A little About Restructuring

Sasol Restructuring Entanglements!

Navigating personal finances amidst corporate restructuring (Photo by KOUSHIK BALA from Pexels)

Imagine being able to benefit from insight on what corporate restructuring really is (in the most basic sense) and how it affects your personal portfolio. You don't have to always panic when you see a drop in one of your stocks, as you hear "We sold off our non-core assets." It might be trouble or none at all. To know, we must take a closer look.

Covid-19 has really done its work, bringing to light things we normally don't take note of, some of which are new to us. Though there are in our circles those who knew entanglements in the context of quantum mechanics, the rest have recently been forced to delve into the meaning "with immediate effect". And what a glorious learning curve it’s been!

There is, in addition, an important buzzword going around in the financial space right now: restructuring. It takes many forms, and addresses many problems. Let's take a look at what it is, and use a homegrown example to illustrate it.

Restructuring is a process whereby a company performs an assessment of its financial health and decides to act on certain financial statement line-items in order to get them to a particular number, usually to satisfy a particular ratio.

One example of an important ratio in finance is the Debt/Equity ratio. This is used to measure how much debt a company has relative to the equity it holds. If company A has R1 million in debt, and R4 million in equity, the Debt/Equity ratio is “1/4 = 0.25”, or 25%. This means that for every R1 of equity, there is R0.25 (25 cents) of debt. Note that the total capital of the company is R5 million. Now let's say that company A is run by Elon Musk, and that for some random reason, Musk decides that the ratio of 25% is too high. He says he wants the ratio to be, at most, 20%. This is where the crux of restructuring comes. The question to answer is "What do we interfere with to get a debt/equity ratio of 20%?"

There are 3 options: increase equity, decrease debt, or perform both operations simultaneously. Splitting these into scenarios in their stated order, we get:

Scenario 1:

Increase equity from R4 million to R5 million. Thus, 1/5 = 0.20, or 20%

Scenario 2:

decrease debt from R1 million to R800 000. Thus, 0.8/4 = 0.2, or 20%

Scenario 3 (a little less intuitive than the others):

Increase equity from R4 million to R4.5 million, and decrease debt from R1 million to R900 000. Thus, 0.9/4.5 = 0.2, or 20%.

That was the gist of restructuring. We see that it involves decreasing debt and increasing equity but (in the words of J Cole), the number one question is "how?" Well, there are options here as well pertaining to restructuring. Based on scenario 1:

1. The company can issue new equity

  • If the company is not listed on the JSE (or any public exchange platform) and raises money by listing for the first time on the JSE. This is called an Initial Public Offering.

  • If the company is already on the JSE, it will be called a Seasoned Equity Offering.

  • If the company is not using the JSE, it is called a Private Placement or Private Equity Offering.

2. The company can also issue rights

Rights are instruments that give investors a claim to be able to exchange/purchase a certain amount of shares when they are eventually issued later. They are "right of first refusal" instruments. They have a value (can be bought and sold), and an exchange ratio, which tells investors how much of the new shares they are entitled to for every share they currently hold.

In line with scenario 2:

1. The company can pay off their corporate loans.

2. Pay off or buy back debt instruments in public markets. Public debt occurs when a company writes out the corporate equivalent of an IOU to public investors. This comes in the form of Bonds, Debentures, Notes, Commercial Paper and other various debt instruments, which have a given initial value, pay interest or coupon payments, and mature at a given date. So we now have a pretty good idea of what restructuring is, but is there something relatable we can attach it to? Enter South Africa's international energy giant, Sasol.

(Sasol Head Office in Sandton)

In recent months, you may have heard that Sasol was in a bit of trouble. True, but maybe not as much as the media may have made it out to be. Sasol is still operationally sound if you ask me. They primarily have a debt management problem. About 7 years ago, Sasol approved a major project: the Lake Charles Chemical Project (LCCP). This was an initiative to build the world's first ethane cracker, on which I wrote a tailored report. The projected cost of the LCCP was $9.8 billion, which amounted to almost $12 billion by 2016 - a $2 billion cost overrun. Fast forward to 2020, they issued a $6 billion (about R100 billion currently) restructuring plan. Part of the plan involves selling non-core assets. They are in talks with PetroSA to sell off all their fuel stations.

Another part of the plan is to sell stakes in their core assets, for which they are in talks with various parties to sell off a stake in their Lake Charles Chemical Project. The last part of their plan involves organic reorganization, underpinned by cost-cutting and revenue maximisation. If you follow the news on Sasol, they usually talk about aspects of their restructuring.

In all, Sasol is doing this to restore investor confidence. Sasol lost out on a good deal of confidence on the JSE due to lack of effective governance and management controls. A restructuring is a closely observed corporate action. It is important to ask why a company is restructuring. It could be a result of changing strategy and business focus, or a sign of trouble. It's also important to be able to block out noise and observe the operational soundness of the company objectively. So that's about it on restructuring. The actual process of doing one is immensely difficult and is done by seasoned Investment Bankers. There are therefore a lot of variables to consider, stakeholders to engage with, options available amongst other things.

Though in the past months we've seen Sasol engage in business dealings that have left many feeling less confident about the company, those with understanding of corporate restructuring, and the underlying concepts, are still able to maintain steady progress in their personal finance journey, or at least steer clear of confusion related losses.

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Author: Nkanyiso Nyawose

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