Mergers and Acquisitions in South Africa

Competition, Growth, and Financial Stability

Merger and acquisitions (M&A) are strategies that allow – if executed effectively - companies to expand, reach a larger customer base, improve access to new geographical locations, industry knowledge, resources, and materials, and ultimately develop competitive advantages.

M&A is a general term that is often blended, as integrating two companies will always have unique circumstances. However, this guide will discuss the terms separately for more clarity. Regardless of if it is an acquisition or a merger, the end goal will be specific to each transaction - but it is commonly used to achieve an advantage in a competitive market and expand and grow.

According to a report from the Africa Journal of Management, South Africa is a target nation when it comes to acquisitions, given that it is a leader in economic power on the African continent. It is also a country rich in mining, oil, and gas, which attract considerable international attention.

The report also indicates that South African firms are the most active acquirers on the continent. In 2021, M&As associated with the technology sector significantly increased, boosted by the COVID-19 pandemic that led to inbound investments in South African tech companies.

Nonetheless, South Africa’s M&A market is much smaller than other global players, and the country’s political and economic uncertainty has reduced its economic growth, and ultimately M&A activity.

The Definition of an Acquisition

Acquisitions are understood as transactions where a company takes over another and establishes itself as the owner. Usually, the acquirer will take over the target firm’s management, stocks and/or assets, depending on the deal structure.

Acquisitions can be hostile, whereby a target company does not consent to the takeover, but the acquirer forces the acquisition by purchasing large stakes of the target, thus seizing control.

Hostile acquisitions are permitted in South Africa, but they aren’t very common. The South African Takeover Regulations and Companies Act allow the board of the target company to have a significant amount of control, including publishing an opinion on the substance and merit of a hostile offer.

‘Friendly’ acquisitions are common. This is when the board of directors and shareholders of the target company agree to be acquired, usually for strategic reasons. Someone looking to sell their business can also be acquired by another company that has the resources to grow and expand it.

Groups of Acquisitions:

Stock acquisition:

An acquisition involving stock is when most of the shares from the target company are purchased by the acquirer, thus initiating a change in ownership. The acquiring company will own the assets and liabilities of the target company.

Asset acquisition:

If an acquirer is looking to purchase a specific division of the target company, an asset acquisition is usually pursued. The acquirer can purchase selected assets and liabilities that it agrees to, allowing a range of flexibility.

Why Do Companies Acquire?

Acquiring high-value businesses is initiated for specific objectives, and these will depend on the strategic profile of the acquirer. Strategic integration, economic certainty, and accurately valuing your target are the vehicles to a successful M&A journey. A valuation is crucial in M&A transactions, as it will provide an intricate assessment of the target company’s risks and opportunities.

Companies acquire for different reasons, and these are often to gain some sort of commercial advantage. Some of the most common reasons include:

• Improve market share and take corporate control of markets
• Gain control of a supply chain, and improve economies of scale
• Cost reduction
• Expand into new product lines and increase recognition and reach
• Purchase innovative elements of a company to reduce research development costs and save capital

The Drawbacks of Acquisitions

Acquiring another company will always involve risks, so ensure you are familiar with them, and take steps to mitigate them:

• Possibility of internal disputes, both on a management level and amongst employees
• Communication barriers if an acquired company is from a different culture. This is particularly applicable to South African M&A transactions
• An acquirer may need to eliminate underperforming assets, and this can include employees
• Some divisions may be duplicated, and it can lead to retrenchments
• Retraining staff, which can lead to additional costs

Recent Acquisitions Examples

There are thousands of examples of acquisitions in South Africa. In 2021, M&A transactions raked in approximately R760.8 billion, and the technology sector was the most popular. As consumers continue to rely on digital technologies to communicate and navigate daily life, these two examples prove that the South African M&A tech sector is booming:

DPO and PayFast

Based in Nairobi, payment service provider DPO acquired PayFast, a South African payment processing service in a multimillion-rand deal concluded through a mixture of shares and cash. This is the sixth acquisition that DPO has executed since 2006, and although the exact amount of the PayFast acquisition is not public knowledge, it is estimated that the deal value is higher than R100 million.

Vodacom and IoT.nxt

Telecommunications giant, Vodacom, acquired start-up company SA Internet of Things (IoT.nxt). The acquisition saw Vodacom take 51% stake in the company, and while the amount was not disclosed, it is likely that the deal value exceeds hundreds of millions of Rands. IoT.nxt is based in Pretoria and aims to deliver unique IoT software and hardware solutions.

Acquisition Finance Options

There are a range of options to finance an acquisition, and unless your company has a significant amount of capital, companies often implement more than one funding method.

Acquirers could choose to use a mixture of company funds and company equity to fund and acquisition, but can also consider these options:

• An earnout
• A leveraged buyout
• Loans (from banks or private equity investors)
• Seller financing
• Asset-backed loan

Explaining Mergers

In its simplest definition, when companies merge, they fuse together to become a new company, backed by strategic objectives. Combining two companies can lead to an innovative business model, access to different markets, and increase value and profit. But it can also lead to risks: different members from the board will have to join forces, including employees. This can cause misunderstandings, clashes, and disconnection.

As previously stated, the term M&A often overlaps, as a company can acquire a target and still merge with it. The definition in practice is not as clear-cut, as each transaction is guided by unique strategies and objectives.

Different Structures of Mergers

Mergers can be structured in different ways, depending on the type of company and its industry segment. Here are the most common structures:

Horizontal merger:

When two companies are involved in the same product lines and markets, the often merge to eliminate competition.

Vertical merger:

To consolidate positions in the supply chain and industry, a company often mergers with a supplier or manufacturer. Vertical mergers are a strategic way to access new models of efficiency, in turn generating competition, and competitive prices.

Conglomeration:

In an effort to diversify, companies that have nothing in common can merge to reap certain benefits. Diversification allows companies to enter non-cyclical industries, thereby diversifying cash flows. Because markets are volatile, conglomerations are a strategic way to anticipate losses.

Strengths and Weaknesses of Mergers

There are multiple benefits of merging with another entity. Some include:

• Gaining a larger market share, and becoming a competitive leader
• Efficiency and reduced costs by sharing resources
• Eliminating duplication
• Expansion into new geographical territories
• Strategy to save a company from financial distress or bankruptcy

In the same breath, there will always be disadvantages in the world of business. An evaluation of the merger’s potential effectiveness and failure is vital to anticipate the following weaknesses:

Problems with integration and collaboration

The way employees make sense of the merger will be significantly different. South Africa is a country with unique historical conditions, which can impact integration and collaboration. Unfortunately, there are still lingering effects of apartheid policies in South Africa, and if both companies do not understand this and fail to address this, it can result in unwanted negative attitudes and perceptions. If not correctly managed, this can lead to unwanted clashes. If two companies that don’t have much in common merge, there is a risk that the board will struggle to maintain control, and employees can become demotivated, and their efficiency can reduce.

Reducing underperforming assets

Mergers are often seen as friendly arrangements, but that can be aggressive if they are not carried out effectively. Sometimes, the merged companies will need to reduce costs by cutting off underperforming assets. This could lead to employees losing their jobs, which is an obvious disadvantage.

Recent Mergers in South Africa

Takealot.com and Kahalri.com

Two of South Africa’s most significant e-commerce companies confirmed a merger in 2015. This consolidation allowed both companies to develop into a key entity in the e-commerce market. In 2015, only 2% of the South African retail market was online. This provided a lucrative growth opportunity, and both companies took advantage of this. By the end of 2015, Takealot.com saw a 17% increase in revenue.

Momentum Group and Metropolitan Life

Both companies were established financial services prior to the merger. In 2010, both companies fused into what is known today as Momentum Metropolitan Holdings (MMH). Momentum’s key market is upper-income clients, and Metropolitan focuses on low to middle-market income clients. The merger would allow the entity to expand its target markets and become a leader in the insurance-based financial sector. Although the merger did bring some unforeseen challenges, MMH achieve a market capitalisation of approximately R26 billion, and is one of the top life insurers in South Africa.

Common Documents to Consider

There are many phases of an M&A deal, and there are a wide range of provisions that apply to South African M&A transactions. M&A deals incorporate a plethora of financial, legal, and corporate documentation.

Regardless of if you are on the sell-side or buy-side of the deal, you should ensure that your advisory team is experienced in M&A deals specific to your industry. These documents will form the financial and legal basis of your transaction, so they must be carefully drafted, understood, and audited.

Some of the most common documentation you’ll need are:

Articles of incorporation

This will include a new class of shares, any company brand changes, and details on the development.

Letter of Intent

A non-binding document that will be issued by the buyer. It will include terms, agreements, and the structure.

Acquisition Agreement

The companies involved in the transaction will come into a binding agreement. This will include the terms of deal and primary clauses like conditions, descriptions, contracts, and warranties.

South African M&A Landscape

Mergers and acquisitions are a way for companies to establish growth and gain a competitive advantage in an economy that is difficult to make a mark in. This is especially true for South Africa’s economy, one that is defined by significant potential, but in the same breath, instability, and risk. According to global law firm Hogan Lovells, this economic weakness means that M&A activity in South Africa tends to focus on corporate restructures, consolidations, and business rescue.

However, potential within the tech, telecommunication and agricultural sectors are increasing as digitisation defines the parameters for traditional banks, payment systems, and financing solutions for small and medium market businesses. These new opportunities brought on by modernisation are compelling international investors.

M&A is an effective strategy to promote efficiency, profitability, and power in the marketplace, but it also has disadvantages that you should consider before executing the transaction.

If you have further questions, feel free to contact our dedicated team.