Uganda Clays-NSSF deal was best available option

I recently walk up to the surprising news of a halt by the court of a potential deal in which Uganda Clays Limited was seeking to turn a debt it owed to National Social Security Fund into equity. When NSSF agreed to turn this debt into equity, my confidence in UCL’s potential return to the good old days of profitability had greatly risen without any doubt.

Finding a quick solution to UCL’s debt owed to NSSF would be taking the ‘bull by the horns’ as debt has been a major factor in UCL’s dismal performances and especially at a time when there are not as many alternatives as some other stake holders in UCL think. I therefore believe that NSSF as a major shareholder’s acceptance to turn their debt into equity is the best deal that UCL has ever and will ever make to solve its current debt dilemma.

Of course all shareholders will look at the aspect of dilution of their shareholding as a challenge in this deal and therefore have second thoughts of it but let’s not forget that NSSF is a current shareholder in UCL, mening its current shareholding will be affected. So it’s not a point of the largest shareholder gaining more shareholding but rather finding a solution to UCL’s debt burden.

We therefore should concentrate on the other side of the coin rather than dilution of shareholding as a hindering factor by asking ourselves what would be the effect to UCL if the deal in question failed? A case in point is one of the shareholders who last sued against UCL’s debt owed to NSSF being turned into equity though surprisingly opting for the same solution but through another company buying into UCL (including the debt) and thereafter turn the same debt into equity.

I wouldn’t buy the latter option I think the former alternative is better as it will take a shorter period to conclude and secondly attract a third party financier for the company in a state that UCL is, may be a hard nut to crack.

Company performance
Analysis of the company’s books indicate the need for urgency to do away with debt. Looking at the profit and loss account, EBITD (Earnings Before Interest ,Tax and Depreciation) though at a lower rate have been positive for the last 2 years (an average of UGX 4.87bn for the same period) while on the same income statement (PandL) EBT (Earnings Before Tax) which are the earnings after deducting interest expense have been negative (at an average loss of UGX 300m) an indication that the interest expense factor is what is hindering profitability of UCL.

There is therefore need to turn EBT back to a positive trend and the only way to deal with this interest expense is to eliminate debt. Turning NSSF’s debt into equity will save the company an average of more than UGX 2.5bn in interest expense which will accrue annually but if saved through elimination of the NSSF debt will increase the Profits before tax (PBT) by the same amount.

On the balance sheet, elimination of this date will lower the debt to equity ratio of UCL. This ratio is a key indicator of the potential ability of any company to attract third party financiers. That is one of the major reasons am not in for the alternative of bringing into UCL a new major shareholder (other than NSSF) so as to buy off the debt and may be later turn it into equity.

Attracting a third party financier with the current high debt to equity ratio of 1 (including other debts and retirement benefit obligation) will be a big challenge and if successful, based on the current state of UCL, their cost of capital to be injected into UCL will most probably be higher than any current shareholder in UCL will charge to buy off or turn the same debt into equity. This leaves the UCL-NSSF deal as the best alternative on the table.

Time frame
Let’s not forget the time frame it will take to look for a third party financier which will definitely not be short term given the current state of the company, the effect it will have on the already accumulating interest expense (over UGX 2.5bn annually) at a time when the recently recruited new management needs to settle down and grow the top line numbers of UCL’s income statement that is growing the faded market share of UCL (sales) and cutting on the costs of production through the efficient use of the current available resources of the company.

With new management in place and elimination of the interest expense challenge on UCL’s income statement in the shortest time possible, I anticipate a return to the good old days of profitability and hence a turnaround of earnings and therefore the share price of the UCL stock.
The turnaround in earnings will also ensure price and therefore value growth which will cover up for the dilution effect as a result of the UCL- NSSF debt to equity deal.

But if the deal fails, UCL may not recover. Possible scenarios in that case include Failure to get a third party financier at all or in time. This will lead to NSSF’s demand for repayment which might be next to impossible for UCL. Based on the financial report of 2013, the shareholder loan amounted to UGX 16.7bn as at 31st December 2013 and I estimate it will accrue an extra UGX 2.5bn (if not serviced) which will bring the total of the shareholder loan to UGX 19.2bn.

Current total equity as at 31st December 2013 is UGX 32bn. The estimated share holder loan as at 31st December 2014 represents 60% of UCL’s total equity while total debt to equity ratio 1 (including other debts and retirement benefit obligation) meaning that the current equity will only be able to cover debt and nothing for the shareholders in case of liquidation. I think the UCL- NSSF deal of debt to equity is the best alternative on the table.

Mr Nsiko works with African Alliance-Uganda.

SOURCE: Daily Monitor

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