Just three weeks ago, the hotel group surprised the market with a request for the approval of a R1.2-billion rights issue. At that point in time, its entire market cap was just R1.3 billion.
Since then, it has declined to R914-million. Of course, the impact of Covid-19 and the countrywide lockdown since the end of March has been brutal on the hospitality sector.
City Lodge shares are down 70% this year, so it is tempting to imagine the group desperately needing funding for the market to sustain its currently limited operations.
The reasons disclosed in the rights offer circular include allowing the company to “repay corporate debt; provide for its obligation under the BEE Funding arrangements; allow the Company sufficient working capital to fund its cash flow shortfall as a result of the impact of the Covid-19 pandemic and national lockdown; and create debt capacity and a flexible capital structure to position the company for future growth”.
Remove the substantial burden of BEE funding from its balance sheet, and it would be hard to describe the level of debt as “high”, which the group does in the circular. In fact, it is clear that shareholders are being asked to stump up R1.2-billion for the primary purpose of bailing out City Lodge’s BEE scheme.
Rewind to 2008
In 2008, the group completed a BEE transaction with three entities who, together, would acquire 15% of the company. At that time, the value of the deal was R485 million.
Vuwa Investments would acquire 6%, the Injabulo (“happy smiles”) staff trust a further 6% and an entity to be established by the University of Johannesburg, School for Tourism and Hospitality for the education of primarily black students of the tourism and hospitality industry would acquire 3%. The investments by the two latter entities are held via Newshelf 935 and Newshelf 892.
Vuwa was described at the time as “an empowerment company led by Bulelani Ngcuka who is an 18% shareholder in Vuwa.
Vuwa is majority-owned and controlled by historically disadvantaged individuals and includes African Footprint Investment Holdings, an investment holding company controlled by black women”.
Vuwa was not allowed to dispose of shares until 31 December 2017 and it undertook to “ensure a minimum contribution to City Lodge’s empowerment rating which includes a commitment to remaining at least 75% black owned and remaining 10% owned by black women”.
Funding for the acquisition of City Lodge shares by the various parties would be via preference share funding provided by Standard Bank. This funding would be guaranteed by the company.
|2008||Vuwa||Education SPV||Staff SPV||Total|
|A preference shares||R80 million||R35 million||R80 million||R195 million|
|B preference shares||R64 million||R62 million||R114 million||R240 million|
|Equity||R50 million||–||–||R50 million|
|Total||R194 million||R97 million||R194 million||R485 million|
These seven-year A preference shares would bear interest at 74% of prime, and the (rolled-up) cumulative zero coupon five-year B preference shares at 75% of prime. With the scheme under water, the redemption date on both was extended to “no later than” 31 January 2021.
Fast forward to 2020
Today, the situation is dire. The June circular says matter-of-factly: “The B-BBEE Transaction is unfortunately materially out of the money”. The total value of the BEE SPV shareholding on 15 June was R161 million. The amount outstanding in terms of transaction funding was R750-million.
|2020||Vuwa||Education SPV||Staff SPV||Total|
|A preference shares||R41.2 million||R14.3 million||R49.4 million||R104.8 million|
|B preference shares||R161.5 million||R154.7 million||R284.1 million||R600.3 million|
|Loans||R12.1 million||R11.6 million||R21.3 million||R45 million|
|Total||R214.8 million||R180.5 million||R354.9 million||R750.1 million|
* Amounts rounded. Totals may not add up.
The R50-million loan granted to Vuwa remains outstanding and has attracted total notional interest of R37.4 million, which has been converted to equity. It was not repaid at the original due date of 31 December 2017, as this was subject to the settlement of the BEE preference shares.
Excluding lease liabilities (a change under recent IFRS amendments), City Lodge’s long-term liabilities as at its interim results on 31 December 2019 were as follows:
- Interest-bearing borrowings R660-million
- BEE preference shares R353-million
- BEE shareholder loan R50-million
- BEE B preference share dividend accrual R337.2-million
- Deferred taxation R210.9-million
The total exposure to the BEE scheme funding has since increased to the total of R750.1-million. This is more than the group’s three revolving funding facilities (R660-million) secured over certain of its properties!
It is this exposure that shareholders are being asked to bail out. By 31 January, an amount of R774-million (including interest to that point) will be due to Standard Bank, the preference share funders.
Obviously, if the rights offer is successful, the additional R426 million raised will be useful to reduce (actual) debt further. But, there is an enormous difference between a company trying to raise half its current market cap, or an amount 30% greater than its currently valued at!
To make matters worse, though, the BEE SPVs plainly have no funds to follow their rights. Not to worry, says City Lodge, the SPVs “will sell rights allocated to them and use the proceeds to follow their remaining rights” through a “tail-swallow”.
This will ensure “the degree of dilution of their percentage holding in the share capital of City Lodge” is reduced.
This means it is quite conceivable (in the absence of a detailed circular) that the total stake of the BEE entities reduces from 14.7% to well below 10%. Never mind the R774-million price tag, this will have a significant impact on the hotel group’s prized BEE rating.
This commentary is not a slight on BEE, per se. Companies operating in South Africa have to ensure they comply with government regulation. This is a simple fact and is especially true if companies want government business (and City Lodge enjoys strong public sector support).
In fact, one could possibly argue that the entire reason the majority of its hotels are at a certain standard – comfortable, with not too many amenities – is so that they meet travel criteria for government (and corporate) employees.
At last count, City Lodge was rated a level four contributor, i.e. 100% B-BBEE recognition under the tourism sector code.
BEE is not the issue here. Rather, the highly leveraged structure of this deal from the very start was the problem. To be sure, the bankers will be smiling.
In this transaction, BEE participants were issued 6.4 million shares. Add R86-million in redeemed preference shares to the R774-million due in January (and the Vuwa loan) and the cost of this disastrous deal is over R900-million.
It would’ve been far, far cheaper to have simply gifted shares – for free! – to these trusts and BEE partners.
This article first appeared on Moneyweb and was republished with permission.