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There is much embarrassing material emerging from the Commission of Inquiry into the PIC, not least opening the eyes of South Africans to sky-high fees paid to financial intermediaries. Whether their fees relate well to the value added is has long been a matter of great debate – indeed a few years back Warren Buffett dedicated a couple of pages in his annual shareholder letter castigating the role of these “super helpers”. Veteran investment analyst Ryk de Klerk has spent some fruitful hours examining testimony given to the PIC Inquiry. He reaches some forthright conclusions in this piece which appeared first in Business Report, and is reproduced with that newspaper’s permission. – Alec Hogg
By Ryk de Klerk*
Having cut my professional teeth in the South African derivatives market, the PIC’s facilitation of Lancaster’s investments in Steinhoff and Pepkor intrigues me. The more and more I go through the transcripts of evidence led on the subject before the Commission of Inquiry of the PIC the more baffled and curious I become.
In phase 1 or Project Sierra the PIC provided a loan of 9.35 -billion to Lancaster SPV, a special-purpose vehicle, which was later registered as Lancaster 101 for the acquisition of 2.75% equity stake in Steinhoff including transaction – related costs. The loan was secured by shares and insurance through derivative instruments against a share price drop below a certain level.
The eventual shareholders were the PIC with 50%, Lancaster Group, led by Jayendra Naidoo, with 25% and Lancaster Group Trust with 25%, the latter being a community trust. According to the testimony of Ms Botsang Morobe, Associate Principal in Isibaya Private Equity Structure Products at the PIC, to capitalise the Lancaster SPV, Jayendra Naidoo was going to – or was supposed to contribute R50 million and the PIC then matched that R50 million. The intention was not for the trust to contribute to the SPV. Lancaster Group through Mr Naidoo’s contribution would then be used as part of the BEE trust contribution to the entire SPV.
Advisory and other fees were enormous. Advisory fees to Symphony were R76.95 million and the Lancaster Group got paid R22.85 million. Mystery still surrounds the payment to Lancaster Group.
When questioned by the Commission on the payment, Morobe said there were taxes that had to be paid by Lancaster Group as a result of the transaction as well as legal fees. Why such humungous taxes and/or legal fees?
The acquisition of the Steinhoff shares consisted of two transactions. Shares to the value of R3.91 billion were purchased from Citibank who was also paid a fee to cover the PIC’s loan against capital losses. According to a SENS release by Steinhoff on 28 September 2016 where Steinhoff announced an increase in capital it was stated that Lancaster 101 subscribed for 60 million new Steinhoff ordinary shares at a price of R75.98 per share or R4.559 billion in total. It is evident that Lancaster 101 bought more shares or took up more shares in Steinhoff as according to the evidence led at the Commission the total amount paid to Steinhoff for the shares was R5.33 billion.
According to Ms Morobe, the PIC received an investment proposal by the Lancaster Group and Symphony in May 2017 to buy shares in Star (currently Pepkor). In essence this project known as Blue Buck entailed the formation of another SPV, Lancaster 102 (with the same shareholding structure as Lancaster 101). Lancaster 101 and 102 got loans from Citibank and bought a stake in Star/Pepkor worth more than R6 billion. The shares were pledged to the PIC as security. The same fellas broke away from Symphony, formed their own investment arm called Atraxia and bagged a formidable R49 million. In this process the PIC partially passed on its security put in place in phase 1 or project Sierra to Citibank by subordinating security at no cost.
Ms Gill Marcus, member of the Commission, raised the question “So project Blue Buck was leveraged by PIC having foregone its security in Sierra?”
The rest is now history. As Paul Magula, previous Executive Head: Risk and Compliance at the PIC said in his statement before the Commission: “Yes, (it took) just five months from investment decision to impair up to R5 billions of credit investment.” The PIC effectively took “a naked position” in Steinhoff and gave some hedging strategies (probably valued at many millions) away for free.
The PIC can take a leaf out of the hats of two shrewd individuals. I quote from Steinhoff’s 2018 Annual Report: “In 2015, the Group made the strategic decision to increase its PSG shareholding to above 25%. To facilitate the increase in its PSG shareholding, the Company agreed with certain PSG investors to swap their PSG shares for Shares in the Company. Two of the PSG investors that participated in the swap, entered into separate derivative agreements with the Company under the terms of which the Company would retain economic exposure to PSG (therefore should the Company share price underperform the PSG share price, the Company would pay out the difference in value to these swap counterparties and should the Company share price outperform the PSG share price, the Company would receive the difference in value).” They closed out their positions.
Some questions remain about the PIC’s funding of Lancaster 101. Although it is stated that the information in Steinhoff’s 2016 Annual Report can no longer be relied on, it states on page 25: “In consideration for the commitments in terms of the Lancaster Subscription, the Upington Subscription and the Upington Purchase, Upington and Lancaster received an underwriting commission of 2.5% of the respective subscription price and purchase price, as applicable.”
The Lancaster Subscription refers to the 60 million new ordinary shares subscribed for by Lancaster 101 Proprietary Limited. The underwriting commission therefore amounted to about R114 million. I stand to be corrected but nowhere in the evidence led was the underwriting commission nor the amount mentioned – even searches on the internet led me nowhere.
The question of the underwriting commission raises more questions than answers. In my point of view underwriting commission received is not of a capital nature but an income statement item and subject to tax. One would have thought that the after-tax amount in Lancaster 101 would have been brought into consideration in the PIC’s funding of Lancaster 101 and, as it is a material number, it should have been alluded to in testimonies. Where did the money go? Have the two parties shared the underwriting commission? Perhaps there is a simple answer.
It is clear that savings were not destroyed but just shifted hands – from South African pensioners to Citibank. Is it not ironic that the impairment of Steinhoff is nearly equal to Citibank’s funding of Lancaster 102’s investment in Pepkor?
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