By Corrie Kruger
Asset stripping is a term used to refer to the practice of selling off a company's assets in order to improve returns for equity investors.
In many cases where the term is used, a financial investor, referred to as a 'corporate raider ‘, takes control of another company and then auctions off the acquired company's assets.
At a basic level one would expect the price of a share to reflect the net asset value (NAV) of the company’s assets less liabilities, divided by the number of issued shares.
In practice this seldom happens for several reasons, such as balance-sheet data has limitations as it is published some weeks after the end of the reporting period, and it is not timely. Secondly, as measurement is dictated by accounting standards, it may not communicate the position of the business, the way management or investors sees it.
Many companies across the world find that holding companies in particular trade at a discount to NAV. Examples of such companies are Naspers, PSG which have traded at discounts to NAV as high as 30 percent at times.
Asset stripping in the public sector
In an opinion contribution published on March 1, 2019 by Politicsweb, William Sanderson-Meyer stated that, “South Africa is not run by a government. It has been hijacked and is under the control of a cabal of asset strippers. This is a country not being governed to benefit its people. Instead, it is being dismantled and sold off piecemeal to provide oodles of cash for a small political elite. Asset stripping is one of the uglier manifestations of present-day capitalism. While the phenomenon is modern, the script is ancient”.
Asset strippers gain managerial control, often through the ploy of promising the shareholders they will “unlock value”.
We need not repeat the demise of most of our state-owned enterprises with the ensuing deterioration of operating capacity and at the same time the destruction of assets under management.
Measures to contain the abuse of dividend distribution as part of asset stripping
In 2012, South Africa implemented a new Dividend Tax regime, specifically allowing dividends declared between South African tax resident companies to be exempt from dividends tax.
Some companies subsequently took advantage of the opportunity to extract value from subsidiary (target) companies through receiving large tax-exempt dividends. The target company shares would then be subsequently sold at significantly lower value (as the net asset value would be stripped of the pre-sale dividend), thus reducing the tax applicable on the shareholder on the sale of the target companies’ shares.
National Treasury subsequently released the 2019 Draft Taxation Laws Amendment Bill on July 21, 2019. containing proposed rules setting the requirements to capture schemes that meet the following criteria:
Value extraction (reducing market value of the shares) by the declaration of a large dividend by a target company to a shareholder company that constitutes an extraordinary dividend; dilution of shareholder company’s effective interest through the target company issuing new shares to a third party; prior to the share issue, the shareholder company had a qualifying interest; The extraordinary dividend occurs within 18 months of the share issue.
The new proposed rules have the effect that the shareholder company is deemed to have disposed of a percentage of its shares held in the target company equal to the reduction of its effective interest in that target company.
Only the portion of the dividend relating to the deemed disposed shares (and to the extent that it constitutes an extraordinary dividend) will be taxed, either as revenue income or capital gains, in the hands of the shareholder company.
How prevalent is asset stripping in the private sector?
Asset stripping via the declaration of dividends is not the only action companies are taking. Perhaps the most notorious examples of asset stripping at its worst happened in the liquidation of the South African company Pamodzi Gold Limited, which led to the awarding of rights to the Orkney and Grootvlei gold mines to Aurora Empowerment Systems (AES) in 2009.
The nephew of then president Jacob Zuma, Khulubuse Zuma headed AES while the grandson of Nelson Mandela, Zondwa Mandela and President Zuma’s legal adviser, Michael Hulley, were among its directors.
Between 2009 and 2012, AES stripped the mines’ assets and effectively destroyed their productive capacity. Hundreds of millions of rand obtained from the theft of assets and gold were funnelled to Zuma, Mandela and several others. In addition to this, AES halted workers’ wages in early 2010, plunging more than 5000 workers and 40 000 dependants into abysmal poverty.
A Master of the High Court inquiry in terms of the Companies Act was then launched, during which compelling evidence emerged indicating that the lead Pamodzi Gold liquidator, Enver Motala, connived with AES in obtaining rights to the mines in question. liquidators Enver Motala and Gavin Gainsford were fired by the Justice Department in May 2011.
A quite different but more recent situation is currently playing out and in this regard a closer look at Telkom may provide some answers.
The company is believed to have assets that can be better utilised and, therefore, we see the huge interest in the market by various companies such as Rain, MTN and also investment firm Toto Consortium which made an offer valued at $433 million (just more than R7.02 billion) for a stake in the nation’s third-largest mobile-phone company.
Not related to the proposed takeover, MTN denies retrenchment accusations but confirmed there are plans to sell off stores, and employees will be transferred over to new employers with their current total cost to company packages, for a minimum period of 12 months.
As previously reported by IOL on August 5, MTN has said the retrenchment process it started was part of the company’s transformative journey. There is a clear strategy at MTN to move certain assets out and to acquire new assets that may provide a better return. This may sound like effective capitalism at play, redirecting capital to more rewarding assets. The man that needs to put bread on the table however, is not interested in ideology when he gets home to face his family.
The National Union of Metalworkers of South Africa says it is convinced there will be job losses if MTN's takeover bid of Telkom is successful. As IOL reported in our article South Africa has not learned from the mistakes at Kusile and Medupi, Cosatu states: "If you look at Eskom for example, Eskom management has confirmed to Nersa that part of the reason we are paying so much for electricity is because of the highly-priced IPPs which are privately owned.”
“The cost of IPP is passed on to the consumer. Privatisation will mean that outlined areas and rural areas will not be serviced. MTN and Vodacom do not care about ensuring quality networks in rural areas, but Telkom, which is state-owned must care. Such a move will result in more job losses and stifle economic growth even further.”
There is a famous quote: “The invisible hand is an economic concept that describes the unintended greater social benefits and public good brought about by individuals acting in their own self-interests. The concept was first introduced by Adam Smith in The Theory of Moral Sentiments, written in 1759.
If ever we need wisdom, it is in matters such as these.
Corrie Kruger is an independent analyst.
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