MONEYWEB / 14 MAY 2019 - 00.58 / RIAZ GARDEE
Three main variables factor into its value creation.
Barloworld’s recently launched Khula Sizwe public black economic empowerment (BEE) scheme offer comes to a close in less than two weeks, on May 31. The scheme is unique in that it is underpinned by a property portfolio occupied by JSE-listed industrial conglomerate Barloworld as a tenant and guarantor.
Barloworld CEO Dominic Malentsha Sewela. Picture: Moneyweb
Barloworld has a R28 billion market capitalisation.
The scheme can be likened to buying a house with 80% debt, with Barloworld as the tenant who has signed a 10-year lease with 8% annual escalations – and has also effectively guaranteed the debt to the banks. These factors provide significant downside protection to prospective BEE shareholders.
Conversely, the upside is limited to the maximum rise in the property values over the term. Given these variables, investors want to know how much value the scheme can create.
The three main variables in the value creation of this scheme are:
The future value of the property portfolio
Outstanding debt after five years and thereafter, and
Any illiquidity discount for restrictions on BEE shares.
The 8% annual rental escalation for the next 10 years will underpin the future value of the property and allow for the debt repayments to be serviced. The debt of R2.2 billion, on an average interest rate of 9.5%, has been structured as interest only in the first year and thereafter amortising to R900 million at the end of year 10.
Based on these assumptions, as detailed in the prospectus, and an estimated 5% per annum escalation in property values over the period the following scenarios* unfold:
Based on the above assumptions, the value of the share should be around R25 after five years and in the region of R50 after 10 years, assuming a 25% illiquidity discount due to the envisaged BEE trading restrictions. As there will be trading restrictions after five years, some illiquidity discount should be applied. After 10 years the value should increase even further as the debt is repaid, leaving the shareholders with the full value of the property portfolio. Assuming a 7% per annum escalation in the property value, no debt and no trading restrictions, the value should be around R100 per share in 15 years, excluding any dividends paid. Hence shareholders are urged to remain invested for 15 years to obtain maximum benefit of the deal structure.
Any change to the property value growth, positive or negative, will have a corresponding impact on the value. The above is referencing the value and not the price as the price will be determined by buyers and sellers in the market in five years’ time. However, it is critical for any investor to assess the underlying value of any purchase. This is succinctly summarised in Oscar Wilde’s definition of a cynic as “one who knows the price of everything and the value of nothing”.
Another important consideration for shareholders is how much they will receive in dividends. As there is significant debt upfront, 80% loan-to-value, the dividends are only likely to increase after five years as follows:
Years 1-5: It is unlikely that there will be a significant surplus, and any surplus would be used for expenses or to repay the debt. Shareholders should not anticipate any significant dividends.
Years 5- 10: It is likely that some of the excess cash will be used to pay dividends. Depending on the company’s strategy at this point it may use the excess cash to repay debt, pay dividends, acquire new properties, or a combination thereof.
Year 10 and beyond: The company should have cash surpluses at this time and is therefore likely to pay dividends and settle any outstanding debt or make further acquisitions.
Therefore, meaningful dividends should not be anticipated before year five.
For a further explanation on the above, watch the video below:
VIDEO : https://youtu.be/e7gZZKkCE6A
Value will be created through the combination of any increase in the property values and the use of financial leverage, which is effectively guaranteed by Barloworld.
Launching a public BEE scheme is commendable as it truly gives broad-based BEE shareholders the opportunity to create value over time, inculcate an investment culture and integrate into the mainstream economy. The only negative of the scheme is its small size at only R163 million. It is therefore likely to be allocated in smaller amounts across many shareholders even though there is no maximum subscription limit.
This is certainly no get-rich-quick scheme. It is designed for long-term capital value uplift which is typical of any highly leveraged property transaction. Patience is the hallmark of a seasoned investor. When Warren Buffett was asked why many people don’t just copy his simple investment thesis, he replied: “Because nobody wants to get rich slowly.”
Riaz Gardee is a mergers and acquisitions specialist and financial writer.
* The views and opinions shared in this article belong to their author, cannot be construed as financial advice, and do not necessarily mirror the views and opinions of Moneyweb.
Disclaimer - The views expressed here are not necessarily those of the BEE CHAMBER