Published: July 01, 2008
Following a strategic decision taken by the Imperial Board during 2007, the integrated leasing and capital equipment division, (subsequently rebranded as ‘Eqstra’), was unbundled from Imperial and listed on the JSE during May 2008. As is typical for many of Imperial’s divisions, Eqstra operated as an autonomous division within the Imperial Group.
Eqstra’s businesses include leasing, distribution and value-added services, with the following main asset classes:
Leasing businesses generally have long-term contracts with customers, which are backed up with assets and which lend themselves to higher levels of gearing. The gearing or high debt levels can be justified based on the certainty of future cash flows and the low volatility of earnings. As a leasing business needs a ‘funding component’ for the business to be viable, it therefore needs to operate as a quasi bank and must reduce its weighted average cost of capital through increasing its debt levels relative to equity. International leasing businesses have debt-to-equity ratios of anywhere between 4x to 6x.
Imperial Holdings’ debt-to-equity ratio, however, as a diversified industrial business, required a ratio of around 1x. With the leasing business having a gearing ratio of around 3x (on the conservative side of international standards) and this business is increasing significantly in size due to the commodity and infrastructure boom taking place in South Africa, the Group’s gearing ratio increased. On a sum-of-the-parts basis, the gearing levels in each business could be justified but at a Group level the ‘debt’ was perceived as being too high.
A simple illustration of this is shown in Figure 1.
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The forecasted plans for the Leasing Division showed an increasing need for additional funding as the business operates in a ‘sweet spot’ of the economy with the expectation of increased commodity and infrastructural projects coming on stream. These forecasts would further exacerbate the overall leverage position of the Imperial Group going forward.
Imperial Holdings therefore reviewed its businesses and decided on a number of strategic initiatives, which included investigating the unbundling of Eqstra. As a standalone entity, Eqstra has the ability to attract higher and more appropriate levels of gearing and debt liquidity to enable participation in its growth segments. Given the different capital structure requirements, it made sense to unbundle the division to optimise the group’s capital structure.
In the past, Eqstra had benefited from the use of Imperial’s large bank facilities as well as its access to the South African and offshore debt capital markets. The most significant challenge was therefore going to be the raising of sufficient new funding based on the stand-alone leasing balance sheet. Two significant funding challenges were firstly to ensure that a debt-to-equity ratio of at least 4x was achieved to make the business competitive and, secondly, that the funding raised covered not only the current funding needs but also for the expected rapid growth.
From a structuring perspective, the assets comprising the Eqstra businesses were located within a number of onshore and offshore legal entities within the Imperial Group, which required a series of complex restructuring transactions to consolidate the assets within the new listed Eqstra.
It was during this restructuring process that Eqstra’s stand-alone treasury function was set up to prepare for the eventual acquisition of its external debt. Early indications were that Eqstra would require around R6bn in funding to finance its current and projected needs. In the long term, Eqstra would need to access the capital markets in order to achieve optimal pricing and to be able to access sufficient funding to grow the company. However, to facilitate the unbundling in the required time frame, a bank funding package was implemented that would provide the necessary funding and liquidity and also included the flexibility for the eventual migration to capital market funding. This was achieved by the use of scheduled maturity dates, which gave a finite timeline to the expected migration to both commercial paper and corporate bond issuances into the capital markets. [[[PAGE]]]
In order to prove to the initial funders that a migration to capital market funding was achievable, it was critical to get a rating for Eqstra that would show sufficient demand for the close to R5 billion capital market funding aspirations that the business would have in the next few years. It was important to understand how a rating agency rates a company that is mostly a division within a larger group and so does not have stand-alone historical financial information. To be able to arrange the necessary levels of debt in the South African capital markets, Eqstra would need to have an A national scale credit rating at a minimum. Local institutional mandates reduce significantly below this rating level. The challenge was therefore to achieve this rating level but, at the same time, ensure that the debt-to-equity ratio was high enough so the business could be competitive from an overall funding cost perspective. The three main international rating agencies in South Africa were approached to see how this could be achieved.
Detailed analyses were performed to benchmark the proposed Eqstra gearing levels with suitable international peers. Empirical evidence indicated international companies targeted a capital adequacy ratio i.e. capital to risk adjusted assets in the range of 8% to 20%. The Eqstra capital adequacy levels were pitched in the late teens, placing it on the more conservative side of the international spectrum.
Capital adequacy is the ratio between total tangible assets to total tangible equity. Companies calculate this in different ways, with certain companies risk-weighting their assets. Eqstra calculated this ratio by looking at the risk of the underlying asset classes in each division and using historical data and experience to calculate the capital required to cover any potentially unexpected losses relating to these assets. Even though the analyses revealed that the company could operate within a capital adequacy ratio of around 17%, management felt that it was more conservative to start this business on a stand-alone basis with a ratio of 21% to provide additional capacity for the significant growth potential within Eqstra.
The merits of a secured funding package versus an unsecured funding package were vigorously debated. It was finally decided to ring-fence the South African and common monetary area group of companies (‘SA Group’). The SA Group have an unsecured funding package, thereby giving all lenders equal access to its assets. It is more common in South Africa to have unsecured funding but with guarantees from all the operating companies. In addition, it would also be easier to manage the funding in the business, if the largest portion of the funding being that of the SA Group was on an unsecured basis. The funding package included cross guarantees between all the companies in the SA Group as well as from the holding company, Eqstra Holdings Limited, to avoid any structural subordination issues.
However, for companies operating in the rest of Africa and the United Kingdom, asset-backed funding would be obtained, as these companies require funding in the relevant country’s currency and it being common practice in Africa to provide asset-backed financing. [[[PAGE]]]
Eqstra needed a combination of general banking facilities and short- and long-term facilities. It was decided to incorporate all the above under one umbrella funding package, which would have common terms and conditions, including common covenants, events of default and security arrangements. This would make it easier for the company to manage and also benefited the banks that participated in the transaction as they could select which tranche best suited their risk appetite.
The long-term funding has a legal maturity of five years and a scheduled maturity of three years. A step-up margin after year three was built in, if the funding has not been repaid from corporate bond issuances. A three-year period was considered long enough for Eqstra to tap the capital markets.
The short-term funding has a legal maturity date of two years and a scheduled maturity of one year. Again a step-up in rate was built in after one year if the funding has not been repaid from commercial paper issuance. There were very limited prepayment penalties built into the package.
The general banking facilities have notice periods of between 30 and 90 days and will be used mainly to finance intra-month funding requirements and other banking services.
For Eqstra to have sufficient standby committed liquidity facilities, the short-term facility is backed by an equal amount of committed standby liquidity facilities. The reason for this is that the company raises short-term commercial paper and because the business assets are long-term in nature, it would run a liquidity mismatch and these committed standby facilities would support the refinancing and liquidity risk relating to the commercial paper. The package is structured in such a way that the committed standby liquidity facilities come into effect as soon as the commercial paper is raised or the short-term facilities expire. These standby facilities are also critical from a credit rating perspective.
The unbundling of such a large and diverse division was a complex transaction, which required many parties from different disciplines working together to ensure a successful outcome. Accurate planning and professional project management was key to this.
The unique legal requirements surrounding the funding package were addressed by implementing a master agreement with separate facility letters by each funding bank. The actual draw-down of funds had to take place before the unbundling took effect to ensure it occurred with the new debt in place. This gave rise to further legal and structuring complexities which had to be dealt with.
In addition, there were many treasury issues relating to the repayment of current funding to external parties and the actual flow of funds to settle a significant portion of Imperial Group’s existing debt.
Eqstra achieved a national scale A rating issued by Standard and Poor’s shortly after the unbundling.
In total, eight banks including two international banks with local offices, participated in the transaction. The ‘club’ of banks provided total commitments of R6.95bn for the initial funding period, exceeding the R5.6bn initially required for the SA Group and in addition further facilities were secured for the UK and African operations - certainly one of the largest, if not the largest ‘club deal’ of this nature put together for a company in South Africa prior to unbundling.
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