Having said “no”, the IDC is under pressure to save Patel’s pet project

The battle to save Frame Textiles puts a spotlight on the cosy relationship between members of the new cabinet and the labour movement.

The government initiative to save SA’s largest cotton spinner is ostensibly about preventing job losses and further de-industrialisation. But it is hardly a clear-cut case and, on the face of it, government is already compromised.

The first issue is whether Frame, a subsidiary of SA’s largest clothing manufacturer, Seardel, is merely a victim of the global downturn or a company that has been in structural decline for years.

The difficulty in drawing the distinction is partly why government has shied away from bailouts to date. In April, department of trade & industry (DTI) spokesman Vukani Mde told the FM that it was not considering bailouts: “A fundamental problem with bailouts is that companies that don’t deserve to survive because of their own structural weaknesses become the recipients.”

In giving reasons for its decision to close Frame, Seardel lists five structural issues that plague the whole industry, none of them specific to the economic crisis. They are: ongoing pressure from cheap imports; competitors are subsidised by the state (both abroad and at home) or don’t comply with labour laws; hikes in input costs, especially electricity; and structural deficiencies with respect to the duty credit certificate scheme and regional trade arrangements. In its statement, Seardel says it looked at every avenue, including major internal restructuring.

“Over the past 10 years, more than R360m has been spent on plant and machinery, but it’s become clear that improved efficiencies alone will not be sufficient to compensate for the structural issues in the industry.”

Seardel CEO-designate Stuart Queen told the FM last month that it had modelled every possibility but couldn’t see a way to improve Frame’s margins.

“Those business units have been making a loss for years — by December we were losing more than R10m/month,” he said.

Seardel also approached the Industrial Development Corp (IDC) but, after several meetings, the IDC declined to assist.

“We couldn’t see a way we could structure an arrangement because we didn’t believe the company had economic merit,” said Willie Fourie, who heads the IDC’s textiles & clothing unit. “We have to believe a company can be returned to long-term profitability.”

Last week, DTI minister Rob Davies and economic development minister Kbrahim Patel initiated a process with Seardel and the SA Clothing & Textile Workers Union (Sactwu) to get the IDC to take another look. The IDC is a state owned, self-financing development finance institution. Its board and CEO are appointed by cabinet and it reports to the DTI.

Industry consultant Justin Barnes thinks the IDC was too ready to give up on Frame, arguing that it is too important in the clothing value chain to be allowed to fail. “A lot of money has been invested in the business over the past few years and it’s got a strong technical manufacturing capability with some really good equipment,” he says.

“To lose Frame would be to wipe out hundreds of millions of rand in value addition to the economy and would contribute to SA’s deindustrialisation. Better to save what we have, because to encourage a mill like that to establish itself in SA would require a fortune in incentives and subsidies.”

Frame was started in 1928 by Jewish immigrant Phillip Frame, with money borrowed from his relatives. At its height, Frame employed more than 30 000 people and was the largest textile operation in the southern hemisphere. It has since dwindled and employs just over 1 400. But if Frame “has no economic merit”, then how can government or the IDC justify throwing more money at it?

The IDC says it’s keeping an open mind. ‘The retention of jobs is very important to the IDC but that doesn’t mean we’d support a company where we cannot prove long term sustainability,” says IDC chief financial officer Gert Gouws.

The second major issue is that the IDC already owns Prilla 2000, SA’s second largest spinning mill. The move was approved by the competition tribunal in 2004 when Prilla was unable to repay its debt to the IDC. Last year, in another rescue action, the IDC also acquired a major stake in Sheraton Home Textiles.

It seems unlikely that the competition authorities would approve of the IDC also taking a controlling stake in Frame. On the other hand, Frame’s demise will in itself concentrate the industry.

The third major issue is how government can favour one distressed, but well connected, company over others — a point raised by Textile Federation executive director Brian Brink. The industry shed 5 000 jobs last year and another 3 000 in the first three months of 2009. This included the closure of Sans Fibres, one of the most technologically advanced plants in Africa, with the loss of 1 500 jobs. “One can defend a broader rescue plan for a whole sector, but they have to be very careful when selecting one company as it raises questions about vested interests,” says Brink.

The feeling on the ground is that Seardel is getting special favours because of its link to Sactwu. When Seardel was staring at liquidation last year, Sactwu pressured HCI to acquire a 71% stake in the company through a rights issue. (HCI is 40%owned by Sactwu.)

For the past 10 years, Sactwu has been run by Patel. The initiative to save Frame is one of his first acts in office as minister of economic development.

A well placed source says the IDC is being asked to acquire a 75% stake in Frame. In return the company would have to return to profitability in two years. But how? The argument goes that the DTI’s customised sector programme (CSP), as well as a special rescue package for the industry, will make the industry, including Frame, more competitive. But, as Seardel itself has noted, “improved efficiencies alone will not be sufficient to compensate for the structural issues facing the industry”.

The draft rescue package, of which Patel was a key architect while still Sactwu secretary general, is more controversial than the CSP in that it advocates “an urgent cash injection to secure many companies’ immediate future”.

Such a scheme could return a firm like Frame to profitability, at least in the short term, but at what cost to the taxpayer? The danger is that unless the cash is tied to upgrading or reskilling to ensure sustainability, it will simply go straight to improving a company’s bottom line, benefiting its current owners and shareholders at taxpayers’ expense.

One must also query the wisdom of handing out cash to an industry with more than its share of ailing, ageing firms, and where even business owners themselves harbour doubts about its long term viability. But Patel is known for his tenacity. He is unlikely to take no for an answer.

Source: Financial Mail – Claire Bisseker