Deep Catch. Deep Earn-Outs.

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Deep Catch. Deep Earn-Outs.

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Published Date: 2021-06-18 | Source: INCE|Community | Author: The Finance Ghost

Deep Catch. Deep Earn-Outs.

Imperial has made it clear to the market that the focus going forward is on building an integrated logistics business that dominates in Africa. The group has divested businesses in other regions, in a move to focus on its home continent in which it believes it can win.

The company calls this its "Gateway to Africa" strategy which is bold and beautiful in a way that is far more appealing than the old soapie. If you are too young to understand that reference, ask your parents.

This African focus is a sensible strategy. The act of companies choosing to return to core competencies has become the flavour of the day in a Covid world, where balance sheet management and tight corporate strategies are rewarded by investors.

It helps that African trading activity is buoyant at the moment, assisted by a greatly improved commodities outlook.

True to its word, Imperial has announced an acquisition that is firmly in line with an African strategy. The target is Deep Catch Namibia Holdings, a diversified and vertically integrated business that focuses on the wholesale, distribution and cold storage of perishable foods.

As the name suggests, fish is included in the product range, although there are poultry and dairy products as well. The business is headquartered in Namibia but has a presence in South Africa, Zimbabwe and Zambia as well. There are three commercial cold storage warehouses in Namibia and South Africa and the business also controls one of the largest freight forwarding businesses in Namibia.

Operating a successful cold chain in Africa is a competitive advantage of note. For stark examples of this, consider Woolworths' product reputation on one hand and our government's vaccine efforts on the other. Cold chains are powerful when you get them right and extremely limiting if you miss out.

This is a great example of an "earn-out" structure

The purchase price is around R630m but will vary based on Deep Catch's performance at an EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortisation) level from the 2021 to 2024 financial years. This is a typical "earn-out" structure which is used in transactions to reduce the risk for the acquirer of the business.

Around R340m is guaranteed if the deal closes, nearly R130m depends on FY21's result and a further R160m or so is payable across FY22 - FY24, again depending on results.

It's a tough earn-out.

If actual EBITDA is less than 90% of target EBITDA, the sellers only receive 50% of the payment for that year. If actual EBITDA is at least 90% of target EBITDA but falls short of the target itself, the sellers receive 80% of the amount due for that year.

There is an allowance for a catch-up at the end, with the sellers able to recoup lost amounts at the end of FY24 based on average EBITDA over the years in question.

If management beats the target on a cumulative basis in FY22 - FY24, there's just over R40m in additional payments to the sellers.

As a fun fact, there is no currency exposure here for Imperial as the Namibian Dollar is pegged to the Rand i.e. the exchange rate is always 1:1.

What multiple has Imperial paid?

Disappointingly, the latest available numbers for Deep Catch are for the year ended June 2020 which means they are extremely outdated. I would've liked to see Imperial give an idea of profitability for FY21.

Working with what we have, the revenue was just over R1bn and EBITDA was around R100m. Net profit after tax was R22m. Imperial is forcing us to guess here, but we can safely assume the multiple is around 5x - 6x EBITDA, which is standard for deals like this.

What can still go wrong?

The "conditions precedent" are the things that need to fall into place in order for the deal to go ahead. Regulatory approvals are always included in this section, like Competition Commission approval. It goes a step further here, with COMESA approval required in addition to the South African and Namibian authorities, because of the exposure into African jurisdictions.

Other usual terms include consent from founders and no material adverse change event taking place, which is an event that severely impacts the business during the time of the deal being implemented.

Interestingly, the deal also requires 3-year service agreements to be signed by key managers in the group, which will no doubt come with some kind of sweetener for those individuals.

Finally, waivers of pre-emptive rights are needed from other shareholders in certain subsidiaries in the group. A pre-emptive is a feature of investments in private companies, in which shareholders have the right to buy other shareholders out if a bona fide third party offer lands on the table. So, in this case, the other shareholders would need to be willing to match the price offered by Imperial in order to throw a spanner in the works.

Usually, deals like this are at least discussed with the other shareholders under a non-disclosure agreement before the time, in order to avoid an exceedingly embarrassing situation where the deal falls over at a later stage because of something like a pre-emptive right. It's unlikely that Imperial hasn't achieved some level of comfort on this already.

This is a Category 2 deal under JSE Listings Requirements, which means that Imperial shareholders won't be asked for their opinion or their vote on this deal, as it falls below the threshold required to trigger a vote.

Imperial is a R10bn company, so this deal represents around 6% of the market cap. The trigger for a shareholder vote is a deal that is 30% or more, except in the case of a deal with related parties in which case the threshold is only 5%.

Provided there are no hiccups with competition authorities, it looks as though Imperial has secured a much stronger cold chain presence through which to move perishables.





1 Comments

Curious 6 months ago

why would Imperial be buying into perishable food assets in Africa after selling similar assets in SA?



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