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Economic downturn calls for innovative solutionsFOR most of the year it was bonanza time on the JSE as a seemingly endless procession of runaway listings successes grabbed the headlines. But it diverted attention from the real trend unfolding in the corporate finance arena - SA is catching up with the rest of the world in the complexity and variety of its mergers and acquisitions (M&A). South Africans were given a taste of the new trends unfolding in corporate finance - hostile takeovers, shareholder activism and innovative funding structures in the face of interest rates at unprecedented levels in real terms. For corporate finance teams the story of this year will ultimately be viewed as one of two different halves. When the stock market nose-dived in August it brought the flurry of new listings and scrip-based acquisitions to a halt. The appetite of investors for new listings has dulled, but this does not necessarily mean that listing activity will cease totally. There will still be a strong push for listings around which an entire industry has been built. Brait's Graeme Stephens says: "Solid companies with good fundamentals, proven track records and high growth prospects, listing in the right sectors, will still be listable, albeit at substantially lower p:e ratios than before the crash. "Companies should not make hasty decisions in panic. A decision to put on hold a listing which is already relatively far advanced can negatively affect the company concerned when it comes to the market at a later date. "Our view is that if the underlying motives for a listing are sound and still make sense in the changed market circumstances, then there is still every reason to proceed with listing plans. Listing as a mechanism for capital raising is obviously now less attractive than before, but debt has also become an even more expensive source of capital. It shouldn't be forgotten that Dimension Data was listed around the time of the 1987 crash. The ability to attract institutional investors and underwriting is really a function of the pricing of the listing." Since August there has been a smattering of listings - with mixed results. Only those companies that listed on relatively low p:e ratios made any sort of impact on the market. Many corporate finance teams are advising their clients not to come to the market just yet, but rather to hold out until the market establishes a more solid base and indicators of a turnaround become more discernible. Peter Schlebusch, head of corporate finance at Real Africa Durolink (RAD), says: "M&A activity should increase, but unlikely by enough to fill the vacuum left by the postponement of listings. From empirical study, M&A activity levels tend to follow the economic cycle." This implies a flat period in the industry followed by increased levels of activity when the economy begins to pick up, during the middle of 1999 according to many economists. Schlebusch says RAD has been recommending to its clients to hold off listing until things get better, and every one of their planned listings has been postponed. "Arguably the world's top investment bank, Goldman Sachs, has announced the postponement of its own listing. You can't get a better endorsement of our stance than that. No company wants to be remembered as the company that lost 70% of its market cap on listing day, as some of the recent listings have experienced." Rights offers will also become rare, only sought by companies in the most dire circumstances. Quite apart from the bearish market conditions which are unprecedented in the lives of many youthful corporate financiers, a number of trends were already beginning to assert themselves. In a market which was overtraded even in the festive listings heyday, the future looks bleak for at least some of the 76 banks and registered offices in SA. Those that offer the full range of corporate finance services will simply take up the slack by shifting emphasis from listings (which, for most, only accounted for 20% of business) to traditional M&A, private equity, structured finance, unbundlings and globalisation and by originating creative ideas rather than waiting for them to walk through the door. But for many of the listings shops and boutique banks, the dramatic halt in their deal flow may have potentially fatal repercussions, and their lack of depth of skills may hamper their ability to adapt to a changed marketplace. A shake out in the banking sector may well be upon us. As happened after the 1987 market collapse, recently listed companies - particularly those IT companies for whom an underlying motivation in their listing was to incentivise staff and lock into the business their scarce skills - may see little benefit in remaining listed. In many cases the exact opposite effect has been achieved with many employees finding themselves with negative equity in their share option schemes, providing a perverse incentive to cut loose from their albatross and seek out better incentives elsewhere. Current market conditions may bolster a trend already creeping into the SA marketplace - that of shareholder activism. African Life's unsuccessful bid for Norwich throws relief on the potential for more hostile bids once cosy corporate control structures are loosened. RAD's Schlebusch says the theory behind hostile bids is that existing boards and executive management appointed by the current shareholders do not always operate in the long-term best interests of shareholders. A hostile bid is merely another way for an acquisitive company to achieve its strategic objectives. Big institutions holding large stakes in such companies may take the initiative by calling shareholder meetings to push through unbundling programmes or replace the board with one that can add value. Dave Thayser, corporate finance partner at Ernst & Young says: "The increase in unbundling activity in recent years suggests South African business is continuously reshaping itself in a quest for greater efficiency. Companies are also feeling pressure from investors to unlock shareholder value bottled up in control pyramids." Multinationals may seize the current window of opportunity to buy out minorities and delist the company. IBM has already led the way in this direction and there may be more to follow. With borrowers being exposed to unusually high interest rates, and lending institutions likely to come under pressure as a result of their clients' growing inability to service debt levels as crushing interest rates continue to take their toll on those less liquid, one may see more debt into equity conversions. Demand for equity funding instead of interest-bearing debt and in place of some of the smaller listings may send private equity funds into overdrive. However, companies making use of this option need to be selective as they may find it is not cheap. South Africa's big corporates have already spread their wings abroad and are now looking also to list abroad - SA Breweries, Old Mutual and maybe Sasol will be listing on the London Stock Exchange, for instance, while Brait and Tridelta recently listed in Luxembourg. Business Bank's Ferreira says that there will be an increase in M&A activity simply in reaction to the over-heated listings environment of 1997/98. "Some companies will be forced to consider mergers where rationalisation and synergies will reduce cost structures to ensure survival. Those less advantaged must, however, expect to be stalked by better-structured predators looking to make killings under difficult circumstances. It will indeed be a case of the survival of the fittest."
Despite widespread criticism of the slow pace of privatisation, all corporate finance teams involved in privatisation agree with government's desire for thoroughness and say they are heartened by its recent unequivocal commitment to the process. The privatisations of significance to date are Telkom, commercial radio stations, the Airports Company and Aventura resorts. What is certain is that the game of corporate finance will be challenging, with those players who devise innovative structuring and M&A solutions being assured of a consistent workflow.
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