Kroks' vote the big swing factor in Gold Reef's fate

Tsogo Sun's bid to merge with Gold Reef to create a new leisure Goliath looks set to get the green light in eight days - despite signs that small shareholders may get a raw deal.

The R21-billion transaction will catapult the new firm - which will own assets like Montecasino, Southern Sun hotels, and Gold Reef City - into the JSE's elite group of the 40 biggest firms and make it one of the 10 largest gaming firms in the world.

Shareholders of the two companies, Gold Reef and Hosken Consolidated Investments (HCI), which controls Tsogo Sun, are due to vote on the deal on Monday April 26, but the outcome is still in the air.

The big swing factor will be the Krok family, now splintered into six factions, who together own 25.9% of Gold Reef - enough to block the deal.

Brothers Abe and Solly Krok founded Gold Reef in 1989 using a fortune they had amassed from selling skin-lightening creams during the apartheid era. Until July last year, Abe's son Maxim chaired Gold Reef.

Gold Reef CEO Steven Joffe, who will leave the new group once the deal is final, said "we don't know which way the Krok family intend to vote".

"We've made sure they've got the circular and they understand it, but that's where we left it."

One investment banker working on the deal for Gold Reef, but who asked not to be named, said the Krok family had yet to decide which way to vote.

"We've held several meetings with various representatives of the Krok family, but they said they want to study the circular before deciding," he said.

Asset manager Allan Gray holds 23.6% of Gold Reef and hasn't officially announced its vote, but it seems likely to support the deal.

Allan Gray portfolio manager Duncan Artus said: "I think it's a fair swap ratio for both sides", adding that there was "no reason why we wouldn't vote in favour" of the transaction.

One factor that could influence the Kroks is the statement in the circular by independent expert Grant Thornton that it "(does) not believe the deemed offer price of R19.25 to be fair and reasonable to independent Gold Reef shareholders".

Grant Thornton concluded that the deal effectively puts a value of R19.25 on each Gold Reef share, "which is 10.3% lower than (our) base case valuation, and only marginally higher than our (worst) case valuation".

Grant Thornton put the "fair value" of Gold Reef shares at between R18.78 to R25.05.

However, this is misleading because Gold Reef shareholders won't be given the option of taking that R19.25 in cash. Instead, they will get a share of the merged company based on "swap ratios", which determine that Gold Reef investors will get 19% of the new company, while Tsogo's investors will get 81%.

Joffe says the R19.25 figure is a red herring.

"The R19.25 is irrelevant, because we came up with the swap ratio based on the relative earnings of Tsogo and Gold Reef. Ultimately, the deal depends on earnings, not the share price," he says.

But the earnings aren't strictly comparable either. While Gold Reef published financials for the year to December, showing operating profit of R691-million, Tsogo's most recent figures - used to determine the swap ratio - were for the six months to September 2009. For that period, Tsogo made an operating profit of R800-million.

Gold Reef financial director Jarrod Friedman - who is also leaving - said: "We used models to project Tsogo's earnings for the full year in our calculations".

One shareholder, who spoke to Sunday Times anonymously, raised concerns that Gold Reef was being "undervalued" in this share swap, and so the 888million shares it will issue to Tsogo would dilute shareholders more than necessary.

In a short note to its clients, brokerage Barnard Jacobs Mellet (BJM) also said it believed the merger may be "overly demanding" on Gold Reef shareholders, who would effectively be paying nearly 10 times Tsogo's historical profits, before interest and other deductions are factored in.

BJM said this was pricey, especially given "our concerns around a slowing SA casino industry".

Although there are also concerns that the Competition Commission might still force the new group to sell one of its casinos, the deal is still likely to get the go-ahead from shareholders, based on the expectations that big things will be possible for the new hotel and gambling giant.

The big winner from the deal will be HCI, which is 39.5% owned by the SA Clothing and Textile Workers' Union. HCI is run by former unionists Johnny Copelyn and Marcel Golding, both renowned as uncompromising dealmakers. If all goes according to plan, HCI will end up holding an indirect 41% of the new mega-gaming company.

But another point of concern is that to make way for HCI's chosen leaders in the new Tsogo Sun, Gold Reef's executives will quit.

Thanks to a "no fault termination" clause in their service contracts, these four - Joffe, Friedman, Christian Neuberger and Tapson Sadiki - will be paid a handy R42.8-million to disappear.

HCI's circular to shareholders explains: "(those) executives have decided not to accept Tsogo Sun's proposals, or the alternative positions they were offered, as (this) constitutes a material change to their existing duties".

But the fine print of the deal circular shows that the Gold Reef executives only struck their new "service agreements", which include that termination clause, in August last year. Less than a year later, they'll walk away with millions of rand.

But Joffe said there was no intention to put in place a golden parachute deal last August in expectation of just such a deal taking place.

"At the time, the board were worried that because of the hostilities (between Tsogo and Gold Reef last year), we would consider leaving. That's why they offered us the new service agreements. They had no idea this deal would happen," he said.

However, those service agreements were struck after a private equity offer for Gold Reef from Ethos fell apart in February 2008, and it had become clear Tsogo had its sights on a deal with Gold Reef.

Also, Joffe admitted that it was Gold Reef's executives who first raised the prospect of a merger to Tsogo Sun CEO Jabu Mabuza in November last year.

But Joffe pointed out that had the Gold Reef executives remained in their current positions in the new merged company, the "no fault termination" would not have kicked in and the R42.8-million would not have been paid.

"We all wanted to remain with the company. I was the first employee at Gold Reef, and it's our life. But at the end of the day, Tsogo's shareholders are dominant, and they decided on the roles we had to take," he said.

It probably didn't help that Gold Reef's bosses had initially fought Tsogo last year, preferring instead to support Ethos' buyout offer, which ultimately failed.

Joffe said he hoped that Tsogo no longer harboured ill feelings towards the Gold Reef executives, saying they had worked hard to "restore the relationship" after the Ethos debacle.

But it's not just Gold Reef's bosses who will make a bundle. The various advisers to both sides will scoop R43-million. Here, the big winners are Gold Reef's adviser, Deutsche Securities, which will make at least R26-million in fees - it could be as much as R60-million - and Investec, which will get R5-million for advising Tsogo.