Abandoned: Is it the end of SA’s construction industry?

To hear Mohau Mphomela describe it, South Africa faces the real prospect of losing its once mighty construction sector within less than a decade.

“In five years’ time, the builder of South Africa will be China,” he tells the FM. “They are waiting to come in with cheap labour and cheap materials. Before we realise it, we’ll be like Kenya — you just have to see the highways being built there. Or the roads and infrastructure built by China in Uganda.” 

These aren’t the overblown rantings of a hysterical bystander. Mphomela is the executive director of the Master Builders Association (MBA) North — a body that represents about 500 of South Africa’s 2,000-odd registered construction groups. And the portents from his vantage point are decidedly ominous.

In the past eight months, three of the biggest second-tier firms in the sector — those one rung lower than JSE-listed giants such as Wilson Bayly Holmes-Ovcon  (WBHO) or Raubex, say — have either closed shop or succumbed to business rescue. 

Giuricich Construction, founded 82 years ago, decided earlier this year it had had enough. Then GD Irons, the Pretoria-based firm that had recently converted Nelson Mandela’s Houghton home into a prestigious boutique hotel, tumbled into business rescue in April. And Belo & Kies, founded 22 years ago, has also just folded.

Mphomela seems disconcerted by the demise of Belo & Kies in particular, as the Bethal Mall it built is “brand new”, yet the company has been “nailed”.

“I get goose bumps when I say that because these are new projects I’m talking about,” he says.

So what lies behind the spike in company closures?

“The challenges we are facing are predominantly contractual issues,” says Mphomela. “In other words, the contracts signed between the parties themselves.”

Surely not? Can SA’s construction sector really be on its knees thanks to poorly drafted legal agreements?

Well, as Mphomela sees it, the desperation for work that has characterised the sector since South Africa successfully pulled off the 2010 Soccer World Cup, in part by building new stadiums worth $2.1bn, has led to builders being squeezed to an unprecedented extent.

It’s a harrowing decline for a country where long-standing players were once among the JSE’s most valuable firms. Fifteen years ago, the construction sector was a money-printing machine: Murray & Roberts, Aveng, Basil Read, Group Five and WBHO made up the “big five”, racking up billions in profit.

Since then, there’s been blood on the walls. Basil Read and Group Five collapsed; Murray & Roberts has ditched local construction, and begun providing engineering services for the oil and gas sector; and Aveng barely survived an extended stint in intensive care.

Even WBHO, now SA’s largest construction firm, with more than 6,000 employees and still producing revenue of R17bn a year, has seen its share price shed 36% over five years.

It underscores how the construction industry is in protracted decline, having posted negative annual growth rates for five years in a row. It is in a grim, and deep, recession.

Once pivotal to the economy, the sector has been left for dead by the government, which promised big infrastructure projects that never materialised. The result: while construction contributed 3.47% to the economy in 2015, this shrank to 2.47% by last year.

It’s been a disaster for jobs too, as construction is one of the most labour-intensive sectors. Stats SA’s recently released 2020 Construction Industry survey bears this out. It shows that between 2017 and 2020:

• There were almost 119,000 job losses (25% of the workforce) — most in civil engineering companies;  
• The industry’s total income dropped 7%, and its profit margin fell from 3.5% to just 2.2%; and
• Capital expenditure by the industry declined by 6.1% a year.

It’s not a coincidence. The decline neatly mirrors the government’s waning appetite to spend on big infrastructure projects: public infrastructure spending fell 40%, from R193.7bn in 2016 to R116.4bn in 2020. Underspending became the norm, with public entities spending no more than 65% of their capital budgets on average between 2015 and 2017.

The final straw, for many, was the decision by the SA National Roads Agency to cancel tenders worth R17bn.

‘Localisation’ rules spawned a mafia

Few saw this coming after the World Cup — a global event “done by South Africans, for South Africans, on time, despite the doubting Thomases”, says Mphomela.

Almost as soon as Sepp Blatter had climbed into his jet after the final at Soccer City, government tenders dried up, margins took a beating and construction firms that had been less scrupulous about ensuring their contracts covered their risks suddenly found themselves badly exposed.

Today, Mphomela says, with so little work out there, builders are “being forced by the professionals — the quantity surveyors, the architects that happen to be the project managers, or the client’s agents — into changing the conditions” of their contracts, exposing them to huge risk.

When there are delays in equipment, or strikes or bad weather, it’s the builders who shoulder the risk. Having struck deals at wafer-thin margins, any hiccup plunges them into the red.

This risk was brought into sharp relief by the arrival of an insidious new force: the “construction mafia” — gangs of thugs who arrive on building sites and demand a cut of the contract value in return for “protection” from the local community.

Now euphemistically known as “business forums”, these rent-seekers have popped up thanks in large part to an act signed by former president Jacob Zuma, which stipulated that 30% of any government project should involve local players. 

“This 30% was only supposed to be for government projects,” says Mphomela, “not private projects. Government did not implement this law in a manner that they explained it to everyone.”

It means that when a project starts, these “middlemen” line up for their cut. It’s outright extortion, yet the police are nowhere.

“Some of them come in and solicit money: they’ll say: ‘Oh, we see this project is worth R100m, so give us cash and we’ll walk away,’” says Mphomela. “If the contractor doesn’t succumb, these people will block the site, incurring further delays.”

It’s a problem cited by WBHO chair Louwtjie Nel in the company’s annual report, released this week. He recounts how these “business forums” have arrived on sites to disrupt projects with “unrealistic demands and extortion tactics”.

While he says WBHO negotiates to “resolve the situations”, he is “concerned that this practice is fast becoming normalised in our society”.

WBHO breaks down how this hurts three distinct groups. For investors, it causes “delays and occasionally the long-term suspension of projects impacting business continuity and profitability”; for staff, it creates “tangible concerns over their safety due to the increased threats of violence and intimidation”; and for clients, it causes costs to spike.

And yet, WBHO says, this practice has thrived because of the “weak response from the state”. Far from jailing the kingpins, the police have, in some instances, been found to be assisting the gangs.

Managing contracts

This illustrates how hard it is to manage contracts in an environment where work is scarce, clients are fickle and unwelcome surprises (such as extortionists) are the order of the day.

Take WBHO, which tendered for R31bn of government contracts last year. Nel says in the annual report that “less than one-third, in value, of public sector tenders on which we have bid over the past few years have been awarded, the balance remain pending or have been cancelled”.

And those tenders that are awarded take more than a year to be finalised, “which makes resource planning exceptionally challenging”.

WBHO CEO Wolfgang Neff says: “Businesses have a finite resource capacity and it’s challenging to determine how many projects to continuously submit bids for without knowing the outcome of bids submitted between nine and 12 months ago.”

Nor is WBHO alone — firms that tender for government work express common frustrations over the slow pace of procurement, officials’ lack of accountability over cancelled tenders and their lack of understanding of the economic costs this imposes.

In this context, the skill of managing contracts has become all-important  and is now the difference between a firm coming out of a project in the black, or going bust.

In an interview with the FM, Murray & Roberts CEO Henry Laas says: “Even if the design is 100% complete, as you build it, there’s design optimisation and changes, and this is what contract management is all about — you must manage that change.”

Some clients are a nightmare to deal with, however, and Laas says these have been blacklisted by his firm. “For us, client risk is a big thing.”

In other cases, says Mphomela, clients simply refuse to pay what they owe, often declaring disputes to delay or avoid paying — another reason for many of the failures in the sector.

Mphomela says some clients “want a Rolls-Royce for an Uno price. And the client doesn’t care what the contractors’ problems are — and when you don’t deliver on time, that’s where the problem lies. Then you face penalties which are huge, which could erode every margin you were going to make.”

The problem isn’t just sluggish state officials. In some cases, he says, property developers try to pull a fast one on construction firms, when a new shopping centre or residential project battles to attract tenants.

“Having built this fancy building, with no tenants coming through, [developers] resort to dirty tactics when they realise the building is coming to an end and it’s not going to generate the income they thought it would,” he says.

Tricky clients

As dark as the clouds seem, not everyone shares Mphomela’s doomsday outlook. For some, the industry is simply at the bottom of a cycle from which recovery is inevitable.

Raubex CEO Felicia Msiza, for example, is decidedly less bearish.

“I don’t think we will get to a point in five years where the Chinese might be taking over,” she tells the FM. “I think there is an opportunity for contractors to try to find common ground with clients.” 

Raubex is an old hand at dealing with tricky clients — it’s been in business for 48 years, after all. But, Msiza concedes: “When the client amends the joint building construction contract (the JBCC) the risk is then transferred to the contractor, and it becomes very difficult.”

What gives Raubex credibility in this debate is that it has managed to keep going amid the rout. Its shares have gained 64% over the past five years, even if they’ve taken a 25% dive this year.

In its results for the year to March, Raubex produced an operating profit of almost R1bn, with revenue soaring 31% to R11.58bn. Critically, its profit margins were 8.2% — an almost unheard-of number.

And this trend, mercifully, is still on track. Next week, Raubex is due to release its half-year numbers to September, and has flagged a 10%-20% rise in earnings per share.

“The construction mafia is a threat, but I don’t think we’re on the cusp of a complete breakdown,” says Msiza. “We make sure we engage with the communities we operate in and we spend a lot of time before we start any project making sure we understand the environment and who the players are. So far we have been able to work around those threats.” 

Three months before it starts any project, Raubex  sends in a team to work with local communities to hit the “community participation” goal of 30%, including local labour, materials, and training.

“If we don’t do that, the level of penalties can be quite significant. It’s really worked to the point that some local communities help Raubex to protect its sites as well.” 

It’s a model that has worked for Raubex. So much so that while others such as  M&R are quitting the local construction sector, Raubex has actually expanded its tentacles into this niche, as well as renewable energy and electrical infrastructure, house and telecoms.

Still, Msiza argues that Raubex has been “very selective” in tendering for work — a conservatism that has been key to protecting its margins. 

So too with WBHO, which says the “proficient assessment and pricing of project risk is fundamental to submitting competitive bids”.

Green shoots

The good news is that, after the trauma of the past decade, some construction firms have wised up. Perhaps this is why, despite the government’s molasses-like infrastructure programme, there are green shoots.

In the first six months of this year, the private sector drove a mini-recovery in fixed investment, accounting for 86% of the R267.6bn in big, expansionary fixed-investment projects announced, according to an analysis by Nedbank. This was an increase of 24.6% on 2021.

And Nedbank expects a gradual improvement in fixed investment over the next five years driven, especially, by renewable energy projects. Still, it warns that a broad-based fixed investment upswing is unlikely, given SA’s energy shortage and the global economic slowdown.

To Mphomela, the industry can prevail again — but it depends on how the builders manage their contracts. In particular, he says, they need to band together and refuse to waive their contractual rights — a contentious suggestion given that the large construction firms were found guilty of colluding to fix projects relating to the 2010 Soccer World Cup, and were fined R1.46bn.

In April, he called a meeting of the MBA’s members to discuss precisely this. “We said: Don’t allow yourselves to change these contracts. If you all refuse to submit to unscrupulous contract practices, very soon where will [the developers] go?”

Aware of how this could look, Mphomela approached the Competition Commission to sanction the meeting — and asked it to endorse the JBCC contract as a standard guide. It wasn’t easy. The builders “don’t even want to come into the same room — they’re scared that if developers hear they’ve attended such a meeting they’ll be sidelined for future work.”

Still, some — about 15 of the 50 biggest firms — signed that pledge. “The pledge is only as good as how many members have rallied behind it,” he admits.

But, he says, the industry needs to draw a line in the sand to protect their margins, or there’ll be more failures such as we’ve seen in recent months. And the country can’t afford that.