SOPHISTICATED FRONTING IS THE SMART GUY'S TRICK

This article first appeared in the Business Times section of The Sunday Times on 3 April 2016

THIS week, the Department of Trade and Industry held a conference to discuss the illicit practice of “fronting” in broad-based BEE transactions.

“Fronting” refers to a deliberate circumvention of broad-based BEE whereby an entity claims BEE credentials by misrepresenting facts. In short, it is lying about one’s BEE credentials.

Its most common practice is having black people registered as shareholders and directors but with no beneficial ownership of their equity and no say in running the company.

In a typical broad-based BEE fronting deal, the economic benefits of the purported ownership or directorships would flow disproportionately to the black people, if at all, and the lion’s share would be pocketed by their white counterparts.

Over the years, we have seen many reports of cases in which domestic workers and gardeners discovered they were BEE partners of their unscrupulous white “masters ”. These have never been investigated and prosecuted. Well, until now.

Recent amendments to the Broad-Based BEE Act make “knowingly engaging in a fronting practice” a criminal offence, the penalty for which is a fine, or up to 10 years’ imprisonment, or both.

In addition, a person convicted of fronting will be disqualified from business with any organ of state for 10 years.

The “domestic worker” cases are the obvious ones, and it’s easy to see the injustice and accept that those who engage in such practices should indeed be jailed and never be allowed to do business with the state, or any one else for that matter.

However, the truth is that fronting has been happening for many years, in a much more sophisticated manner and by much more sophisticated people than some scruffy, khaki-wearing “master ” hoodwinking his unsuspecting gardener.

In the late ’90s and early 2000s, every major South African company was under tremendous pressure to do a BEE deal. CEOs and chairmen had accepted there was no way to stop or even slow down the government’s transformation agenda. To prosper in the new South Africa, one had to introduce broad-based black shareholding.

But there was a problem. These companies were worth billions, and “selling” 26% to black people with no money, on commercial terms, appeared near impossible. The popular view was that markets and shareholders would hate it, because whichever way you looked at it, a BEE deal would be dilutionary.

So these billion-rand companies had to think of ways to tick the BEE box without giving away the crown jewels. They had to appease a Pretoria that was unwavering on economic transformation, but they also had to retain the support of Stellenbosch and Cape Town, the capital cities of South African asset managers.

A number of CEOs at the time would call BEE “giving away value to black people”. Of course, this was never said in public, with every major company CEO singing the praises of BEE and how it was the “right thing to do”. The truth is that many resented it and worked hard to devise ways to be seen to be doing the right thing without really doing it.

Enter the investment bankers, in those days the smartest guys in the room with their double-cuff shirts and Porsche 911s. Their job was to come up with structures that looked like bona fide BEE deals with minimal value leakage for white shareholders and, where there was a gap, an opportunity to profit from this BEE thing.

As you can imagine, most of the mergers and acquisitions at this time involved BEE deals, and lots of effort went into devising BEE schemes that could be sold to clients. Hundreds of millions of rands in fees were earned by lawyers and bankers for designing and implementing structures for the optimal BEE deal for their clients.

One of the popular schemes was the special purpose vehicle structure. It had two variations.

The first was to introduce black shareholders, through a special purpose vehicle, at the level of the mother company.

The white company’s shareholders would “lend” the black shareholders funds to acquire the shares. The black shareholders would cede their dividends to service the loan and interest and, at some point, the share price would have increased so much that a partial sale of the shares would settle the original loan plus interest.

The upside was that the BEE shareholders were the rightful owners of the equity at the mother company level on day one. Tick. The downside was that the equity was obviously encumbered, and the settlement of the debt depended on a consistently growing dividend income that outpaced the interest charge and, of course, also a flourishing share price.

As we now know, many such structures fell apart mainly because the shares didn’t perform as anticipated, dividends were not consistent and, as investment bankers say, the deals eventually went “under water”.

The second SPV variation involved setting up a new company. This was initially a shell that issued 26% shareholding to the BEE shareholders at no cost, with the balance of the shares owned by the white mother company .

The “newco ” would then be the official BEE company of the group. The original mother company, or crown jewel, would remain 100% white-owned and the BEE company, with its 26% black shareholding, would be the vehicle used for all government-related business.

One could recognise the products of these BEE deals by their names — often some mixture of the mother company’s name and some African verb, like “siyaya”, “siyakhula” or “ses’fikile”.

This was a great deal for the white company. It got to do a BEE deal and got a cool black name without giving away any share of the mother company.

The white company didn’t have to fund the BEE shareholders or wait for them to raise capital to conclude the deal. Best of all, the group had a new subsidiary, with politically correct credentials and an incentivised team dedicated to securing government business.

The white companies didn’t stop there. They would often charge the BEE company a management fee for back-office services — sales support, marketing support, office space and so on — and this would often be a percentage of the revenue generated by the BEE company,

which further undermined its margins from whatever government business it secured.

The white companies also recognised they had to sustain the facade that the BEE deal was a group-wide transaction. There had to be a link of sorts between the mother company, which remained lily-white-owned, and the BEE company.

To achieve this, the mother company would appoint to its board the key person in the BEE consortium, who was often a politician or struggle stalwart.

His job, other than ticking the box of being a black director, would be to report to the main board all the “business development and stakeholder management” tasks being carried out by the BEE company on behalf of the group — further entrenching the facade that a group-wide BEE deal had been concluded.

He would earn board fees, the status of being on a listed company board, in return for protecting the group’s interests with the government and regulators.

We never called this a front; we called it a partnership.

As I mentioned, in a typical broad-based BEE fronting deal, economic benefits attached to the purported ownership or directorships would disproportionately flow to black people, if at all, and the lion’s share would be pocketed by their white counterparts.

The reality is that the mother company never transformed. Instead, it pocketed most of the economic value created by the toil of the black shareholders in the BEE company.

So how was this not fronting?

I’M NOT CRAZY: "AFRIKAANS CAPITAL, AFRICAN CONSUMPTION" PART 2

On the plane three months ago, I enjoyed an article entitled "BEE firms need to take a leaf out of PSG’s book" by the talented Phakamisa Ndzamela (@phakie101) at the Business Day. Perhaps in mixed emotion of frustration and awe of the details behind the listing of another Afrikaner-led listed company, it reminded me so much of my "Afrikaans Capital, African Consumption" blog I wrote a while back,.

Phakamisa talks about his experience of the PSG Shareholders Meeting he attended at Stellenbosch, and concludes that Black business people can learn a thing or two from their Afrikaner counterparts. A view I have held for a long time. Here is an extract of his piece:

“CALL me a "native assistant", the favourite words of erstwhile commentator Ronald Suresh Roberts. Do you remember him? What an intellectual joker.

Anyway, I admire some of the ways that the Afrikaners do their business. Their successes easily shine out on the Johannesburg stock market.

I think the Afrikaner business model is one that black economic empowerment companies in South Africa need to look into.

It looks simple and is based on bread and butter issues with no obsession with mining, a laborious and capital-intensive exercise that does not guarantee healthy margins. How do I know this?

Last week, I took time to travel to the land of the "Stellenbosch mafia", if there is such a thing.

The idea was to get a glimpse of how business was done in that part of the world. On arrival at the PSG Group annual general meeting held at the Spier Wine Estate, I walked in with an indoctrinated mind thinking that the Afrikaans elite did not admire luxury goods.

Boy, was I wrong!

I expected to see a parkade full of 4X4 Toyota bakkies and maybe an odd tractor or two on the side.

Clearly, I had delusions of grandeur! The parking was an assembly of high-end German cars reminiscent of the African National Congress’s Mangaung conference.

We walked into the hall and the house was packed with Afrikaans-speaking investors who were anxious to know about the future of their investments at PSG.

The meeting resembled a Stellenbosch version of the annual meeting of Warren Buffett’s Berkshire Hathaway in Omaha in the US. No surprise that PSG founder Jannie Mouton is often described as the "Boere Buffett".

The difference here was that proceedings were mostly done in Afrikaans. This did not irk me much, remember that I am a "native assistant".

Besides hearing the bad news that Mouton’s daughter had been locked up by criminals in a basement while her house was ransacked, what also touched me was the poor representation of black investors in a company whose goods are highly consumed by black South Africans. PSG is the largest single shareholder of Capitec, which made a great deal of money from low-to middle-income earners, most of whom are black.

The group also owns agribusiness Zeder, which is behind consumer brands such as Weetbix, White Star maize meal and Liqui Fruit, to count a few.

But if you look at the shareholding structure, PSG’s major shareholders are its directors who own a 36.6% stake.

Steinhoff, the furniture manufacture led by Markus Jooste, owns 19.6% of PSG, other friends and family own 10.1% and Thembeka Capital owns 5.2%.

Thembeka is led by Zitulele KK Combi, the only "Black Stellenbosch mafioso" that I know of.

Excluding Mr Combi and his Thembeka Capital, there were less than a handful of black investors.

By the way, Thembeka Capital is 51% black-owned and the remainder is owned by PSG.

When one looks at PSG’s market performance over the past 17 years, its share price has been climbing like the Spider-Man.

If one had invested R100,000 in November 1995, today this would be worth about R130m if you had also invested your dividend.

PSG believes that "performance should be measured on the return that an investor receives over time; not on the size of the company," says PSG CEO Piet Mouton, and one of Jannie Mouton’s sons.

Although Piet Mouton understands that the next 17 years will be hard to match he is confident of the company’s prospects.

PSG has a limited war-chest for now to make acquisitions.

But it has many companies in the development phase which present growth opportunities.

Curro, the private education provider, is one of the investments that should boost PSG’s investment portfolio in the next few years.

One of the lessons here is for a black-led consortium to create their own PSG Group; a black-led consumer goods company whose proceedings are partly run in Nguni, Tswana, Venda or any other local South African language. South Africa’s population keeps on rising. The sub-Saharan African population is estimated at 900-million.

Black businessmen and women need to roll up their sleeves and look at the value of agriculture, instead of obsessing about the bling of mining. One of the ways to do this is to redress the injustices of the Native Land Act, 100 years ago.

The act killed the rise of a black farming business class, a situation which has also contributed to the squalor houses in Khayelitsha, which is only a few kilometres from Stellenbosch.”

Thanks Phakamisa. It's comforting to know I'm not the only crazy one!

THE ARMED ECONOMIC STRUGGLE

A Mother Remembers - Alf Khumalo

This weekend I was part of a business delegation invited to attend the ruling party’s January 8 Statement activities in Durban, KwaZulu-Natal. Much has been written about what was said (or not said) by the new ANC leaders that informs policy reform, at least for the next twelve months. The more I listened to the Statement and shared in social conversation with many other business leaders, the more I thought about the struggle for economic freedom. 

I wondered, how did South Africa win political freedom? Are there lessons from that difficult and costly struggle that can be applied to this newer, but equally challenging fight against systemic economic inequality plaguing our society? What will it take to beat this system? 

I think our choice of policy for accelerating effective participation by black people in the economy, was negatively affected by the Convention of a Democratic South Africa (CODESA) as well as the process that culminated into a negotiated political settlement. It is widely accepted that during CODESA certain concessions had to be made. In summary, we agreed to a ‘evolution’ of Black economic participation, and not a ‘revolution’. So the new government was to take a more transformational outlook and not a radical one in getting the scores of poor Black people into the mainstream economy.

I fear that it may take one very costly series of events to render this 'peaceful' economic struggle useless and the people may revert to an 'armed' struggle.

Does this sound familiar? Let me remind you. 

The African National Congress (ANC) was formed in 1912. The ANC Youth League of Tambo, Mandela and Sisulu was formed in 1944. The Youth League brought more vigor to this resistance and successfully argued for a more militant approach. They drew up a Programme of Action calling for strikes, boycotts and defiance. This Programme of Action was adopted by the ANC in 1949, the year after the National party came to power. It led to the Defiance Campaign of the 1950’s. 

But even then taking up arms was NOT on the agenda. So, for more than 4 decades, the ANC largely carried out peaceful demonstrations of resistance to the apartheid government. The 'peaceful' struggle continued and in 1955 African, Coloured and Indian political and social organisations organised themselves in Kliptown and released a progressive document: The Freedom Charter. 

It called for the people to govern and for the land to be shared by those who work it. The document also called for houses, work, security and for free and equal education. How did the government respond to this peaceful gathering and progressive outcome? They claimed that the Freedom Charter was a communist document. Since they had banned communism in 1950, they resolved to arrest ANC and other political leaders and brought them to trial in the famous Treason Trial. 

As if that was not enough, the government then announced that women must also carry passes. Guess what happened? Yet another 'peaceful' campaign was mounted by women countrywide, in 1956.

And then one day, something happened that would change the political struggle forever.

The PAC started a campaign on the 21st March 1960 where people were asked to leave their passes at home and gather at police stations to be arrested. People gathered in large numbers at Sharpeville in the Vaal and at Nyanga and Langa near Cape Town. At Sharpeville the police opened fire on the unarmed and peaceful crowd, killing 69 and wounding 186 people. 

The massacre of peaceful protestors at Sharpeville brought the era of peaceful protest to an end. 

On 30 March 1960, ten days after the Sharpeville massacre, the government banned the ANC and the PAC and declared a state of emergency and arrested thousands of its  activists. 

The massacre of peaceful protestors and the subsequent banning of the ANC made it clear that peaceful protest alone would not force the regime to change. The ANC took up arms against the South African Government in 1961 putting an end to 49 years of a political movement hoping to bring revolutionary change through peaceful resistance. 

From 1961, the ANC effectively became a new movement altogether. In 1990 the ANC was unbanned. In 1994 it won South Africa’s first democratic elections. It’s been in power ever since. 

So, its safe to say, it was largely because of the pressure of the armed struggle that the unwilling counter party was forced to the negotiation table, holding very little leverage leading to political emancipation. 

It is also worth noting that at the time, the emphasis was largely on socio-political freedom. Not to undermine the work that had been done before 1961 by ANC leaders in exile, the "straw that (eventually) broke the camel's back" was how the armed struggle rendered South Africa ungovernable forcing the hand of the oppressors. 

Do you think that ordinary South Africans don't remember this? Do you think our generation has forgotten how one day changed, and perhaps accelerated, the course (and cause) for political freedom? 

This BEE thing is not working.

This 'peaceful' economic struggle is not yielding any real results. How long will it take for an organised group of people, severely disenfranchised by a lack of socio-economic progress, to be adequately agitated and opt for a more aggressive approach? Especially, one that has been proven to work in the past. In fact, one that they, ironically, owe their very political freedom to. 

It should come as no surprise that after 19 years of a 'peaceful' and 'passive' offensive to get black people to be an integral part of mainstream economic activity, one is starting to hear calls for revolutionary means. And therein lies the danger: If we think this is about ceasing economic power from white hands to black hands, we further from the solution than we realise.

What we need to focus on is key levers of growing the economy into one that is controlled by ALL South Africans, equitably so. That means we must establish enabling legislation and supportive policies that will ENFORCE (as opposed to encourage) this behavior, otherwise it is only a matter of time until someone works out that this 'peaceful campaign' we call BEE is not working and we need a more aggressive strategy. 

By then, we may not be able to influence the outcome. The tide may be too strong. Time for rational thinking may be up.

How long before people start saying: "We've seen this before. Peace didn't work against a minority force resolute to keep their political power in 1950's. If anything, whilst we were protesting peacefully, they retaliated with the might of military power. Why should it be any different today? There hasn't been any genuine, scaleable commitment from the "haves" to broaden the ownership and control of the wealth, that was effectively seized from the indigenous people of this land. How much longer are we going to be in 'evolution'. 

You don't have to a be a heart surgeon to figure out what kind of power and leverage resides with 90% of any society that is gripped in poverty, feels highly disenfranchised, with a proven record in organizing behind a common cause. 

Bottom line: We need a Plan B on Economic Transformation. Fast!

AK

Sources: www.anc.org.za