Tongaat Hulett: Barloworld’s coronavirus dodge
Even if the current starch business deal is going nowhere, Africa’s biggest sugar business may yet get a better price for it
"I’m old-school," says Tongaat Hulett CEO Gavin Hudson. "If you shake my hand, we’ve done a deal."
Hudson, who spent 26 years at SA Breweries, is most definitely old-school. So is Tongaat, one of Africa’s largest sugar business, which has found a recent profitable sideline in selling plantation land to property developers.
Tongaat, as everyone knows, is enduring hard times, due to various accounting frauds, as well as a brutal sugar market. Hudson, who took over in February 2019, is clear about his goal: slash Tongaat’s R11bn debt to R3bn by next March.
But it doesn’t help when Tongaat shakes hands on a deal — as it did when it opted to sell its starch business to industrial conglomerate Barloworld for R5.3bn in February — and the buyer tries to slip out of it.
After eight months of negotiating, Hudson thought he had it in the bag. Then, two weeks ago, Barloworld CEO Dominic Sewela called Hudson and told him Barloworld believed that Covid-19 had caused a "material adverse change", to such an extent that the earnings of that starch business next year will be less than 82.5% of what it was this year.
It was something of a shock for Hudson.
"Yes, I am surprised," he tells the FM. "We’ve been negotiating with Barloworld for ages, they did a proper due diligence and we shook hands in February. And when they did so, Covid-19 was already among us, so I don’t think they can argue they never saw it coming."
Hudson says that throughout, Sewela told him the board supported the deal.
"We then met Barloworld on May 8, and we told them they’re not looking at all the right data. We know the starch business, and we know what the opportunities are. I’m not being overly optimistic about its prospects either — I’m being entirely realistic," he says.
He isn’t exaggerating: during Tongaat’s last financial year, the starch business made R4bn in revenue and R777m in earnings before interest, tax, depreciation and amortisation (ebitda). The business, consisting of four mills, has an 86% market share in SA. The sugar business, by contrast, produced just R395m in ebitda, on revenues four times the size.
The transaction will now go into an arbitration process.
Makwe Masilela, chief investment officer at Makwe Fund Managers, believes the Barloworld deal is now dead in the water.
"If someone suspects that, given the economic conditions, demand won’t be there, they’re not unreasonable to [try to walk away]. Right now, if you’ve got money, as Barloworld does, they’ll know they’re in a better bargaining position to get things cheaper, and they’ll know Tongaat is desperate to sell."
But Chris Logan, chief investment officer at Opportune Investments, thinks it wouldn’t be the end of the world if the Barloworld deal fell apart.
"It’s a very good business, and it could have more potential than we think. If Tongaat looks globally, it may get a better deal elsewhere, maybe from a trade buyer, than it would have got from Barloworld," he says.
Still, you can sort of see Barloworld’s point. Because of Covid-19, many businesses know they have to conserve as much cash as possible, so they have slashed staff and salaries, and ditched acquisitions.
In March, Barloworld said it had "delayed" a R3.25bn deal in Mongolia, clinched only in February, to buy two companies that sell equipment under the Caterpillar brand. "The long-stop date is October 31," it said.
When contacted by the FM, Sewela dodged the question. "I am in a closed period, and therefore can’t comment at the moment." It’s a curious position, since Sewela must know that the JSE’s closed period rules don’t prevent him from discussing the Tongaat dispute.
In March, Barloworld gushed that Tongaat’s starch business was a "defensive, cash-generative business with a blue-chip client base", which would allow it to "take advantage of the defensive nature of the consumer food ingredient sector".
But it also warned that the impact of the pandemic on Barloworld was "uncertain", so it was implementing "various austerity measures" to reduce costs.
Globally, mergers & acquisitions have fallen 45% to $619bn compared to last year, according to Bloomberg. Deals are still happening — Uber is trying to buy Grubhub, while in the UK, Telefónica and Liberty Global Plc plan to merge in a $39bn deal — but only the bravest are forging ahead.
Nonetheless, a study by EY in April of 2,900 executives across the world concluded that "56% are actively planning to pursue acquisitions in the next 12 months".
Two weeks ago, Eldad Friedman, joint head of investment banking at Investec, told BDTV that many deals struck before the lockdown "have been put on hold as management teams are refocusing on their businesses".
But, he said, there’s a potential "new wave of deals coming", given the bargain-basement prices of some companies.
Hudson has an interesting take on Barloworld’s reluctance to follow through. "Given that they seem to be delaying the Mongolia deal too, you get a sense that maybe they don’t trust that they have the fighting spirit to close deals and manage their company under duress," he says.
But what if the starch deal doesn’t happen?
"Look, our choice wasn’t to break up the company. But we made a commitment to pay down debt, and one of the options was to sell one of our best assets, which was the starch business. So it’s a great business and we’ll continue to run it," says Hudson.
However, it may delay Tongaat’s ability to cut its debt to R5bn immediately, and then to R3bn by March. "I believe that either way, we’ll reach our debt reduction targets," says Hudson.
Crucially, Tongaat has options. Hudson points out that Barloworld was one of many companies that had bid to buy the starch business, so there was plenty of interest.
Faith in Tongaat’s business appears to be seeping back.
While the wider JSE has haemorrhaged over the past three months, Tongaat’s share price has gained 70%.
You need to see that in context, though: it is still down 94% over the past three years, as news of the "irregularities" saw it plunge.
Intriguingly, some investors seem to have taken a shine to Tongaat.
In March, the obscure KwaZulu-Natal based company Evanstan Investments bought 6.4% of Tongaat. And this month, another company from the area, Artemis Investments, bought 7.4%.
"We’ve certainly seen a demand for our share," says Hudson. "Maybe the Barloworld deal was the initial impetus, but people still see it as an undervalued share — which I think it is, since we’re implementing our strategy of making it a low-cost sugar producer."
In the past financial year, Hudson’s team improved Tongaat’s cash flow by R1bn and by the end of this year he expects to have found another R1bn.
"I believe we’ll exceed that," he says.
It’s not just about cost-cutting, though. Perhaps surprisingly, given that sugar is used in making alcohol, Hudson says demand has been strong, even during the lockdown. "We’ve seen a significant uptick in SA and Mozambique, and in Zimbabwe it’s gone off the charts, probably because the local price tracks the US dollar so it’s a safe hedge against the currency," he says.
If the trajectory is changing, Tongaat’s culture is also changing for the better.
Says Hudson: "A year ago, it looked quite bleak. But I think now there’s a fighting spirit. Talented people are wanting to join Tongaat again, and there’s a new energy."
Logan says Hudson has done an "exemplary job" after inheriting a real mess at Tongaat. "It’s a tough business, but there’s huge costs they’re taking out, as Gavin is doing. But the debt is just huge. They’ll need to address that."