical centres, building roads, providing body corporates or co-ops to farm land and become self sufficient. Grouped in with this component are the company/mine’s obligations to its own workforce in literating its existing labour force, providing career path opportunities, multi-skilling for when HDSA employees leave the company, providing HIV/Aids education, hostels, homes and nutrition.

Lastly the “procurement” component relates to the company giving HDSA companies preferred supplier status, which is not taken to mean that more should be paid for a contract that the HDSA company competently bids for. Although it has reputedly already resulted in some heated debates when an HDSA bidding company is rejected, since some HDSA companies are demanding to know why / who actually did win the bid. Possibly some of the capex equipment to be used can be sourced from HDSA companies, or ore can be trucked by an HDSA trucking company. The SA Govt is apparently looking for a gradually increasing use of HDSA companies over say the next 3 to 5 years, through outsourcing, vertical integration or whatever means possible.

There was also some share price weakness at the time of the Indaba February 2003 conference based on the expected royalties in the Money Bill being announced with the end of February Budget (the announcement did not happen). These revenue royalties were based on what other countries in the world already “charge” mines that operate in their countries, such as 2% to 3% for precious metals and 10% for diamonds (as in Botswana and Zimbabwe). SA used to have a lease tax system in which gold companies could pay up to 6% or 10% of their profit as a lease royalty.

As inferred above, there are a few woolly areas to be resolved, and exploration has yet to be properly classified as to whether black empowerment companies are prepared to expose themselves to exploration risk, or whether they will be able to wait and then be involved ahead of production. However, as a general observation, the expected heavy perceived “unrecoverable” projected discounts that are being applied to operating companies appear to have been an oversimplification and an overreaction to uncertainty, with little provisioning for credits.

Disclosure and Disclaimer : This article has been written by Keith Goode, the Managing Director of Eagle Research Advisory Pty Ltd, who has a Proper Authority with State One Equities, and with his associates, either has or expects to have interests in most of the stocks in this article, This e-mail address is being protected from spambots. You need JavaScript enabled to view it . The opinions expressed in this article should not be taken as investment advice, but are based on observations by the author. The author does not warrant the accuracy or completeness of any information and is not liable for any loss or damage suffered through any reliance on its contents.

  • Written by: Keith Goode
  • Saturday, 01 March 2003

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