Right of Reply: Tongaat tackles Woollam, explains why rights issue is critical and urgent

Tongaat‘s response to David Woollam’s analysis on BizNews 

Context is vital to a proper appreciation of this proposed recapitalisation. Tongaat’s South African borrowing exceeds R6bn, and the company does not have the luxury of time to reduce this debt.

The company has done all it can to reduce debt having already implemented significant asset disposals (including of the starch business), having rationalised the group’s operations and having implemented cashflow management measures (including extracting funds from foreign operations).

Retaining the debt at the current levels is not sustainable. Punitive interest rates require urgent reductions in debt levels. The company needs to secure funding to settle a R2bn PIK instrument by March to meet its commitments to lenders and avoid an increase in borrowing costs.

The company cannot base its future on uncertain and likely protracted litigation. The timeline to potentially recover the debt through litigation is longer than the time we have to repay the debt which has become due to lenders.

It is not correct to draw assumptions as to the final amounts that will be recovered from Deloitte and from the litigation against former executives. Litigation is a slow process, often dragging on for a number of years. The lenders are not willing to wait that long for debt repayments. The company cannot afford to wait that long to reduce its debt. The company must take actions to bring in sufficient monies in the near term. The company cannot base its future on uncertain and likely protracted litigation.

There is no certainty that litigation will succeed. It would also be wrong be expect that litigation proceeds will be sufficient to reduce debt to sustainable levels. One need only look at the difficulties and extended timescales court litigants have had in similar matters. The other parties will inevitably defend their positions. This does not detract from the board’s commitment to continue to assertively pursue claims against the previous executives and Deloitte.

The company must take actions to bring in sufficient monies in the near term.

The company is under great pressure from its lenders to reduce its debt within tight prescribed timelines, which are set out in the circular. The timelines imposed by the lenders necessitated the distribution of the circular at the earliest possible opportunity, which it why it was sent out in mid-December. In normal circumstances, the company would not have sent out a circular at that time.

Defaults under its funding arrangements would trigger lender rights under security held over assets of the group. The realisation of the security could lead to sales of secured assets at substantial discounts and at a significant loss to shareholders.

Given the magnitude and significance of an equity capital raise, the right and fair thing to do is to approach existing shareholders. Whilst carrying out preparatory work in this regard, the board was approached by Magister. An issue of shares to Magister alone was a possible option. The board however remained steadfast in its position that shareholders be afforded the first opportunity to invest in the company, which informed the decision to structure the equity raise as a rights offer.

Aware that a rights offer involves a substantial sum of money and, having taken advice from its adviser Rothchild’s, it became clear that the rights offer quantum was highly unlike to be raised in the absence of an underwriter. With no certainty that shareholders would be able to contribute the full amount, it is logical, prudent and consistent with market norms and in the interest of the company and its shareholders, to have an underwriting.

A number of steps have been taken to limit the potential dilution.

The 60% limit on Magister’s shareholding was a board prerequisite to ensure that there remains a substantial holding by minorities after transaction implementation. This will restrict the degree of shareholder dilution.

Reason #1 – The structure of the transaction, presented as a Rights Offer, is a disguised takeover bid by Magister, without the normal protections a takeover bid would require.

• It is not correct to state that the real intention of the transaction is a takeover bid.
• The company needs funding – that is the primary objective of the transaction.
• Given the magnitude and significance of an equity capital raise, the right and fair thing to do is to approach existing shareholders. Whilst carrying out preparatory work in this regard, the board was approached by Magister. An issue of shares to Magister alone was a possible option. The board however remained steadfast in its position that shareholders be afforded the first opportunity to invest in the company, which informed the decision to structure the equity raise as a rights offer.
• Aware that a rights offer involves a substantial sum of money and, having taken advice from its adviser Rothchild’s, it became clear that the rights offer quantum was highly unlike to be raised in the absence of an underwriter. With no certainty that shareholders would be able to contribute the full amount, it is logical, prudent and consistent with market norms and in the interest of the company and its shareholders, to have an underwriting.
• The company accepts that given the amounts the company needs to raise, there is the potential that Magister will hold a large shareholding.
• Magister however has no certainty that it will have a large shareholding or acquire control. The agreement with Magister is not subject to it acquiring control or even it acquiring a minimum shareholding. Magister could end up with a small minority stake. It has accepted that it has a secondary role which is to put in money to the extent shareholders do not do so.
• The circular is nonetheless clear that if shareholders do not participate in sufficient numbers, Magister could acquire control, up to a 60% shareholding. It is by no means an attempt to avert normal shareholder takeover protections. In the first instance, shareholders have the opportunity to follow their rights (with excess allocations). Secondly, their approval is required to waive their right to a mandatory offer. Thirdly, if they elect to waive their right to a mandatory offer, the agreement with Magister provides shareholders a further opportunity to receive a mandatory offer, if Magister’s shareholding increases post transaction to certain levels. This is a protection which is not commonly secured for shareholders, but was agreed with Magister, specifically to further protect shareholders
• Both the JSE and TRP have been engaged, and they approved the distribution of the circular.

Reason #2 – Shareholders are being asked to increase the authorised number of shares by 33 times from 150 million to 5 billion shares and to place all the unissued shares in the hands of the directors. In theory, this means that if the board were to issue all the unissued shares, the existing shares would be diluted by 97%.

• The equity raise has been structured as a rights offer, specifically to offer shareholders the right to invest in the company as part of the equity raise i.e. shareholders are given a preferential right specifically to avoid dilution. The board accepts that there is the potential for material dilution in shareholdings of shareholders who do not participate in the rights offer. This is however an unavoidable consequence of the amounts the company needs to raise.
• It is incorrect to assume that because an extra 4 850 000 000 shares have been created, they will all be utilised for the rights offer. Given the time and cost implications of sending a circular, it was prudent to allow a buffer.
• A number of steps have been taken to limit the potential dilution.
• The 60% limit on Magister’s shareholding was a board prerequisite to ensure that there remains a substantial holding by minorities after transaction implementation. This will restrict the degree of shareholder dilution. The company is also engaging with third parties on the possibility of further underwriting commitments, which, if agreed, will also result in a lower Magister shareholding post transaction.
• Shareholders have been provided with guidance and parameters on the rights offer. The discount will not be less than 15% to VWAP, and a rights offer size of R3bn to R4bn is contemplated. This information on the rights offer was disclosed to the shareholders with whom the Takeover Regulation Panel permitted the company to engage prior to announcement of the transaction. As stated in the circular, letters of support and irrevocable undertakings were obtained from shareholders holding at the time 38.58% of the shares.
• The discount at which the rights offer is made will be determined by the company (having regard to investor demand), not by Magister. The board is aware of concerns regarding the level of the discount, and will decide what is in the best interests of shareholders (taking into account the need for fresh capital). There is a wealth of precedent in the South African market on typical discounts, and the board will have regard to any similar or comparable recent transactions in the South African market. It is imperative that the board retain flexibility given that the time lag involved – the rights offer can only proceed once regulatory approvals and other conditions precedent have been fulfilled.
• The current market capitalisation does not reflect the underlying value of the group’s operations. It is hoped that the rights offer and resulting debt reduction will contribute to a market capitalisation consistent with the company’s value as a leading regional agriculture business

Reason #3 – There are material omissions in the circular which, in my opinion, do not allow the shareholders to make an informed and balanced decision on the proposed resolutions.

• We believe that sufficient information has been placed before shareholders to make an informed and balanced assessment, and the JSE and Takeover Regulation Panel approved the circular as compliant with their disclosure requirements.
• The circular discloses the amounts the company believes it needs to raise to move forward, and explains why the board regards a capital raise as the preferred method to achieve that objective.
• Projections on monies required to operate the business into the future including projected capex requirements were built into models utilised to determine the lender refinancing. These models were used to determine the level of debt which will be based on assumed cashflow projections which both management and lenders are comfortable with. Additionally, presentations on medium term capex requirements were made at the time of release of interim results. Accordingly, the market has been provided with guidance on the group’s funding requirements over the medium term. With a recapitalised company, the management team will have the opportunity to focus more on improving the business operations, whereas, at the moment, a large amount of time, energy and cost is focussed on dealing with the lenders
• It is not correct to draw assumptions as to the amounts that will be recovered from Deloitte and  from the litigation against former executives. Litigation is a slow process, often dragging on for a number of years. The lenders are not willing to wait that long for debt repayments. The company cannot afford to wait that long to reduce its debt. The company must take actions to bring in sufficient monies in the near term.
• On top of that, there is no certainty that litigation will be success. It would also be wrong be expect that litigation proceeds will be sufficient to reduce debt to sustainable levels. The other parties will inevitably defend their positions.
• The company is working hard on these matters. The issues are complex and the interests of shareholders demands that the company act strategically and based on sound legal advice, which it has obtained.
• The company cannot base its future on uncertain and likely protracted litigation.
• In these circumstances, it would be wrong for the company to make loose predictions as to the likelihood of success or the amounts that will be recovered. Further, it would be imprudent to make any statements which could jeopardise the company’s position. The company will place facts before the shareholders, as it did in announcing on 11 January the actions instituted (after the circular was distributed) against former executives.

Reason #4 – Shareholders don’t have sufficient knowledge about Magister and the Rudland family to understand what value they bring to the group. There remain unanswered questions about their previous business activities. 

• Magister is a private company which necessarily limits the amount of information available, but the company has nonetheless been able to obtain meaningful information on Magister.
• The board and management have placed governance at the centre of the business since 2019, and have adopted the same approach with regard to this transaction. This included voluntarily setting up an independent committee of the board to consider and approve the transaction, and performing a detailed assessment on Magister.
• As part of the board’s assessment and due diligence process, PwC conducted a specified scope compliance due diligence exercise. The independent committee and the board considered the matters identified in PwC’s report and, being comfortable therewith, approved the underwriting support from Magister.
• Magister and Hamish Rudland have extensive and relevant expertise and experience in key sectors which complement the company’s strategic focus areas, including  agriculture, agro-processing, logistics and property, and extensive insight into agriculture in Zimbabwe and Mozambique.
• The board believes that Magister is a suitable investor.

It is wrong to say the transaction will decimate the level 2 B-BBEE status that the company has attained:

• while it is possible that there may be some reduction in the overall black ownership levels as a result of the transaction, the extent, if any, of this is currently unknown and will depend on the extent to which existing shareholders participate in the rights offer;
• shareholders and members of the public can take comfort in the fact that the company remains committed to the promotion of a greater spread of ownership, particularly amongst black South Africans and employees. THL continues to explore potential future ESOP arrangements; and
• THL is fully aware of its on-going crucial socio-economic developmental role, particularly in supporting emerging black farmers and co-operatives in KwaZulu-Natal and upskilling local communities through its partnership with The Jobs Fund, managed by the Department of National Treasury of South Africa.  It is critical to appreciate that far from un-doing all its developmental achievements to date, the transaction is in fact necessary to ensure the sustainability of the company’s operations and in so doing ensure that the company can continue to lend socio-economic support to these communities.

In summation:

This is not an attempted take-over of the company, but rather a transaction designed to raise sufficient capital to sustainably reposition the group, protect shareholder interests and provide a level of certainty to thousands of employees and farmers that depend upon its survival. Sound commercial judgement has been applied to the transaction and it is the board’s considered opinion that the proposed transaction is the most viable alternative that is available to the company and its shareholders in the circumstances. A failure to proceed will expose the group to significant risk of material value destruction. This does not detract from the board’s commitment to continue to assertively pursue claims against the previous executives and Deloitte, and more importantly drive business improvements in its operations to generate shareholder value.

Read also:

• The rise and fall of Tongaat Hulett – analyst and whistle-blower David Woollam 
• Tongaat slaps former execs with R450m in civil claims
• Chris Logan: Tongaat’s turnaround tale turns sour