WHY TSOGO LOAN ISN'T EASY MONEY AFTER ALL

TSOGO Sun’s controversial R200-million “interest-free loan” to five of its top brass to enable them to buy shares in the hotel and casino company is highly unusual — but not for the reasons you might think.

The headlines have trumpeted the criticism that the loan “is empowering five rich individuals” through what is effectively akin to a donation.

The National Union of Mineworkers (NUM) described it as “disgusting”, saying that if you spread the R200-million across Tsogo Sun’s 9 492 employees it would work out at R10 500 worth of shares for everyone.

Despite the bluster, however, that R200-million “loan” is actually far less generous than most other executive incentives -even despite the fact that the loan is interest free and has no fixed repayment date.

In Tsogo Sun’s case, the five executives are exposed to a drop in the share price from the R25.75 at which SABMiller sold its 40% in the hospitality company. This is a rare exception.

“These guys now have skin in the game,” says one remuneration consultant.

This is unusual, he says, because executives are usually not exposed to a fall in the price of shares that they are awarded in terms of executive remuneration packages.

In a more traditional incentive scheme, Tsogo Sun CEO Marcel von Aulock and his four colleagues would have been awarded R200-million worth of shares at R25.75 each. These would have vested with the executives over a period of three to five years had they hit certain performance targets. Then, at the end of the three to five years, the executives would hand over the R25.75 a share and take ownership of them if the shares were selling at above R25.75.

But had the price dropped below R25.75, the executives could walk away, without being obliged to buy the shares.

In Tsogo Sun’s case, however, Von Aulock and his colleagues don’t have a traditional scheme: they are required to buy the shares up front.

There are, of course, variations in how traditional share awards work.

Some schemes award shares to executives at zero cost — which is like donating them. Other schemes set easily attainable performance targets.

Unlike ordinary shareholders, executives in a traditional scheme do not suffer any loss if the share price falls, but stand to reap enormous financial reward if the share price rises.

Tsogo Sun’s R200-million loan, by contrast, is structured so that Von Aulock and his fellow executives will lose money if the share price falls below R25.75.

It is true that they have an advantage over ordinary investors in that they have been able to access R200-million interest free. But that money can be spent only on Tsogo Sun shares, and it has to be repaid when the shares are sold.

Those five executives also have to pay fringe-benefits tax on the loan, which might or might not be matched by the dividends they receive on the shares. This is important because Tsogo Sun’s ability to pay dividends in future will be constrained by the hefty debt it has taken on in recent months.

The executives also give up their future entitlement to the risk-free annual cash payment they received in terms of Tsogo Sun’s phantom-share scheme.

One significant advantage they will have is that any share-price gains will be taxed at capital-gains tax rates and not as income tax.

Johnny Copelyn, the former trade unionist who is now executive chairman of HCI which controls Tsogo Sun, said that within a few years the savings on the phantom-share scheme payments would match the interest that Tsogo Sun paid on the R200-million loan.

Copelyn also argued that the prospects for a share-price fall provided a sufficiently strong performance incentive.

The independent remuneration consultant who reviewed Tsogo Sun’s scheme explained that, generally, the public does not see the potentially huge amounts of money that are involved in share awards to executives.

“The details are published, but they are dense and include all sorts of assumptions, and are not easily accessible to the public. This is why the R200-million figure seemed so dramatic.”

But shareholder activist Theo Botha said that the structure of the Tsogo Sun scheme raised a lot of concerns.

“This appears to have been done outside the remuneration policy. There are no repayment terms. What happens if the share price collapses?”

The other downsides of such a scheme are that, as NUM pointed out, incentivising just a few lucky individuals means that you could disincentivise the thousands of employees excluded from the offer, as well as executives who have not been included.

Another risk is that, if the share price spikes, Von Aulock and his four executives could cash in their chips and walk away. But in that case shareholders will have done equally well.

Seen from the other side of the coin, if the share price drops below R25.75, those five Tsogo executives will suffer a real loss.

If, as NUM suggested, the R200-million loan were spread among all Tsogo staff, they would be just as exposed to a sharp fall in the share price.

The danger of this, as one analyst noted, is that any sustained weakness in Tsogo Sun’s share price could act as a disincentive to the executives.

Perhaps this is why other JSE-listed giants have not used this model, choosing instead share schemes that are actually far more generous to their top brass (see sidebar below).

Either way, if the goal of an executive share scheme is to “align the interests of management with those of shareholders”, Tsogo Sun’s scheme does this better than most — contrary to some of the headlines you might come across.

Source: BDLivce – Ann Crotty (This article was first published in Sunday Times: Business Times)