Category: South Africa

Categories
South Africa

Brait – not all shareholders are equal

Executives of Brait are bailed out, but they insist it is not at the expense of the other shareholders. Is it?

When Brait morphed from a private equity entity to an investment holding company, the management team leading the change were given the opportunity to buy a 18% stake in the new company. They only had to come up with 20% of the value of the deal, the rest would be vendor financed by Brait itself. The shares would be held in a entity called Fleet. As the share price soared, nobody complained. But since then, the management of Brait has made value destructive decisions. That reflected in the share price, which has come down from more than 160 Rand per share to 24 Rands per share. In the meantime, Brait has refinanced the loan with Standard Bank and FNB. Current the value of the loan is a lot more than the security the banks hold, and Brait has decided to settle it. This is essentially worse than what Carlos Ghosn has been accused of by the Japanese prosecutors, when he convinced Nissans board to take on his personal currency swaps which were under water. But we are not in Japan, we are in South Africa. And here the board of Brait decided to issue a statement that the bail-out does not favor executives!

Besides being highly immoral, one must question the behavior this encourages. The board of directors are the custodians of the invested capital and it is their job to protect it and to grow it. Only they can decide where to invest capital. For that, they get paid astronomical salaries. If the capital allocation turns out to be poor, they should be the ones to take the blame. In Braits case, they were greedy and possibly over-confident to take such a large  loan. Bailing them out when the share price comes tumbling down essentially means that they were able to take a leverage position with unlimited upside, but no downside. Evidently it leads directors to take unnecessary risk without considering the downside.

Brait is unfortunately not a unique case. Pepkor recently bailed out their executives, costing the company a few hundred million Rands, when their Steinhoff shares collapsed. Adept IT is considering issuing new options to their executives (at a lower strike price), because the last few were at such a high strike price that they would not be worth executing any time soon. Off-course, the reason for that is because the share price decreased from more than R15 to R5.11 in about 2 years. There are more examples, a few that are more complex, like the recent change in incentives at Woolworths. Their executives are rewarded on the return on invested capital, which is a prudent measure. But at the same time, they wrote down billions of Rands of their disastrous David Jones acquisition, which was their biggest bet ever. That means that the executive will be measured from a lowered bar, and not from the high water mark before the acquisition was written down. At least going forward, their measure of reward is in line with those of shareholders.

To understand the unfairness of these incentive deals where Managements are offered very lucrative incentives, only to be bailed out when things go bad, it helps to look at an analogy. Imagine that a portfolio manager invest so poorly, that the unit trust he manages constantly loses value. After the value of the fund is down by 70%, the management of the company he works for feel sorry for him and decide to pay him is performance bonus anyways. But because there is not enough income generate by the fund, the investors in the fund have to pay him by sacrificing some of their own invested capital. No doubt this would cause a total loss in confidence in the portfolio manager, the same should happen to managers who only scheme how they can make more money, even at the expense of ordinary shareholders.

It seems it is not only politicians who get rewarded for a poor performance.

Categories
South Africa

Aspen Results – need remedies?

Aspen Holdings, a pharmaceutical company listed on the JSE reported their interim results on Friday. The share price has already lost two thirds of its value since hitting an all-time peak in 2015. Never the less, while Stephen Saad presented the results to analysts and investors, the share price plunged intra-day by a further 50%, ending the day 28% lower. Did the performance really warrant such a drastic move? Or is something else at play?

There was much not to like about Aspens recent results. The headlines point to a worrying picture for a once fast-growing company; net revenue increased by only 1%, EBITDA was down 3%, headline earnings per share were down 9%, and free cash flow per share down by 45%. The borrowings increased drastically from R46bl to R53bl, the cash conversion rate is at an unusual low of only 47%. These are troubling numbers for Aspen shareholders, who are used to see growth in the double digits. Some clearly scrabbled to exit their position, accepting a 50% lower price than the previous day, fearing that in hindsight, that decision might still be a good deal. And all this without going through the details of the presentation.

Aspen used to be the darling of the JSE. Lead by the very entrepreneurial Stephen Saad, Gus Attridge and their team, they grew the company from nowhere in the late 90’s to one of the leading pharma companies in the emerging markets. The company was easy to understand. They produced generic medicine, owned a few over-the-counter brands, manufactured products like eye drops for third parties and distributed branded prescription drugs from GSK. The constant exploration of new opportunities led them to grow internationally, especially in Australia and the emerging markets. The business model stayed the same. The key was to open channels of distribution and then pass through an array of products, from their own generics to branded prescription drugs. They were very successful, which reflected in the Aspen share price. In 2015 it hit a peak of more than R420 per share, trading on a price/earnings multiple of more than 35.

But that’s where the strategy changed slightly. Aspen bought a struggling French manufacturing facility in Notre Dame de Bondeville. It provided a great opportunity to change focus from the increasing price sensitive generics medicine markets to sterile focused brands, primarily producing anesthetics and thrombosis drugs. These are much harder to produce, since the quality consistency is so critical. Aspen needed to invest a lot of capital to increase the capacity to produce at a volume level where they can guarantee uninterrupted supply. That investment is still ongoing, just as the investment to upgrade and increase their production capabilities in South Africa and Germany. The full effect of the increased production capacities will only be seen over the next three years, but to achieve higher volumes one would need to spend a lot of costs upfront. Hence also the higher debt levels.

Besides the big increase in debt, a major concern investor have is that much of the debt is denominated in Euro’s. Given that in their most recent results 38% of their revenue is from the Euro area, this should hardly be surprising. A prudent manager should always match the assets with the liabilities.

Investors are also worried about the delay of the sale of the nutritional business, and the sale itself. They are worried that Aspen is selling their crown jewels to finance their new acquisitions. First the delay of the sale itself. The sale was originally to be concluded within 6 months, and ambitious task given that it is a multinational business. This will now be concluded at the end of May. But the answer to the second question might also give an indication on why the share price has been performing so poorly. Yes, Aspen has done very well out of the nutritional business. But the sale is just the nature of the beast. Aspen is constantly morphing into an increasingly sophisticated business. As they see opportunities that fit with their future strategy, they are not scared at making big commitments. If investors buy Aspen shares they buy into the managements ability to spot opportunities in the Pharmaceutical Industry and extract as much value as possible from it. It is very hard to value such abilities, and it gets increasingly harder as the products become more complicated and niche. It also becomes more difficult for mr Saad to sell the good story to investors, as there are more and more moving parts, each of which are difficult to value. Added to that, the investor must look 3 to 4 years ahead to see the results of their current strategy. That is a hard task for those who, at best, are concerned about the next 6 months. It is anyways easier to follow the crowd instead of dissecting the complicated financial statements.

So what is my take on Aspen shares? I hold Aspen shares and have been holding them for ever. For a long time, I didn’t add any, but with the recent price movement I have. I don’t have a target price, because that would just be an arbitrary number. Instead I focus on 3 point: the managements ability to execute, the downside risk to the current concerns and the managements own skin in the game.

Firstly, they have a very good track record. Even though they did get a few things wrong along the way, like their investment into Venezuela, they got most right. The crucial part is that their ability to manufacture products at the highest international standard, which has been proven repeatedly.

Secondly, the downside risk. Their cash on hand covers their current liabilities payment obligations, which secures them for at least a year. The right time to gear up the balance sheet would be when interest rates are at a historic low. The time seems right to do exactly that. The crucial question is what covenants and what durations the loan agreements have. At an interest cover of 5.6 times and a net debt/ebitda of 3.7 (calculated after the conclusion of the sale of the nutritional business) they don’t seem to be in any immediate danger. The proceeds from the sale of the nutritional business will reduce their debt by 18%.

Another important point to remember is that the new accounting standards also don’t allow them to increase the value of any investments they have made (they can only write them down). That means that if they spot an opportunity where they can create value, that value is never reflected in the balance sheet until the business is sold again. Therefor their balance sheet would always be understated. Given that shares NAV is about R110, any price around that surely presents value. Added to that, on a historic P/E multiple of 7.5, even a company with pedestrian growth looks attractive.

This brings us to the third point: managements skin in the game. Two of the three biggest shareholders are Stephen Saad and Gus Attridge. They were happy to buy more shares in October 2018 at a price just above R155. Mr Saad bought for 93 million Rands worth, and mr Attridge for 15 million Rands. If they were happy to buy shares at R150, surely R110 seems like a bargain?

Categories
International South Africa

Long Term review

As the last post of 2018, I thought of giving a long term review instead of the year in review.

South Africa is in and out of a recession, but that should not come as a surprise to anyone who has looked at the underlying strength of the economy. Has SA reached its growth potential?

Ramaphoria seems like a distant dream, almost a fairy tale on how president Ramaphosa has taken the helm and in one swoop turned the stuttering economy around which his catch phrase “please send me”. His state-of-the-nation address was heralded as the start of a new era, and we can finally, unshackled of constant Zuma cronyism interference, proceed to grow again. With enthusiasm abound, investment banks rushed to upgrade their GDP growth forecast. But only 7 months later, the reality check: we slipped into a recession. While the rest of the world is growing strongly, we don’t. But to anyone, who looked rationally at the underlying capabilities of the South African economy, this should not have come as a surprise.

What might have surprised those number crunchers is how long the party seemed to continue. Looking at the performance of the JSE, as a measure on the strength of the economy, it would seem that South Africa is capable of keeping up with the best Asian Tigers. We would lead the African renaissance, famously proclaimed by the former president, Thabo Mbeki. But the reality is that we have been living on a toxic cocktail of steroids that mask the true performance of the economy, and therefore misguide on the potential for the medium term.

The JSE’s stock exchange index has increased by about 375% over the last 15 years (in Rands). That is a truly spectacular performance, and anybody who invest in shares would have done well. But that was just the index. Looking at the different components of the index, it becomes clear that we have had thee super phases, in addition to one over-arching theme.

Start with the three super phases. Firstly, we have benefitted enormously from the commodity boom of the mid 2000. China consumed almost all commodities quicker than anybody could produce, causing all commodity prices to rally sharply. That was a bonanza for the mines, which was reflected in their share prices. But South Africa had severe export transport constraints, and the throughput of Richards bay coal terminal and Saldana has hardly increased. Our mines were earning more Rands and Cents, but they struggled to push through the increase in volume they would have liked to. So what happened to the mining shares since then? Only the best managed companies managed to keep the share price at some reasonable level, many (especially SA focused mines) however are down more than 80%, a few collapsed totally and are no longer listed.

The second phase was the construction boom, spiced up by the Soccer World cup in 2010. There was a deadline, and plenty of projects had to be completed, almost at any cost. Luckily, the South African government had competent finance ministers and a very efficient tax collecting machine. We could afford it, and for the greatest show on earth, South Africa did deliver. This phase went on for a bit longer, because it partly coincided with the third phase, the retail boom, and the mushrooming of shopping centres. But the music has stopped, and the sector is down about 76% since its heydays. In fact, the share prices of most construction companies are down more than 80%. Well known ones, like Basil Read have gone into business rescue.

The third phase can be described as the retail boom. The index has increased by 325% over the last 8 years but seem to be running out of steam very fast. The start of the run was caused by the sharp increase in social grant beneficiaries. In 1994, about 4 million received social grants, by 2008 it was about 8 million. By 2017, 18 million South Africans received some form of social grants. And they spend it. Companies like Shoprite, Pep and mr Price reported dazzling growth figures.  International retailers like H&M and Zara couldn’t wait to open more stores in South Africa. To turbocharge the trend even more, unsecured lenders were happy to finance the difference between the wants of consumers and their ability to have. But this trend, like the two before, was is not sustainable. Not only is the government constrained by their budget on how much they can expand their social spending, but the boom in the retail figures masked another trend: for the last 8 years, the private sector has been shedding jobs, while the government and state-owned enterprises (SOE’s) have been adding jobs. Overall the unemployment rate, though high, remained relatively constant. In 2016/17, national government spent about 7 out of every 10 Rands on grants and employee compensation. That leaves precious little to spend on project enhancing the competitiveness of our economy, like new highways, schools or hospitals.

And what was the overarching theme of the JSE Index? We have had a few, really big companies doing really well. The JSE is a very concentrated index. If one takes the market capitalisation of the index (the value of all companies listed on the JSE), and then divides it up into three equal “boxes”, then the first box consists of 2 ½ companies, the second of 16 companies and all the other companies (200+) combined would fall into the third box. Clearly, the biggest 10 companies have a far greater influence on the performance of the index than all the other companies combined. Within the top 10, you will find companies like British American Tabaco, Richemont, Naspers, BHP and Glencore. The only thing they have in common is that they hardly earn any money (or in Naspers case – any asset price value) from South Africa. All these companies have been doing well and kept the market at elevated levels, because of their foreign earnings.

So what are the underlying problems of the economy, and is it possible the fix them quickly?

It is complicated. Like the performance of a football team, there are a few quick fixes. But to be consistently winning, the foundation of the team needs to be such that there is a depth of talent. This would give the team the ability to perform well, no matter what challenge is thrown at them. To demonstrate one fundamental problem with getting the South African economy going again, lets look at how the economy developed between 1980 and 2016.

In 1980, manufacturing contributed 22%, mining 21%, agriculture 6% and finance 11%.

In 2016, finance is the biggest sector, contributing 20%, followed by government at 17%. Manufacturing declined to 13%, mining 8% and agriculture only 2%. In other words, the government has shifted the economy from a labour intensive to a skilled based economy. But the schooling and system has not produced more skilled labourers. They are needed in such a skills-based economy, because if you can’t read nor write fluently in English, or compound mathematical equations, you can’t be employed at a bank or as an engineer or similar professions.

According to Stanlib, an investment company, each year there are 1.24 million children starting their school career. By grade 10 there are only 1.11 million scholars. That number gets drastically reduced to 687 000 by the time they write their school leaving exams. Of those, only 270 000 will take the maths exam, and only one in three kids get a mark of 40% or more. So only 89 000 pupils will finish school with a pass in maths of 40% or more, that is a rate of only 7% of those who started school.

The story continues at University. Again, according to Stanlib, only 17% of all students at the public universities will obtain their degree. That is no more than 30 000 graduates each year, far too few to replace the skilled labourers retiring each year. The lack of skilled employees become obvious in all corners of the economy. For example, only 55 municipal technical divisions, out of 257 are headed up by an engineer.

The other fundamental problem of South Africa is that the Unions are too dominant. Their membership has been in decline for years, but they remain just as powerful as before – making up for the lack of new members by using increased violence. Year after year, they have demanded above inflation increases, thereby increasing the unit labour costs. Our average manufacturing wage are now 32 times higher than that of Ethiopia. Not surprisingly, China’s “one road” initiative is focused on countries north of Kenia.

Partly because of the high unit labor costs, industries like manufacturing are increasingly relying on robots (the BMW assembly plant near Pretoria is 95% robotic). Mining are shedding thousands of jobs and closing unprofitable shafts while mothballing marginal mines. Just to underscore the Unions complete lack of business understanding, they have now demanded that trying to keep a company profitable is not a strong enough reason to reduce the workforce. They want to make it even harder to fire employees. An analysis of Impala demonstrates the problem facing South African companies. Over the last ten years, the government got R19 billion, labour R77 billion and the shareholders had a loss of R228 billion (that includes the capital loss of the share price, which is now at levels last seen 20 years ago).

The poor education and the ridged labour laws cause a massively dysfunctional labour market. Out of 37.7 million working aged South Africans, 16.4 million are employed. Roughly half of those pay income tax, because most just don’t earn enough. This causes a tight spot for the South African government. They have hardly any room to raise more taxes. Taking into account World Bank indicators, South African tax-to-GDP ratio at 26% is much higher than the world average of 14.5%. In fact, South Africa has the tenth highest tax-to-GDP ratio in the world.  

Under the Zuma administration, South Africa binged on debt, mostly through guarantees to their state-owned enterprises like Eskom and Transnet. They have reached now a debt ceiling where any further increase would surely convince the rating agencies to downgrade the South African debt to junk status. So where to from here? If the government under Ramaphosa is not able to take on massive amounts of debt and spend it on infrastructure projects, what can they do?

Firstly, they need to recognize that they need the help of investors, most of them foreigners. That means that the environment should be as investor friendly as possible. They would, for example, like to have policy certainty. When they make investments where the payback period is 20 years, they want to be sure that the rules don’t change midway through. The returns that they get from their investment should be attractive enough to convince them to invest into South Africa, and not Argentina, Chile, Vietnam or Portugal. The investment world is fluid, and investors are not limited to invest into South Africa – they can invest where ever they want to.

Secondly, they will have to rebuild the schooling system. It doesn’t help that a child in the rural areas will have a 1 in 100 chance of eventually being able to study, not because of costs, but because of their dismal schooling system. It also doesn’t help that all teachers are paid the same, even though the national average of absenteeism of teachers is 40%. Good teachers need to be paid more, and bad teachers (or absent teachers) need to be fired. Mathematics and English are crucial in today’s world and should be compulsory subjects. The pass rate should be calculated on the number of pupils starting schools each year, and the governments target should be for 80% of those to pass matric. The government should also focus much more on early child development (the first 1000 days), thus making sure that everybody gets the same chances in life.

Thirdly, the state-owned enterprises should be freed of corruption and returned to profitability by a management team that is employed based on their merits, not their political affiliation. The tender processes need to be transparent and accessible to everybody. Their debt levels need to be reduced by raising more capital through a partial listing on the JSE. They could contribute greatly to the economy but should not be an expense to the economy. Since the fiscal policy is a zero-sum equation, spending money on bail outs of the SOE’s means that there is less money available elsewhere, for example education or health.

Lastly, the government need to rebuild many public institutions. The Hawks need to be free of political interference and should have the capacity to investigate complex commercial crimes. Currently they don’t. We need more and better policing. It can’t be that the citizens live in fear of violence and crime. The courts need more capacity to hand down judgements quicker and more consistent. The public prosecutors need to operate free of favour and need to improve their competence. Red tape needs to be drastically reduced, and the government needs to be made leaner, more efficient and free of corruption. These are only some suggestions, but they would go a long way towards building a solid foundation for the economy to grow sustainable into the future, and therefor creating jobs and opportunities for everybody. It would raise the GDP per capita and make a real impact on the life of South Africans. They changes will take time to have an effect, but with a strong leadership, it should be possible. Until then, the economy is fragile. It will largely depend on external influences that it has no control over, such as the level of commodity demand of China, the health of European economies and the level of the Rand. Not only would international investors ignore any possible opportunities in South Africa, but talented South Africans would seek opportunities elsewhere.

Categories
South Africa

Viceroy strikes again

Viceroy, as small research outfit (and short seller) based in America has struck again with a report on Nepi Rockastle, one of the biggest eastern European focused Real Estate Investment Trusts (REIT). The recent merger seems to have been very overpriced, and mainly benefitted a few insiders. The Romanian shopping centres seem to be running at a loss and according to Viceroy the share price in general is very overpriced. They supported their claims by a few detailed Romanian submissions, and although it seems fact based, their claims can and probably will be disputed. Without going into details on who is right and who is wrong, what have we learned by the report?

 

Viceroy gained notoriety because of the particularly well-timed report into Steinhoff almost a year ago. The claims in that report have not yet been proven, we are still waiting for the forensic audit to confirm it in the next few weeks. But the timing, just as the then CEO, Marcus Jooste resigned under a cloud of confusion, was impeccable and contributed to the 90% fall in the share price of Steinhoff. Ever since then, executives have shivered when it was rumored that Viceroy is looking into them. Companies like Aspen have been rumored to be a target, and without any report released the share price has hovered around the lows for a year now. Capitec was a target by Viceroy and the share price did react sharply, but a strong response from Capitec means that the shares recovered. No report of a SA listed company by Viceroy has been proven to be right by independent auditors. Is there anything good about their reports then?

 

I think yes, it is good that they issue their reports. It gets boards of directors and fund managers to be more on their toes and don’t simply rubber-stamp everything. As an investor you should always question everything, and don’t take the information for granted. For far to long have related party transactions been under reported, for far too long have fund managers simply held all of the top 40 shares, and just tried to follow the markets. For far to long have fund managers believed everything management told them. Because all of us stand to lose, if South African shares are avoided by international investors because of a reputation of poor corporate governance and fraud. If we are not able to attract foreign capital, local companies will find it harder to raise extra capital because the current economic circumstances don’t allow individuals to save more. By reducing savings in favor of consumption, the local pool of capital depletes thus making capital more expensive. That is something we can’t afford.

 

Like my father always used to say: Trust is the most important part of business, once it is gone, it is very hard to get back.

Categories
South Africa

Investing in turbulent times

October has thus far been one of the worst months for equity investors in the past few years. Lots of people have asked me how to invest in these times, here are my thoughts.

The market is on a rollercoaster. The tech-heavy NASDAQ is heading towards another week of declines, the S&P 500 has had more down-days than up-days this month. The effect of the negative sentiment is even greater on the South African markets. The JSE All Share Index is down from a high of 61 684 points to a current low of 50 877 points. That is very close to bear market territory. Yet the base case seems to be that this is still a correction in a bull run, rather than the start of a bear market. Everybody points to the strength of the US economy, a feature that president Trump takes full credit for. I don’t agree. I would be very cautious. In the fund I manage, I have been selling equity in June and early September. I have never had this much cash.

There are a few reasons for my pessimistic view on the future short-term prospects of the share market. Many originate in the USA .

We have had almost a ten-year bull run since the end of the great recession of 2008. The recovery from the second most severe downturn in the last 100 years has been shallow, but because of that, it lasted very long. Companies now record record profits, mostly aided by un-natural low interest rates. Since Trump was elected president of America, the economic growth accelerated even more, topping 4% on an annualized basis. The unemployment rate is at a very  low level,. The share price valuations reflected such optimism. Not since the dot.com bubble, when valuation of a business plan written on a napkin was worth U$100 million, has the Shiller’s P/E ratio reach such lofty levels.

The problem though is that the last spurt of growth was caused mainly by the Tax cuts imposed by Trump. I am not against the Tax cuts, but using it now leaves the president with one less tool should the economy slow down. You would want to have some powder dry, because open economies do have natural cycles.

Then come the tariffs. The first salvo was aimed at almost all aluminum and steel producers outside of the US, friend or foe. The problems are twofold. The first is that if the biggest consumer imposes tariffs, other big consumers of the metals need to follow suit or fear of getting the surplus glut dumped onto their market. The marginal cost of finished steel and aluminum are the transport and storage costs. The second issue with tariffs on steel and aluminum is that they are also mostly input costs for other goods such as cars or buildings. The knock-on effect on prices is far greater than tariffs on finished products. US producers would have also increased their prices to reach import parity and as such, almost everything – from cars to houses to beer cans get more expensive, and somebody will have to pay for it. Initially the producers would absorb some of the costs, lowering their profit margins. But eventually the consumer will need to pay more for their goods.

In an effort to “make the USA great again”, president Trump started a trade war with China. His reasons are debatable, but the economic impact is underestimated. Gone are the days where the Chinese only imports were cheap cloths and plastic goods. These days, much of the imports are sophisticated electric and mechanical machinery, often used in the production of other goods. Thus this supply chain is very difficult to replace overnight, let alone get American companies to take over the slack. Therefore, all that would happen is that in the short-term consumer prices will increase. And as anybody who has done economics 101, if prices increase, quantity demanded decreases. One can see it already in for example the new home sales or vehicles sales, both of which are significantly off their highs.

Because of the reasons mentioned above, demand for goods will decrease as prices rise. Therefore companies will not reap in as much profit as they have before. Profit growth will certainly slow. The share prices in September did not reflect that.

They are more reasonable now, but I do think that we have more to go before we reach a bottom. There are two main reasons for it. Firstly, markets always over and under shoot. Secondly, we have recently seen a few times markets that closed lower a couple days in a row, followed by a massive up day. The rallies tended to fade, and the next day Asia opened weaker again. That shows clearly that there is no more the glut of money waiting on the side just waiting to enter the market.

So why does that affect us? Simply put: If America sneezes, the rest of the world catches a cold. Since they are by far the biggest market, they will have an influence over the direction of the JSE. The tricky part is how to position yourself as an equity investor, because if history is a lesson, the Rand US Dollar exchange rate will weaken.

I took a dim view on South Africa, because we have structural problems that need to be addressed before we grow at 4%+. Thus I am underweight SA focused companies. Most of the selling I did recently were such companies that mainly serve SA. That portion is now held in cash. As before, I am overweight defensive Rand hedges such as BAT. Yes in general their shares would also go down in a bear market, but since I expect the exchange rate to weaken, it would absorb some of the losses and protect the value of the investment.

(please note that this is from a South African standpoint, it differs depending on where you live. Always consult with your own investment professional before you make any investment decisions)

Categories
Namibia South Africa

Good for headlines or good for growth

Two stories were released at the weekend that should boost investments in two neighboring countries, one is little more than window dressing while the other will have actual and fairly quick impact.

 

South African president, Cyril Ramaphosa took to the streets on Saturday to celebrate a commitment of companies to invest R290bn over the next ten years. This was largely achieved by his star-studded investment envoys who have been traveling the globe, trying to lure more investments to SA. While they were rightfully celebrating the milestone in the streets in Soweto, Tom Alweendo, the Namibian mining minister announced that they will scrap a rule that requires mining companies to have at least 20% of their shares in the hands of previously disadvantaged Namibians.

 

While Ramaphosa’s achievement sounds good, Alweendo’s amendment to the ownership requirements will have a much bigger impact. To see why, one needs to analyze the numbers. The investment pledge is spread over 10 years. It is not clear if they are new investments, or if capex already planned anyways is included. Industries such as mining, real estate development, manufacturing, energy and communications will have a steady stream of capital expenditure that is needed just to stay competitive. Is this counted as new investment? And even though R290bl sounds big, if one compares it to the R200bl that was invested into the renewable energy sector between 2011 and 2016, Ramaphosa’s announcement sounds modest. Bloomberg, a financial data provider, estimates that there was another R550bl investment planned into the renewables energy sector of South Africa between 2016 and 2020. Hopefully the joyful celebrations in the streets of Soweto don’t cause the government to their eyes off the ball, because there is lots more to do to turn around the ailing economy.

 

Contrast that with the Namibian announcement. That’s will have an immediate impact, because the mining companies’ rate of return will increase by owning 100% instead of 80%. That’s will make new investments a lot more attractive. It also shows that the government is serious about becoming more business friendly, a seldom feat in Africa. I do think that the impact of minister Alweendo’s decision is far greater than that of Ramaphosa, and should be a bigger reason to celebrate.

Categories
South Africa

The land debate is clear …. or is it?

After a two-day policy huddle, the ANC announced that they have decided to proceed with changing the constitution to be able to expropriate land without compensation.

When Ramaphosa took over as president of the ANC, and a few months later as president of South Africa, he was dealt a weak hand. The party is divided between populists and traditionalist. Some care to continue the legacy of Nelson Mandela, to build an all-inclusive South Africa where everybody gets the same opportunity to work and create wealth. Others only care about enriching themselves, while some just care about winning the next election. After all, a politician is one of the best paid jobs in South Africa. Ramaphosa’ s first task would be to unite everybody within the ANC ahead of the next elections. That requires compromises, but surely none as great as giving in to populist policies that are sure to backfire. Sadly, that is exactly what he has done.

A commission was established to investigate the possibility of amending the constitution to allow expropriation of land without compensation. They are currently busy holding public hearings, where citizens can express their views. But before they are able to compile their report, or even finish the public hearing, the ANC, under the leadership of Ramaphosa, decided to amend the constitution, which makes the commission pointless. But that will be the least of their worries.

As a typical trait of modern times, the campaign has been fed by misleading information. According to the economist Johann Bornman, more than half of all farm land in the three most fertile provinces is currently already owned by black farmers. The Ingonyama Trust, whose sole trustee is the Zulu king, owns 3 million hectares, about the size of Belgium, making him the biggest landowner. Much of the rest is owned by companies such as Sappi and Ilovo.  The three provinces with the lowest share of black ownership are the Western Cape, Northern Cape and Freestate, probably because most of the land is semi-desert making farming extremely difficult.

Through the ongoing re-distribution program, the government has already acquired vast amounts of land, on a willing seller willing buyer basis. Many emerging farmers could have been given land (which is just sitting idle now) were it not for the governments incompetence.

What many attendees of the public hearing seem to be focusing on though is urban land, rather than farm land. That makes sense. As South Africans became richer over the last 20 years, more have been drawn from the rural areas to the cities. This is a worldwide phenomenon.

No country has ever become richer by getting more people to take up farming.

A side effect is that there is an enormous pressure on urban land. Government is making progress though. According to the Race Relation Institute, a think tank, there are 10 new low-cost houses built for every informal shack erected. That is the inverse of what happened 15 years ago. But the pressure on housing is relentless, as evident by companies like Calergo M3, a low-cost housing developer. They just reported that they have had delays in delivery of units because of illegal occupants tried to “hijack” the units before they were finished.

The real problems are less obvious though. A move to take away land without compensation puts the whole banking system at risk. Banks lend out money and take the asset as security. The size of the loans are determined by the banks ability to recover the money in a fire sale, should the borrower default. If the bank can’t be sure that the applicant will always be the owner of the land, they will simply not lend any money at all. And if some of the banks current assets held as security are repossessed by the government, they will need to shore up their capital ratios to cater for the increase in non-performing loans. Simply put: banks will stop lending out money, and the money that do get lent out will be done at a higher interest rate. This would not only affect farmers, but everybody.

Secondly, white farmers would surely not be in a rush to invest in their farm if they can’t be sure that they will always own the land. This is already happening, as the debate continues. This not only affects our food security but puts thousands of seasonal workers at risk.

Thirdly, this change in constitution does nothing to shore up the confidence of international investors. They would rather invest their money in an environment where they can be sure that the rules they signed up to will stay throughout their investment. Have we not learned the effects of the constant changing of the mining charter? Foreign investment into our mining industry has almost dried up, declining sharply since 2003, through the biggest commodity boom the world has ever seen. Is the ANC willing to do the same to farming, just to counter the populists?

Lastly, it is a very highly charged moral issue. White settlers arrived in 1652, 50 years after the first Europeans settled in the USA. That is 150 years before the great Zulu king, Shaka Zulu took the reign, and expanded his territory dramatically. To which point in history would the government like to turn the clock back to? Besides that, most land has been bought by the present owners, no matter if they are black or white. Should they suffer from consequences from actions taken centuries ago? It can’t be denied that under the apartheid system there have been all sorts of dubious deal done (like the “rent” of the land on which the Wild Coast Sun casino is built), but that should be addressed through the ongoing land reform, where claimants can either get the government to buy back the land and give it to the rightful claimants or pay them a compensation.

The stakes are very high. The economy will not be limping along as it is now, but another recession will be much more likely.

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South Africa

Eskom is drowning South Africa – what to do

Eskom, the electricity producing giant is South Africa’s biggest state-owned enterprise (SOE). It has a monopoly, but is drowning in debt, corruption and inefficiencies. If nothing is done, it is in danger of dragging the Government, who guaranteed most of the debt, down to junk status.

Out of a need to be self sufficient during the apartheid years, Eskom continued to build power stations far beyond their actual needs. 7 out of the 15 coal fired power stations were commissioned in the 1980’s. Eventually they produced so much electricity that South African businesses enjoyed some of the lowest tariffs in the world, and excess was exported to the neighbouring countries. The new government rather focused on expanding the grid to electrify most of the population. That was done successfully, but the increased demand was not matched with increased supply. The resource boom years were not anticipated and in 2007 Eskom began to run out of electricity. This forced Eskom to build new capacity. Among the expansion plans are two big coal fired power plants, called Medupi and Kusile. Both cost a lot more than planned and are lagging far behind their completion date.

Besides the operational difficulties, Eskom was plundered by scrupulous contractors, aided by corrupt Eskom management. Eskom also has a bloated staff contingency, who enjoyed underserved massive bonuses and pay hikes. All that lead to the issuing of more and more debt. But that party has now ended, and like after the end of any good party, the hang over is starting to rear its ugly head. We now know that there are a lot of things they should have done differently, but that doesn’t help explain what should be done going forward. For that, the very capable Minister of public enterprises, Pravin Gordan has enlisted the help of some of the top CEO’s to come up with a strategy to get Eskom back on its feet.

Here is my take on what should be done: Eskom should be broken up into two units, power generation and grid. The grid should be kept by the state, because it provides the infrastructure to get everybody connected, no matter if rich or poor. A private company would prioritise the profitable lines, and neglect the ones just costing them money. In a fair society, this would be an unfair practice.

The power generation section should be partly privatised. This can be done by selling off power generators, mainly the coal fired power stations to the highest bidder. In return they would get a 10,15 or 20 year electricity take-off agreement, similar to those of the renewable power generators. With that in hand, the winning bidder will be able to raise funding in the private sector to finance the purchase of the power plants. Thus, it is ideal for previously disadvantaged, and will help the governments goal to foster black industrialists. It would be up them run the units as efficiently as possible. The government will use the money raised by the sales to settle the outstanding debt.

 

It might sound a little bit simplistic, because I have not taken into account a failure of power generation from any of those newly established private companies, but when that happens, you can be assured that competitors are quick to jump at the opportunity. As we have seen with the renewables, give the private sector the right playing field and a reliable set of rules, and they will fill any opportunities that might present themselves.

Categories
South Africa

South Africa’s universal healthcare plan

The South African health minister, mr Motsoaledi has unveiled his long awaited universal healthcare plan, called the National Health Insurance (NHI). It has a noble cause – to make the same healthcare available to the rich and the poor. His solution shows that he has not understood the problem though.

According to the website news24.com, Mr Motsoaledi plan envisages one big fund that will act as the single purchaser of health services, and thereby it will “pool funds to provide access to quality health care services for all South Africans, based on their health needs and irrespective to their socio-economic status. He went on to say that “currently the private sector spends 4.5% of GDP on health but only provides care to 16% of the population while the public sector spends 4.2% but provides 84% of the population.”

The public hospitals and health care institutions are in such shambles that something needs to be done about them. A recent example of public healthcare blunders is the life Esidimeni tragedy, that cost the life of 143 helpless patients., which was purely down to bad management decisions. No one has been arrested and held responsible for it.

Mr Motsoaledi insists that, currently, the poor are subsidising the rich, and that needs to be turned around. 16% of the population that currently spend 4.5% of GDP on private healthcare are also the main income tax generators. Thus, they pay taxes, but do not make use of the healthcare provided by the government

Whoever has the means, takes out private health care insurance. It is an indirect tax, because healthcare is something that the government should, but does not provide.  Insurance companies offer different packages, because not everybody wants or is able to pay for a full comprehensive package. Health insurances are zero-sum businesses. Essentially, the co-payment required on the cheaper packages can be viewed as the statistical shortfall in previous contributions.

But mr Motsoaledi also wants to eliminate co-payments, forcing everybody who want to be privately insured to take out the comprehensive insurance plan.

. What should be done? The private sector is only able to provide the service because the public sector is not providing it. Maybe the most noble thing to do would be to admit to the current mis-management and commit to make sure that the public institutions are run efficiently and effectively. That would eliminate the urge to go to a private hospital at almost any cost. It would also ignite competition and therefore bring down prices of private hospitals. Lastly, let those who can, take out private healthcare insurance. At least they will not be putting pressure on the public healthcare system. The rich and poor would not compete for the same public health service, rather the rich would subsidise the poor.