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The Islamic option
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Razina Munshi
Financial Mail
Friday, April 30, 2010
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When black economic empowerment (BEE) share schemes began to collapse after the 2008 stock market plunge, the need for other funding structures became apparent almost immediately. After more than a decade of reliance on debt and high share prices, a number of large deals need refinancing.
SA-based private equity firm ScandCo Capital Partners believes a model based on the principles of Islamic finance could be the solution. The Islamic model, which is a private equity arrangement, does not allow debt and is therefore a practical alternative, says ScandCo CEO Shukri Cornelius.
Using this model, cash-strapped BEE partners would not be expected to outlay capital if share prices lost a chunk of their value. “Funding extended using the principles of Islamic finance would make a deal completely free of risk and uncertainty,” says Cornelius. It’s a factor that BEE partners in recent collapsed deals have been eyeing with interest.
The Islamic system’s rejection of debt prevented it from going the way of conventional finance during the crisis. The private equity industry, in particular, has been accused of making large amounts of money out of transactions that were fuelled by cheap debt.
The most important difference is that Islamic finance has to be backed by assets, says ScandCo director Zulker Nain Moolla. Islam prohibits interest, because it is deemed exploitative, and bases financial arrangements on Shariah (Islamic) law. Shariah, which seeks to promote social justice, does not allow gambling or investing in firms that deal in weapons, alcohol or pornography.
Traditional BEE funding vehicles used in deals like Sasol’s Inzalo share scheme have relied upon debt. At least 70% of such vehicles are debt-funded and rely upon dividends and share price appreciation to cover costs. In Sasol’s case, 90% of the cost of its BEE shares were debt-funded.
But the price of oil plunged, pushing the value of Sasol’s stock substantially lower. The share price was used as security for the debt, but once it dropped, this security evaporated. Today, the share is worth far less than the debt owed on it. It may also take far longer for Sasol to rebuild the value it lost when the share price plunged, and the interest on its debt will continue to increase.
“Islamic private equity takes a 100% equity approach. Share price fluctuations would have no short-term effect on the funding or the status of the deal,” Cornelius says. But, as in any private equity arrangement, the investment would have to appreciate to realise gains.
If the share price appreciates, the private equity firm and its BEE partners share the rewards based on proportions agreed earlier. But the risk is also shared. This means that if the share price goes down , the burden of the loss is the responsibility of both the private equity partner and the company.
“Because of this shared risk-reward orientation, Islamic finance structures need to be more prudent. The way partners are selected is crucial, and the private equity vehicle may be involved in the management of the company,” Cornelius says.
Already, the appeal of this funding structure is high, and Cornelius says ScandCo is in talks with a number of BEE partners. The outcome could be announcements of a few large deals being refinanced through this model. The company’s particular focus is on investments in infrastructure development and telecoms in Africa.
Internationally, Islamic private equity is still in its infancy. ScandCo, the only exclusive Islamic private equity firm in Africa, is backed by Muslim investors from the Middle East . These investors want high returns and the option of investing their money in a manner that is religiously acceptable to them, says Cornelius. This system, he says, gives them both.
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