What a bitter-sweet quandary for shareholders in debt-laden Tongaat Hulett.
Either fork out for a staggering R4bn rights issue that will cull debt and give management breathing room … or let an opportunistic new investor, Magister Investments — controlled by colourful Zimbabwean tobacco barons the Rudlands — swoop in.
Not great options either way — especially as some say there are better ways to reinforce the balance sheet and rebuild shareholder value.
Leandro Gastaldi, a portfolio manager at Blue Quadrant Capital, says Magister’s emergence as a controlling shareholder could end up being good for Tongaat in the long term, but the way the new investor is gaining control does not leave much upside for existing investors.
"If what Magister really wants are the sugar operations, then why doesn’t Tongaat spin that off into a separate company and it can buy into it at a fair value?"
Even a listed spin-off of the Zimbabwe, Botswana and Mozambique sugar operations "might work", he says.
"There just seem to be many levers that management could have pulled first before undertaking such a dilutive rights issue."
The bottom line is that Tongaat, after selling its cash-spinning African Products starch business and other entities, now has two assets: its sugar operations (in SA, Zimbabwe and Mozambique); and huge tracts of land in KwaZulu-Natal (KZN) for property development. Plagued by difficult cyclicality, neither fits well into a public company.
As one fund manager puts it: "Do you really want to be invested in sugar and property development where returns could be in limbo for a long period?"
After the rights offer was declared, Tongaat shares got burnt, losing more than 30% in just a week. But before the news, the shares, buoyed by an undetailed cautionary announcement, had been ticking up hopefully. The market had clearly got excited about "discussions regarding various initiatives directed at the reduction of debt" — presumably interpreting this as a sale of assets rather than a rights offer.
Gastaldi is also puzzled by the role of a key shareholder, the Public Investment Corp (PIC). "What we really don’t understand is how someone like the PIC can support this." Of course, if it doesn’t support the rights issue, its stake will become insignificant and represent "enormous destruction of value", he says
Gastaldi points out that the PIC has long-term return objectives (20 to 30 years) and has expressed a positive view on SA as well as an intention to support local investment.
"So why would it not buy the land back from Tongaat for, say, R4bn? This would be at a 50% discount to current estimated value and an almost 90% discount to future developed value. If the R30bn figure for the future developed value for Tongaat’s property proved accurate over 30 years, it would realise R1bn a year for the PIC."
Gastaldi reckons existing shareholders would more than likely support such a deal, since the land will only accrue in value over three decades, while the R4bn would eliminate the debt issue and make Tongaat a leaner and more focused sugar company.
"It would avoid a rights issue and result in an immediate and significant rerating in Tongaat equity, which also benefits the PIC as a major shareholder."
The market might have acted differently if the rights offer was underwritten by RCL Foods (which owns the Selati sugar operation) or Associated British Foods (which owns Illovo and an expanse of African operations).
Google the Rudland family, and you might not view Magister’s participation with complete equanimity.
Still, it prompts the question of whether Magister’s entry was prompted by reluctance on the part of institutional shareholders to enthusiastically back Tongaat’s rights offer plans.
That said, 38.6% of Tongaat’s shareholders are supporting the rights offer proposals — though that might not necessarily mean they will be following their rights.
In truth, the outrage on social media around the proposed rights issue was only partially justified.
For one thing, anyone scanning Tongaat’s last investment presentation at midyear would have seen a prominent graphic explaining the likely timeline and strategy for refinancing the balance sheet. Presuming no strategic asset sell-down was in place, Tongaat indicated it would announce an equity raise by December, send extraordinary general meeting notices out by January, detail underwriting arrangements by February and finish the process by end-March.
For the record, Tongaat’s disposals have included collecting R5.4bn for its starch business, R663m from liquidating a legacy pension fund and about R750m for selling smaller operations in Namibia and Eswatini and various landholdings.
This cut debt from more than R11bn to about R6.6bn. Selling further land holdings, on paper, would be an obvious option to slash debt further, but the recent unrest in KZN put a damper on property development and potential values of developed land.
The shock, of course, was the shift in the quantum of the rights issue from an expected R2bn to R4bn — and the out-of-left-field underwriting arrangement that could see Magister taking up new stock worth R2bn.
But Tongaat CEO Gavin Hudson says no minimum shareholding has been agreed with Magister. "While it is difficult to predict the outcome, we believe Magister’s holding in Tongaat will … allow [it] to play a meaningful role in unlocking the value within Tongaat for the benefit of all other shareholders."
Many punters say it’s effectively a cover for a takeover. But that might be jumping the gun a tad.
For Magister to emerge as the dominant shareholder it would need Tongaat’s existing shareholders — which include dogged backers such as PSG Asset Management (15%), the PIC in the form of the Government Employees Pension Fund (16%) and private equity firm Artemis Investments (7.85%) — to surrender their rights. That seems a most unlikely value capitulation for longer-term investors with potentially R8bn tucked away in the property portfolio.
Of course, the rights offer will still be significantly dilutive for Tongaat’s share price. With a market capitalisation nearing R850m, a R4bn issue will need a cut-price pitch to lure shareholders. Market watchers canvassed by the FM suggest 400c a share, or even less.
There has also been criticism that Tongaat should have entertained a rights offer earlier, when the share price was considerably higher.
Hudson counters that Tongaat could not realistically do this due to the restatement of previous earnings, its suspension on the JSE and the share price being under pressure.
He adds that the then significant debt burden of about R11bn could have hurt the perceived value of the business.
The fact is, it’s now crunch time for Tongaat.
"The equity raise is needed to pay down two payment-in-kind debt facilities, so as to strengthen the balance sheet. [This] will allow for funding flexibility and reduce the large interest burden the group currently faces," says Hudson.
A portfolio manager who asked not to be named believes that after the sale of the starch business Tongaat was always likely to propose a rights issue. "With the cash-spinning crown jewels gone, you have sugar and property development assets that probably can’t generate the reliable cash flows needed to service large debt. The only way to preserve value is to raise fresh capital and work the value out of these assets … Shareholders could do a lot of damage by not supporting the rights offer."
Hudson does believe a huge dollop of fresh capital would improve management’s ability to deliver on its strategic objectives and position the company to deliver value over time. The focus, he says, will be on long-term demand for sugar across regional markets and realising value from its vast property portfolio.
"We have always maintained that a rights issue would be the last resort once we have sold all saleable assets, and that the board has prioritised keeping the business intact."
What’s more, a successful rights offer would mean Tongaat would not have to sell its sizable portfolio of "premier" commercial properties.
"Keeping the group intact provides the most compelling proposition for all stakeholders," says Hudson.
The "intact" business case entails retaining exposure to its sugar businesses in Zimbabwe, Botswana and Mozambique, and continued gains under SA’s sugar industry masterplan.
As for turning around the SA sugar business, a previously proposed MillCo structure — whereby farmers would buy into a production joint venture with Tongaat — is on pause after uncertainties stemming from Covid and other economic challenges. Hudson says MillCo may be "repackaged as appropriate".
There is an intriguing rider attached to the rights offer proposals.
Tongaat has indicated that if the total percentage shareholdings of Magister and related entities increase by certain levels in the future, Magister will have to make an offer to minorities to buy all their Tongaat shares.
In this regard Tongaat’s last annual report shows a company called Braemar Trading holding almost 13.5-million shares — a stake of nearly 10%.
Braemar also recently popped up at the top of the share register of small agribusiness Quantum Foods, suggesting this entity is building a presence on the local agricultural front.
The FM is aware of rumours that Braemar has links to the Rudland family, and understands that — as a related-party entity — it will recuse itself from voting on the rights offer proposals.
But the collective shareholding could be important after the rights offer results are tallied — especially considering that some thought has already been given to Magister (and related entities) making buyout offers to other Tongaat shareholders at a later date.
Hudson does clarify, though, that in such circumstances the offer price would be based on prevailing market conditions.
This could turn out to be an interesting twist to developments, and the circular should make fascinating reading.
Would you like to comment on this article?
Sign up (it's quick and free) or sign in now.
Please read our Comment Policy before commenting.