Amid a turbulent and unpredictable investment environment featuring trade wars, actual wars and uncertainty around local and international fiscal and trade policy, one risks losing sight of matters at the coalface of M&A activity, namely the status of local merger control and whether it is adding to these uncertainties or firming up to increase investor confidence.
In South Africa, at the level of deal regulation through merger control, we see signs that the Competition Commission (Commission) has continued to develop its perspective and understanding of the effect of its policy of ownership of firms by historically disadvantaged persons (HDP) and workers on a merger transaction. At the risk of adopting the peculiarly South African bent of identifying green shoots before they are edible, there are indications that the Commission may be moving its ownership policy under the Competition Act in a more pragmatic direction.
The Competition Act requires that when assessing the effect that a proposed transaction will have on the public interest, the Commission must determine the effect that it would have on the “promotion of a greater spread of ownership, in particular to increase the levels of ownership by [HDPs] and workers in firms in the market”. Generally speaking, and as expressed in its own guidelines on public interest in mergers, the Commission has taken the view that “promotion”, in this context, meant that acquiring firms were required to improve on the HDP and/or worker ownership levels in target businesses. Over the past couple of years, this has resulted in the Commission routinely requiring merging parties to tender conditions such as commitments to enter into HDP equity transactions in the future, or establishing an employee share ownership plan (ESOP) for the benefit of a broad-base of workers.
These measures often posed challenges for investors, particularly private equity firms whose growth capital deployment strategies typically mean that the commercial mechanics of a deal are carefully calibrated; all the more so when investing in marginal economic circumstances. If local private equity firms’ deal making is subject to costs and strictures affecting deal value, or reducing equity value, private capital may well choose other markets. The introduction of internally financed ESOPs, for instance, could also run contrary to private equity’s requisite capital growth, including through reduced dividend flow. Often, private equity investments are for less than a 100% stake (often, management retains a level of control, or a private equity firm is part of a consortium). In those circumstances, a reduction of equity is all the more difficult to contend with.
In our experience, the strident application of an ownership policy resulted in reduced investment sentiment due to resulting increases in transaction costs, extended investigation timelines with resultant knock-on delays in closing, reduced returns due to equity commitments and, for black fund managers, uncertainty regarding inherent difficulties in exiting effectively at the end of their respective investment horizons. Minority black shareholders also found their stakes to be less attractive for buy-outs by private equity firms, who may prefer to leave these in place to avoid creating a public interest headache.
Fast forward somewhat to the establishment of the Government of National Unity (GNU) and the appointment of a new Minister of Trade, Industry and Competition, and the picture seems to be getting a little rosier. South Africa’s desperate need for private investment appears to be becoming a bigger part of the regulatory equation – though not to the exclusion of economic transformation objectives, of course – so the Commission is finding itself having to wrestle with two equally weighty policy imperatives: addressing inequalities of the past, and supporting investment so that the future can be secured.
A New Era of Flexibility?
Some recently reported merger decisions suggest that the Commission has, of late, adopted a more holistic view of its public interest assessment, taking into account the effect on all public interest grounds (not just HDP ownership). In the past, transactions which had a positive effect on other factors of the public interest, but which reduced HDP ownership levels, were met with a steadfast Commission who insisted on HDP equity or ESOP remedies – despite the adverse effects it may have on the private equity firm’s investment or exit. However, it now appears that the Commission has begun to look more earnestly at the entire public interest impact of a transaction, even allowing unconditional approvals for some transactions which reduce HDP ownership, but which come with sufficient countervailing public interest benefits.
Another shift is that in transactions that reduce the level of HDP ownership, the Commission has begun to seriously consider innovative solutions which meet regulatory requirements while also supporting private equity investment objectives. In particular, there seems to be a greater receptiveness towards alternative business friendly remedies (other than equity and ESOP remedies) in the face of a reduction in HDP ownership. These remedies include:
• HDP and small, micro and medium enterprise development initiatives, including spend commitments throughout the value chain which would align with companies’ B-BBEE strategy.
• Empowerment of HDP fund managers. The Commission has allowed for skills transfer arrangements and empowerment initiatives geared towards prospective HDP fund managers, ultimately fostering a more inclusive and dynamic investment environment.
• General public good remedies, including community development initiatives such as donations to schools, hospitals and other community areas.
Although these remedies still require capital outlay and implementation, they are often more business friendly than their traditional equity-displacing counterparts, and are more likely to align with the merging parties’ B-BBEE / ESG strategy.
Too pragmatic?
The Commission’s willingness to meaningfully engage with merging parties is very welcome. Allowing for more business-centred remedies – which still achieve positive public interest outcomes under the Commission’s interpretation of the Competition Act – creates a positive obligation to improve ownership outcomes. However, it is important to continue ensuring that any remedies tendered in deals are still meaningfully connected to the deal, and to the Commission’s mandate to investigate deals under the Competition Act.
In the absence of detailed reasons explaining the nexus between a deal and a given remedy, there is a risk that certain of the more ‘transactional’ remedies that have been offered are seen as unjustifiably removed from actual deal effects or commercial rationale. In a global environment that is currently suffering the effects of overly transactional approaches to trade policy, this approach may run the risk of reducing the public interest test to mere Rands and cents (the more cynical may say: rent extraction) rather than the balancing act envisaged by the Competition Act.
Where to from here?
While many investors would love to hear that statutory obligations, the requirement of mergers to promote the public interest, and transformation of ownership trends in particular, are on the cusp of being sacrificed on the altar of “regulatory reform”, the reality is far more nuanced. Certainly, deal architects who are able to work within the transformation paradigm, or at least are able to create deals that meaningfully promote the public interest, will find their path to approval smooth. Those who are less flexible will continue to face headwinds.
That said, the Commission does appear alive, and even somewhat responsive, to concerns from the investor community around perceptions that the policy may be hostile to deal flow and economic growth. Threading the needle between two policy imperatives is an unenviable task for a regulator. Like most of South Africa’s socio-economic paradoxes, these challenges will no doubt result in some mixed messages and seemingly capricious pendulum swings. Ultimately, a willingness between investors, their advisors and the regulator to engage in constructive dialogue, each willing to give a little and meet somewhere in the middle, could go a long way towards narrowing the policy spread.
Reece May and Albert Aukema are Directors of the Competition Law practice and Chris Charter is a Director and National Head of the Competition practice | CDH
This article first appeared in Catalyst, DealMakers’ quarterly private equity publication.
DealMakers is SA’s M&A publication.
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