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The battle of Brooklyn

Posted On Wednesday, 06 February 2002 14:01 Published by
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The Brooklyn Mall, a shopping centre in Pretoria, was the centre of events which contributed to foiling a listed company's dreams of obtaining control of the huge Canal Walk centre in Cape Town.
The Brooklyn Mall, a shopping centre in Pretoria, was the centre of events which contributed to foiling a listed company's dreams of obtaining control of the huge Canal Walk centre in Cape Town.

Debt of hundreds of millions of rands presumably contributed to Richway Retail Properties selling its entire portfolio, including its flagship, the Brooklyn Mall in Pretoria a few weeks ago.

Richway's preliminary results for the year to 30 June were announced shortly before the sale in September. For some holders of linked units (shares and debentures), the debt was probably a surprise. Others, who had read the fine print in the annual report last year, would have known about the increasing off-balance sheet funding. The price at which the sale is taking place is a huge surprise, because it is about R360m more than the book value at which Richway reflected it in its balance sheet a week earlier.

Holders of linked units at first glance look like the winners in the battle, but Richway has lost control of its former portfolio. The annual report and a circular on the sale should provide more answers.

Behind this loss of control lies the story of a company which waged a symbolic and a realtime war on several fronts. A war against smaller players which stood in its way. A war against debt. And a war to realise its 'imperialist' ideals.

It is the story of a company with more ambition than capital, which was very eager to become a really big player in the SA property industry. In its backyard in Brooklyn, great pressure was apparently put on small competitors. From court papers it seems as if one competitor, the neighbouring Brooklyn Square, was not and still is not impressed with the behaviour displayed by its larger neighbour.

The court proceedings between the two Brooklyn neighbours were still pending when a transaction was signed at the end of last year whereby Richway would buy a 58% interest in Century City from BoE and Monex. Century City, an unlisted public company under control of BoE is the owner of the giant Canal Walk shopping centre in Cape Town. The court proceedings are still pending.

As part of the purchase price, Richway had to find the relatively small amount of R200m. The group was unable to do so, and that was presumably the beginning of the end of its dreams of controlling a R2bn portfolio.

Any experienced banker who looked at the 2000 financial statements would have been able to take the implications of the off-balance sheet debt into account.

The new technological era has reduced the importance of bricks and mortar as a fundamental value factor. Old world land barons who believe firmly in property as an investment are few and far between in the modern investment world. That is why the market capitalisation of these companies in SA often amount to hundreds of millions of rands rather than billions of rands.

But don't forget man's primeval instincts. Instincts which presumably had their roots in feudal times and which made the possession of property a highly visible symbol of power.

Think of the historical example of a Donald Gordon, former chairman of Liberty, who had the vision to build a Sandton City when others were still tied to the Johannesburg CBD.

There is also the interesting story about Gordon and Liberty's former head office which was planned in 1968. The story is told in his biography Larger than Life by Ken Romain. Gordon apparently considered it quite an achievement that the 22-storey building would be about 9 metres higher than the neighbouring headquarters of the Schlesinger organisation under the leadership of his former business enemy Mandy Moross.

But back to Richway which is listed in the property loan stock sector of the JSE and currently has a market capitalisation of about R340m. Even according to SA standards, this is by no means a large company. But Richway's ambitions were much bigger.

In this regard, the well-known Wapnick family of Pretoria was for many years connected with property companies which eventually led to the establishment of Richway.

Family patriarch Alec Wapnick is, according to the website, a director of 238 companies, most of which are in the property industry. Whether the Web site's information is 100% accurate cannot be determined with great certainty, but this makes no difference to the reality of the Wapnick family being highly influential in Pretoria property circles.

Wapnick is also a director of two other listed property companies, Premium Properties and Octodec Investments.

The listing of another Wapnick company, Tomkor, was ended in July 1994 after the company sold its property to Richway. In exchange, Tomkor received a 68% interest in Richway. Sixteen months later, at the time of a rights issue by Richway, the company announced it had no controlling shareholders.

The only conclusion that can be drawn from this is that Tomkor was either sold or unbundled, because after that the Wapnicks were reduced to being a significant minority shareholder in Richway.

A loan stock company like Richway has by definition a high gearing ratio. This company's linked units each consist of an ordinary share of 1c and a debenture of 399c. Technically the debentures are debt, although the redemption date is only in 2019.

Interest and dividend distributions are in a ratio of 1:200 between dividends and debenture interest and are of course dependent on operating profits. From 1996 to 2001, the distributions per linked unit were 50c, 54c, 52,25c, 57c, 56,25c and 48c respectively. Certainly not a picture of fast growth and probably also the reason why the price of the linked units marked time for so long after 1996.

The group's financing works basically on the principle that the debenture capital is used to fund the property portfolio. As ambitions to obtain more property increase, the need to use other sources of financing, such as bank debt, became more and more urgent.

By 1999, interest-bearing debt had already reached about R48m, which was still comfortably under the target of 50% of the value of the property portfolio which the group had set for itself.

On several occasions since about 1999, Richway raised the possibility of alternative financing. The issuing of further debentures would presumably dilute earnings per linked unit.

Wapnick revealed in his 1997 chairman's report that the group was using off-balance sheet financing. He repeats this in 1998 and 1999. No details of the implications of this are given in the financial statements.

Reservations in market circles about this probably contributed to the lacklustre share price at the time.

Only in 2000 was more detailed information revealed by means of a note in the financial statements. Off-balance sheet financing is a complicated matter. This is actually what merchant banks would call structured financing.

In brief, it involves the bank taking control of the particular asset and also financing it. The company on whose behalf the bank is doing it gets an option to buy the asset after an agreed period.

This buying option creates a future liability which must be disclosed as a contingent liability.

In the directors' report for 2000, it is disclosed that Richway sold its interest in the Brooklyn Cinema for R36m and has an option to buy it back within two years.

Brooklyn Cinema is situated on a property between Brooklyn Mall and Brooklyn Square and belongs to a private company called Cinebrook Investment.

It is also one of the reasons for the dispute between Brooklyn Mall and Brooklyn Square, because Brooklyn Mall allegedly would not build a pedestrian link to facilitate traffic to Brooklyn Square, as previously agreed.

Investec Bank took over temporary ownership of the company and the property in terms of a structured arrangement. Richway's contingent liability for this asset for the period 2001-2003 and later as disclosed in 2000 was close on R120m.

At much the same time, other new extensions to Brooklyn Mall were undertaken. The same method of financing, in principle, was used here. The sum of future liability in this case was R750m and the two banks involved were Investec and Nedcor.

It could be argued that the funding arrangements indicate, rather, real and established liabilities and that it would be better to show these with the asset concerned on balance sheet.

The balance sheet at the end of the 2001 financial year, seen against the background of the off-balance sheet financing, was no huge surprise. Richway's indebtedness suddenly leapt from R49m to about R490m. Of this, R184m was attributable to the acquisition of new property and a further R258m to refinancing the off-balance sheet debt.

What is interesting though is that the R258m mentioned is considerably less than the amounts disclosed in 2000 as being due for refinancing by 2002. The provisional report makes no mention of any other outstanding off-balance sheet financing. The annual report should provide answers, but it appears that easily another R500m in outstanding off-balance sheet financing may have remained.

It's of course possible that the parts of Brooklyn Mall financed by off-balance sheet debt were all included in the sale, in which case the off-balance sheet debt would now become actual debt on Richway's balance sheet. Again, the annual report and the circular concerning the deal should provide more answers.

Amid all these dramatic events, Richway went through a change in control during 1999. After 1995 there has been no controlling shareholder and the mines pension funds, Nedcor Investment Bank (NIB) and the Wapnicks have retained significant blocks of shares in the company.

In October 1999 a consortium consisting of BoE, Vestacor and The Strathmore Trust initially acquired a joint 45,1% interest in Richway, paying R4 a unit. NIB and the mines pension funds were the sellers. The consortium, housing its interests in the private company Retail Investments Holdings, subsequently increased its stake to about 63%.

The Wapnicks have resigned from the board but are apparently still minority shareholders. Gerald Rubenstein of Vestacor took over the chairmanship from Wapnick. The Wapnicks have also retained an influential position as their private company, City Property Administration, is responsible for the administration of Richway's properties. In 2000 this earned them R6,4m in fees – representing a 10% slice of Richway's revenue.

But what makes the takeover interesting is the fact that it has been financed entirely by debt. The initial 45,1% cost R118m, which was paid for by a R112m loan from BoE and R6m in share capital from the three consortium partners. BoE also made a further R107m available for an offer to minorities.

The interest rate on the loan was 15,75% at the time. On the original 45,1% stake, the consortium is currently earning interest and dividends worth about R14m. Calculated on the initial loan of R112m, this gives a return of 12,5%.

Depending on the current interest rate on the loan, the consortium is apparently managing to pay the interest – by the skin of its teeth – but at this stage no capital, it would appear. This is something that few bankers like to see.

If the consortium could sell, it could get back its capital and the bank could rest easy.

The irony is that BoE financed the controlling shareholders of Richway while Richway was a serious candidate to acquire control of Century City. BoE must surely have wondered if such a transaction really made sense.

Negotiations took place during the second half of 2000 and shortly after Richway's results had been published, in which the 'contingent liabilities' of R750m were reflected.

BoE must have had misgivings about such a big deal. In any case, it would stretch Richway's balance sheet by a further R417,7m, R200m of which was payable in cash. For that the group from Pretoria would get a fully diluted 58% stake in the Cape-based property giant.

From the purchase price it's clear that BoE was keen to do the deal, which represented a 14% discount to the price BoE and Monex paid in 1998.

All that Richway had to do was to find the R200m. BoE would not be entirely rid of Century City. Ultimately it would mean that its interest in Richway would be increased and that it would still have a large indirect exposure to Century City.

Richway was unable to fundi the R200m and the deal fell apart. The writing was on the wall and alternatives had to be found.

The next step came a couple of weeks ago, with the selling off of Richway's portfolio to Primegro, another property loan stock company. The purchase price was an astonishing net R1 107m.

As mentioned, this was about R360m more than the amount indicated on Richway's balance sheet, just a week previously, as the carrying value of its portfolio.

In any event, Richway has changed its accounting policy and now shows property at market value. It would appear that by far the largest part of the R360m could be attributable to assets at Brooklyn Mall previously financed by off-balance sheet debt. But what has happened to the corresponding liability?

The deal leaves Richway with R952m in cash and a 26% stake in Primegro, which may not be sold before June next year. It clear that Richway's board creates conflicting expectations. The impression is created on the one hand that it's a deal with a view to the longer term.

But there is also talk of distributing the cash and liquidating Richway. . The latter option seems the more likely one.

The Primegro deal raises the pro forma net asset value per linked unit from 539c to 631c. A simple calculation therefore shows assets of about R1 107m, a net asset value of R412m, leaving us with about R695m in liabilities. The million-dollar question is whether all former off-balance sheet financing has been included.

On the surface, holders of linked units have benefited from the situation, since the price of the units has risen above R5. The 15-20% discount to net asset value reflects the uncertainty regarding the off-balance sheet assets.

As the new owner of the Brooklyn Mall, Primegro will have to make peace with Brooklyn Square, a development that took place with capital raised from a number of private investors.

It can't do the image of any listed company any good to be involved in drawn-out disputes with its neighbours – especially where a large player seems to be bullying a smaller one.

In court papers the impression is being created that Brooklyn Mall has the (passive) support of the Tswane Metropolitan Council. The unilateral plan to sell off that part of Bronkhorst Street closest to the two centres is simply one example of such passive support.

The Council itself can hardly afford any more controversy, after Beeld recently reported on an investigation into corruption and fraud at the council's building department.

Richway paid a heavy price in its quest to realise its 'imperial' dreams. Perhaps it is a case study from which other SA companies can only learn.

Publisher: Finance Week
Source: Finance Week
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