The question of how a company’s solvency ratio is calculated could determine whether an R11bn contract awarded to a private operator to manage South Africa’s biggest container terminal — a key economic reform for President Cyril Ramaphosa — goes ahead or has to be restarted.
Rail and ports operator Transnet has awarded the contract to upgrade, manage and operate Durban Container Terminal Pier 2 (DCT2) — which handles 46% of all South African container traffic — to Philippines-based International Container Terminal Services Inc (ICTSI).
Losing bidder AP Moller Terminals (APMT), a subsidiary of Danish shipping giant AP Moller-Maersk, has gone to the Durban high court to get Transnet to justify how ICTSI was awarded the 25-year contract.
Transnet’s rail and ports have been in operational decline for years. Ports have experienced underinvestment that has affected the maintenance of vital equipment. According to the Container Port Performance Index (CPPI) conducted by the World Bank, four of South Africa’s ports rank among the worst-performing in the world.
Cape Town is ranked in last place of the 405 ports listed in the index. The Port of Ngqura (Coega) was ranked at 404, Durban at 398, and Port Elizabeth at 391.
At the heart of the court challenge is Transnet’s admission that it ignored its own tender requirements, including expert opinion it sought, on how a company’s solvency ratio is calculated.
ICTSI’s $618m (R11.1bn) offer for the groundbreaking private-public partnership at DCT2 is about R1.9bn more than APMT’s $515m offer.
However, APMT contends that ICTI’s bid should have been disqualified because its solvency ratio of 0.24 fell short of Transnet’s solvency ratio requirement of 0.4 as set out in the port and rail operator’s request for quotations (RFQ). Solvency ratios help indicate whether a company will have adequate cash flow to meet its financial obligations over the contract term.
ICTSI was the only bidder to rely on market capitalisation to calculate its solvency ratio, while the other bidders used “total equity” as recorded in their annual financial statements.
According to Transnet’s RFQ, a respondent is deemed to have sufficient “financial capacity” when its solvency is equal to or exceeds 0.4 when calculated according to a formula where total equity is used as a numerator and total assets as a denominator.
Nick Ferreira, Transnet’s legal representative, told Durban high court judge Rob Mossop this week that as part of meeting the minimum financial criteria, Transnet wanted bidders to demonstrate they had sufficient financial capacity to attract the required funding for the envisaged investments in DCT2. He said Transnet relied on additional considerations including balance sheet, going concern, and cash in the bag.
“We contend in our heads of argument that if you comply with these financial requirements that is sufficient but not necessary to establish if you have financial capacity. In other words, you can jump through the financial capacity hoop, you have solvency, liquidity and earnings before interest, taxes, depreciation and amortisation (Ebitda) requirements and guarantee that you are in if you comply, but you do not have to comply with all of them.”
It was manifestly inappropriate to use market capitalisation as the amount for equity in the solvency calculation, making the result submitted by ICTSI meaningless and unusable for solvency assessment
— Financial expert Prof Harvey Wainer
Responding to Ferreira, Mossop asked: “Where does it say that?”
To which Ferreira responded: “It does not say that.”
Ferreira said bidders would qualify provided they could demonstrate that they had the financial capacity and the finances necessary to satisfy the contract.
But Mossop asked: “How would anyone know that from reading the tender documents? How would anyone know that from the wording? How would anyone sitting there know I don’t have to answer those questions as long I’ve got letters from my bank or whoever? How would anyone know?”
Mossop was referring to ICTSI producing letters from Citi Group, HSBC and Standard Chartered to demonstrate it had a strong balance sheet compared with other bidders, following concerns raised by APMT.
After APMT raised concerns, Transnet conducted a six-month due diligence exercise to look into the complaint and verify the documentation in the bids.
Law firm ENS, acting on behalf of Transnet, contracted Mettle Corporate Finance to establish whether it was generally acceptable for a company’s market capitalisation to be used as “total equity” when calculating its solvency ratio.
Mettle opined that there was no direct connection between the amount of money that shareholders have invested in a company as equity and the value of the company’s market capitalisation.
“It is not acceptable for the market capitalisation of a company to be used or substituted as ‘total equity’ for purposes of the calculation of its solvency,” Mettle wrote.
Transnet’s own internal auditors agreed with Mettle, saying market capitalisation is simplistically determined by multiplying a company’s issued shares by the closing listed share price on a particular date. They said market capitalisation and equity are not related.
“The meaning of ‘total equity’ in the context of the RFQ and specifically in the use of the equity to-debt solvency ratio is unambiguous.”
Transnet lawyer Max du Plessis said his client had to conduct due diligence after APMT raised concerns about ICTSI’s solvency ratio.
“Had they not done due diligence they would have been subjected to a review by ICTSI who would have said we have given you a perfectly good reason and we want you to interrogate the criteria,” he said.
APMT consulted financial expert Prof Harvey Wainer, who found the solvency calculation by ICTSI was “fundamentally flawed” and contrary to the clear requirement of the RFQ.
“It was manifestly inappropriate to use market capitalisation as the amount for equity in the solvency calculation, making the result submitted by ICTSI meaningless and unusable for solvency assessment,” Wainer said.
In part A of its two-part court bid APMT sought an interim interdict to prevent Transnet from negotiations and implementing its decision to name ICTSI as the preferred bidder pending the outcome of part B, that aims to seek a review and the setting aside of the decision. Part B may take anything between six to 10 months to be heard after papers are launched.
Du Plessis told the court that if the interdict was awarded, it would apply a “handbrake” to the government’s structural reforms that include concessioning some of the country’s key port terminals to unblock logistical constraints that are slowing down economic growth.
“It is a proper handbrake ... that comes on the back of years of problems in the ports,” he said.
Mossop was not convinced: “This government that did not do anything for 22 years will be prejudiced by the court?”
Du Plessis responded that the harm if the interim interdict is granted is not just to Transnet but to the economy.
“There is the harm that the president highlighted in the papers that by virtue of Transnet not being able to initiate policies, there is going to be a cascading number of problems, like jobs created and the usual problems that arise when the economy is not able to generate growth.”
The court is expected to make a ruling this week.
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