South Africa remains attractive for global M&A activity

Chris Green, Partner at Hogan Lovells

Simone Izzard, Senior Associate at Hogan Lovells

Despite the effects of the pandemic and periods of civil unrest, South Africa experienced robust Mergers & Acquisitions activity last year, with more than 430 transactions totaling approximately R750 billion in value.

In 2022, we have seen a general decline in M&A activity from 2021 levels. Notwithstanding this, the fundamentals which drove deal activity in 2021 remain largely in-tact, with local companies continuing to produce solid financial performance, valuations remaining generally attractive (with the upside potential for future earnings), the Rand being weak, and interest rates remaining within expected ranges despite the recent hikes. The Africa Continental Free Trade Area agreement is also likely to bolster investment in the country.

Realising growth
These factors, when combined with the fact that many global investors are still sitting on significant cash reserves following a protracted period of inactivity throughout the pandemic, point to sustained levels of African M&A activity throughout 2022 and beyond. South African companies, including those which may be distressed given the ongoing impact of the pandemic, will continue to have opportunities to look to global sources of capital for development and growth. Investment by these established internationals can, and frequently does, unlock previously untapped synergies for South African businesses. In turn, this provides avenues for business optimisation and growth which would otherwise not be available. Global players in developed markets will also be searching for growth and synergistic opportunities outside of their established territories which are typically characterised by competition for market share, rather than industry growth.

We also expect ongoing foreign investment to drive enhanced activity in the market from local players. Those that face a depressed local economy, and which have significant deployable capital will continue to look north of the border to other accessible developing markets as a means for growth or to more mature markets in which to deploy capital as a means of consolidating their position. The same fundamentals that drove deal activity in 2021 and the need to grow through acquisition in many sectors will drive healthy competition amongst local companies.

Sectors to watch
The technology, media, and telecommunications (TMT) sector has seen sustained levels of activity during the pandemic and since the easing of lockdown restrictions. Linked to this, we expect to see sustained and potentially increased M&A activity in the short to medium term in the financial services, retail and logistics and supply chain sectors, with businesses in these segments continuing to look for growth opportunities to address increased consumer demand for technology solutions to meet daily needs (for example, online shopping and delivery services). In the context of this ongoing investment in technology, our expectation is that major investments will continue to be made in data centres (of which there are currently over 50 in South Africa), with the country uniquely positioned for growth due to its geography, relatively advanced IT, and fibre infrastructure and, more recently, significantly enhanced potential for captive renewable energy generation.

Investment in the energy sector (particularly investment focused on the energy transition) is also likely to continue its upward trajectory, with the South African government under ongoing pressure to address the energy crisis and its impact on the economy by removing "red tape" which hinders private sector involvement. We expect to see significant activity and investment in renewable energy across the board. This will be driven by both the government’s Renewable Energy Independent Power Producer Procurement Programme (REIPPP) and, more importantly, the need for commercial and industrial operations to secure private power supplies. Recent regulatory changes pursuant to President Ramaphosa's 10-point power crisis plan permitting private power projects of up to 100MW without licensing requirements having to be met have spurred activity in this regard (the recently announced financial close of SOLA Group’s two 100MW PV solar projects to supply power to Tronox Mineral Sands sites in South Africa being an excellent example of this). We expect this trend to continue, particularly considering the imminent removal of any licensing cap on private power projects.

More broadly, the transition away from fossil fuels is having, and will continue to have, significant consequences on M&A activity in South Africa. Traditional powers in conventional energy have, in many instances, embarked on corporate activity to separate and even sell down their interests in coal assets to newer and smaller market participants who may not be subject to the same global investor pressures. These participants are capitalising on the practical reality that, despite a move towards renewable energy, conventional energy will continue to account for the majority of South Africa’s electricity demands for some time to come, given the constraints on existing electricity infrastructure. Similarly, as C&I and other captive power projects become increasingly common, we will continue to see significant investment across the sector. This is likely to result in a consolidation of industry participants as this sector matures.

Regulatory landscape
Recent changes to competition/antitrust law will continue to affect M&A activity in South Africa. The competition authorities are increasingly focused on public interest considerations and have started requiring a greater spread of ownership by historically disadvantaged persons (HDPs) and workers in M&A transactions. They are also examining digital firms and markets more closely and have proposed that small mergers in this sector be notifiable as, despite often falling below the notification thresholds due to the firms involved usually being start-ups, these mergers are likely to have a significant impact on competition and market dominance. Another proposed amendment to the Competition Act will look at determining whether mergers involving foreign acquirers may have an adverse effect on the national security interests of South Africa. In line with global trends, environmental, social and governance (ESG) considerations have also become central to South African M&A. There is increasing stakeholder activism in South Africa and acquirers and lenders alike are applying more stringent ESG standards to targets and borrowers to mitigate reputational risks and in support of global imperatives of driving sustainable business. In terms of corporate governance, there are plans to amend the Companies Act to give workers the right to appoint directors to the boards of companies, and to extend directors' fiduciary duties to consider the interests of employees and other stakeholders (in addition to shareholders), which will undoubtedly impact a board's consideration of future M&A transactions.

Future planning
While South Africa seems likely to continue to face significant political and economic headwinds for some time to come, several macro-economic factors remain conducive to sustained levels of corporate activity across various industry sectors. As a resource-rich nation, impediments to the country’s ability to capitalise on these resources remains, first and foremost, structural. At a political level, industry participants require enhanced regulatory certainty. In terms of infrastructure, the country still requires significant development and improvements in energy supply and infrastructure across ports, roads, and rail. While these structural issues are currently impediments to investment in many cases, they also present opportunities for investors and market participants alike. Ultimately, it comes down to identifying the opportunities within challenging local conditions to position a business for growth and make it an attractive investment target for global role players. Of course, there are external factors, such as the uncertainty introduced into global markets by ongoing economic sanctions on Russia and high levels of inflation that are likely to have an impact on M&A activity. However, corporate South Africa has proved that is able to navigate crises, while still being able to harness growth opportunities, and there is no reason to believe that this trend will not continue into 2023 and beyond.