Sasol’s fight for survival

In a sea of red share price movements, Sasol has stood out over the past couple of weeks as a turd that even the COVID-19 toilet paper hoarders would struggle to get rid of.

Nonetheless, it’s a turd that many financial professionals are buying up at the moment. The reason is pretty simple – if it recovers, it has the potential to deliver 10x and possibly even 20x returns. You either lose R10k or you pay off the remaining debt on your car.

That’s a simplification of the situation (not least of all because of tax) and sounds a lot like gambling, mainly because that’s what it is. Many investors choose to use a portion of their portfolio to make high-risk investments like this.

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Whether you invest or not, Sasol is a great learning opportunity.

Sasol released a detailed announcement on 17th March entitled:

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What a mouthful. 

In simple terms, Sasol’s management needed to tell investors how they plan to keep the company alive. The market rewarded Sasol’s verbosity (but mainly its financial dire straits) with another substantial drop in the share price.

Interestingly, Sasol reports its financials in ZAR, but the announcement was written in USD, likely because it was aimed at the foreign debt providers that Sasol is desperately trying to keep at bay. Shareholders aren’t top of mind for them currently.

At 31 December 2019, Sasol had over R120bn in long-term debt. That number has grown further. The market capitalisation of the company (the number of shares multiplied by the share price) is now just over R17bn.

That isn’t the kind of debt : market equity ratio that helps investors sleep at night.

Let’s break the plan down into high-level measures that will help you understand the financial terminology a bit better…

Cash conservation

Sasol wants to increase its cash reserves by US$2 billion, because they’ve been very naughty with the credit card.

They suggest that US$1.5 billion will be found from “working capital optimisation and re-prioritising capital expenditure” – a fancy way of saying they will be paying their creditors later, making their debtors pay earlier and lowering their overall inventories, all while investing less in infrastructure.

Hardly ideal, but they are in survival mode.

The other US$0.5 billion will come from general cost saving measures, which isn’t good news for Sasol employees, although the announcement doesn’t specifically reference retrenchments etc.

There are only so many ways to save that kind of money, so it’s probably just a matter of time.

Asset disposals

When you’ve been so naughty with the credit card that you are out of options, you might have to start advertising unused items in your house for sale. Unfortunately, the unused stuff is often useless or old, so you either don’t get any buyers or you lower the price significantly.

The same is true for corporates in trouble.

They either sell their best divisions, which then leaves shareholders with very little reason to stick around, or they sell underperforming divisions at bargain basement prices.

Either way, asset disposals in times of crisis aren’t great.

In Sasol’s case, the Lake Charles project is probably up for sale. Talk about a disaster from start to finish – this is the project that helped get them into trouble in the first place.

Potential rights issue of US$2 billion

This is where it gets nasty.

A rights issue is a capital raising transaction through which shareholders are given a choice to either put in more money or watch their % shareholding drop as other investors put the money in instead.

If the rights issue takes place at a company’s traded market price, then in theory shareholders don’t lose any money. Whether you pay R50,000 for half a car or R100,000 for the entire car, you’re in the same value position in a perfect world. 

In practice, rights issues take place at substantial discounts to the market price, especially where they are being done as a last resort. The company is desperate for the money by that stage, so the management team finds an underwriter who promises to plug any gap resulting from current shareholders not following their rights to invest.

Underwriters don’t do this for free – they charge underwriting fees (a % of the capital raised) and demand to get the shares at steep discounts (often 20% less than the market price).

The net result is a company with enough money to survive, an underwriter who got a good deal and a group of upset shareholders with bloody noses.

The share price tanks on the rights issue announcement and shareholders either throw good money after bad or simply watch their value drop.

To make things worse for Sasol, they want to raise US$2 billion (around R34 billion currently) when the entire company is only worth R17 billion. That means existing shareholders get wiped out unless they dig deep to follow their rights and invest more money in Sasol.

It’s worth noting that rights issues certainly aren’t always bad. It all depends on what the money will be used for. If the company is making a terrific acquisition and needs money to pay for it, the market views this very differently.

Why would any sane person buy these shares?

If you’re buying Sasol at these prices, you need to believe a few things:

  • The risk is priced in;
  • The rights issue might not even happen;
  • The oil price cannot stay at these levels; and
  • The potential reward outweighs the considerable risks

Investors who bought into Sasol a few months ago have been decimated, but the brave few who buy at the bottom may be rewarded with incredible returns if things go to plan for them.

They may also lose everything. Buying the crisis certainly doesn’t always work – just pull a share price graph for Steinhoff to see for yourself.

(If you want to read the full Sasol announcement, find it here:…/SENS_20200317_S428167.pdf)

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