Tongaat’s monster R4bn rights issue – Chris Logan on the unavoidable

Opportune Investments founder Chris Logan has a closer look at Tongaat’s massive R4bn proposed rights issue. The embroiled agri-processing business has a market value of around R1bn, which means it will raise equity capital of up to four times its value. Logan discusses the reasons why Tongaat finds itself in this precarious position, after years of mismanagement and fraud from senior executives. The capital raise, given the size, is likely to be extremely dilutive and at a significant discount to its shares, currently. In early morning trade following the announcement, Tongaat was down close to 50% before paring losses to close 24% lower. The pricing of the rights issue will be of particular interest to Tongaat shareholders, who will be expected to pay up in order to their pro rata share holding in the company. Logan says the rights issue was largely unavoidable, given the operational mishaps and Covid-19 that have caused a troublesome period for the once high-flying business. – Justin Rowe-Roberts

Chris Logan on the reasons Tongaat finds itself in this position:

Years and years of mismanagement, wholesale mismanagement, which the executive tried to cover up with accounting, falsification and fraud. The mismanagement included capital misallocation. For instance, they spent something like R11bn on sugar assets, sold off a whole lot of prime property – coastal property – to finance some of that, and incurred debt. A lot of the capital they spent turned out to be almost worthless. So, it was wholesale mismanagement and the fraud was something like seven years. When the fraud was eventually uncovered, the company went from [around] $11bn in equity to negative equity, technically insolvent. It was a real mess.

On the size of the rights issue:  

Well, the terms have still got to be announced; what price they are going to pitch it at. There is quite a lot of guesswork. Although the business still technically has negative equity, they have stated that the fair value of the assets is greater than the value of the liabilities. Meaning that some of their assets are understated. So, that’s the one thing. There is also an undisclosed asset – or what I would call a contingent asset – they’ve got a claim outstanding against Deloitte for signing off on seven years of falsified accounts, which I think could be quite big. There’s a lot of guesswork. What the rights issue will do, will remove the financial risk if this thing goes belly up.

On whether a rights issue is avoidable:

It was probably always going to need some capital raised unless they were able to sell some of the big strategic assets or raise equity against some of their big strategic assets – like their sugar mills – which they haven’t been able to do. They have gone through the worst of times on the land side because of Covid-19 and all the rest. One other thing that really hurt them – which was unexpected – was they lost 25,000 tons of sugar on the refining side that equated to hundreds and hundreds of millions. They’ve had a lot of things go wrong over the last year or two, which has complicated it. I guess when you inherit a desperate situation like this, things are going to go wrong with an underlying company that has been poorly managed and under tremendous pressure.

On whether the rights issue provides an investment opportunity: 

It could be an opportunity. You need to look at it because the rights issue will be positive in that it will take the financial risk out of this company. I think the company needs to provide shareholders with a lot of detail of the future; now that they’ve got a clean slate on debt. Particularly if the rights issue is pitched at a very low price. There could be quite a substantial rally once it’s all settled. But ultimately, it will hinge on what the strategic plans are and how they can execute and unlock the value in the assets like land and sugar.

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