JOHANNESBURG — In this interview, BizNews editor and publisher Alec Hogg asks the Head of EMEA Credit Research at Debtwire, Nicholas Smith-Saville, about the company’s perspective on Eskom’s debt woes. Debtwire is well-known for its analysis of debt markets worldwide and in-depth credit analysis. As a result, Smith-Saville provides a much needed global perspective on Eskom’s financial conundrum. Interestingly, Smith-Saville says it’s not all bad news for as long as Eskom can start to get itself on the right trajectory and avoid becoming a target for political exploitation. – Gareth van Zyl
Nicholas, why is there interest, from your perspective, from Debtwire’s perspective, in Eskom?
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That’s a good question. So, Eskom is clearly a huge company with a significant amount of foreign currency debt outside of SA, and given the challenges that the company has seen, as well as the uniqueness of Eskom’s situation, it’s one that a lot of investors are struggling to get their head around what the outcome may be and what the options for the various parties involved are.
It’s pretty complex, isn’t it, the situation that Eskom finds itself in?
Yes, a lot of the companies that we look at are your more usual level corporates but with Eskom clearly, it’s a hugely, politically sensitive situation. You’ve got the symbiosis between the sovereign credit as well as the corporate credit and the changing energy landscape that Eskom faces, all of which combine to make an incredibly complex situation because you can’t tackle any of those aspects in isolation. You have to tackle the whole thing, and that’s what’s got a lot of people, I think, scratching their heads trying to find the right solution there.
The starting point would be the reality that free cash flow doesn’t even meet the interest charges every year so, you’ve got an unsustainable business model, at the moment.
Exactly, and particularly in the last results the one thing that stuck out for us is that this isn’t a problem of the one capital structure. You’ve got an asset base, which is now… It just doesn’t have the capacity to meet its demands. It needs further investment and you’re seeing the kind of brownouts and the lack of investment that Eskom’s power plants have had in recent years have really taken effect on the business’ ability to sell its product, which is electricity.
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Nicholas, what has happened to the pricing of Eskom bonds over the last few years, as it has slid ever closer to the crisis?
Yes, so the bonds have been relatively… it’s been a tricky one. They’ve been relatively resilient and obviously Eskom was able to access the Euro-bond markets back in the summer with a guaranteed-bond. However, over recent months as the group’s troubles have become even clearer those have now slipped as well but the bonds certainly, when we published our report earlier last week, we’re still trading in the 90’s so, yields are between 7% and 9%, although looking today some of those bonds have traded lower still with some of those bonds now yielding a little bit more. The group’s funding costs were they to come back to the market and we saw that they did an investor roadshow last week. They are likely to be higher than they achieved in the summer, which were they to try and refinance – that’s just going to put more pressure on the group’s cash flow and liquidity.
That’s an interesting point, the fact that they did have an investor roadshow last week but the consequences of that on the pricing of their negotiable debt, has actually been the opposite of perhaps, what they would have anticipated. Or, was it a question of giving more information so that investors are now better informed and also looking at it more negatively?
Well, I think when you look at the outcome of that roadshow, where the idea of the government taking on R100bn of Eskom debt, so that was the company’s point of view. The government has said that they are quite constrained by the sovereign ratings and so that will be their first focus. You seem to have the two parties approaching this from quite different starting points, so I think it’s difficult to see what the outcome will be, at this present moment.
The impact of that R100bn, if the Government were to take it on, as Eskom is hoping, would that have a positive, or obviously it would have a positive impact on the perception of global investors, but how significant would it be?
That’s a good question. With Eskom’s debt it would very much depend on exactly which R100bn they took on. Clearly it would, if they’re able to remove that from the balance sheet, it would improve their maturity profile. It would potentially lower the cash costs of their annual debt servicing but I think when you look at the amount of investment that Eskom needs to reinvest in generating capacity to push through their operational restructuring – I think it would be good to see whether that would completely change the pitch (let’s put it that way).
You’ve done a lot of work. Your report on Eskom runs through many pages and with plenty of detail. What’s your view of the turnaround plan that they have put on the table so far?
It’s a start. I think clearly, they need to invest in improving the generating capacity, availability is one key weakness that we see from an operational point of view. The question really is, no matter how much they invest into their coal power plants are we seeing a stranded asset situation where because Eskom is so invested into coal power that actually it misses the opportunity to invest in a robust renewable energy plan, and similarly, will they be able to affect the cuts that they need to make in terms of their operational costs, particularly in its workforce, where we’ve seen a number of reports that demonstrate that the company is overstaffed. Is that going to be politically achievable? Well, I think those questions are still unanswered and that’s what we’re going to need to see early next year that there is a clear and robust task to having a long-term sustainable business.
So, what exactly is it that global investors would like to see? What’s the best possible outcome early next year on the Eskom scenario?
I think in an ideal world, a right sizing of the workforce. As I mentioned, that may be politically un-viable. The question of whether Eskom needs to exist in the form that it does as one kind of end-to-end business. There may be value to be unlocked by separating the various parts, generating distribution and then perhaps retail. We’ve seen that idea be somewhat dismissed but that may be an argument to say, actually there is value to be unlocked here. There are assets within the group that can be used to relieve the group as a whole and free up cash to invest in the business. Really, investors need to see a clear plan, one way or the other, that puts Eskom on a sustainable footing. Without that everyone is still playing guessing games and you can’t price guessing games. You need something coherent to say, ‘this is what’s going to happen, we can take a view on that plan.’
Nicholas, obviously, a lot has changed at Eskom in the last year. Had it continued along the path it was on, i.e., with the endemic corruption and the issues that have now been very well documented, before the change on the board, etc., what would the likely outcome have been?
That’s a very interesting question. I think certainly it would have been perhaps more difficult to secure the funding that they’ve secured this year. Clearly, the group is reliant on being able to raise more funding. I think the point at which investors stopped trusting Eskom and relied evermore on the SA government, would have come earlier. So, I think the actions that have been taken so far have certainly brought the group a bigger or longer window of time, from which to focus on. How do we go forward from here? It has given investors a degree of confidence, as you’ve seen throughout SA credit more widely. That the issues from the past 10 or 15 years have been, I guess, stopped and there is a concerted effort on the part of government to tackle these. So, I think certainly, it’s bought the group time to make the changes it needs to make and investors can now focus on whether those changes, the plan that’s going to come next year is sufficient to put the company on a long-term footing.
How big is that window? How long will it last before it closes?
That, in part, depends on global markets and also, what happens with the wider SA government budget. Clearly, there is symbiotic relationship between Eskom and the sovereign. The government has guaranteed a significant portion of Eskom’s debt, R350bn. The productive capacity of Eskom is crucial to enabling the SA economy to work and I think if Eskom is not able to generate power for the country on a reliable basis, and that can knock GDP growth. GDP growth or even negative GDP growth then cedes into the debt to GDP ratios of SA, and clearly increasing reliance on Eskom on its government sponsor, if you like. Will then start investors thinking about how they price that support into their willingness to buy SA government debt and you can argue that there is this potential for, without wanting to sound too alarmist about it, but a vicious downwards cycle. I think that is the risk that we see when we’re looking at Eskom and SA. So, I think if they can come out early next year with a robust plan and a good funding plan alongside that then that will give investors confidence. But I think, as I’ve said, we’ve got the government and the company starting from two differing points – if we don’t see that convergence, I think that may close the window next year.
Nicholas Smith-Saville is Head of EMEA Credit Research at Debtwire.
