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Pep Stores, take two

‘There won’t be any material changes. The model, policy and principles of the group will stay the same. Perhaps just a change in style.’ 1

Christo Wiese in an interview, 1981

One of the first things to change was the name.

The Pep Stores in Wiese’s charge had become a different animal. It had ballooned from five clothing shops in the Northern Cape, when he first joined the business, to a group with 500 stores and total sales of more than R200 million a year. And it no longer sold only clothes, but also groceries, because in 1979 Pep Stores took over a chain of eight shops with the name of Shoprite. The group also ran a property portfolio and several factories. Within months Pepkor replaced Pep Stores on the Johannesburg Stock Exchange.

Wiese and his team restructured the company into four divisions: clothing stores, food retail, manufacturing and property. But the new structure would serve no purpose for Wiese and his team if they couldn’t retain control. Together, he and the other Pepkor directors controlled around 29% of the shares in Pepkor. This was not nearly enough to discourage a hostile takeover. And with sanctions choking off foreign investment opportunities, some of South Africa’s largest companies had morphed into conglomerates hungry for businesses to buy. So Wiese took a page out of Pick n Pay boss Raymond Ackerman’s book and set up a pyramid control structure.2

These structures had been prohibited by the JSE after the stock market crash of 1969, but in 1981 Ackerman got the nod to create his control pyramid called Pikwik. By April 1983 Wiese had listed Pepgro, which had a majority stake in Pepkor and in which he and his colleagues, in turn, held the most shares.3

Wiese’s aim was for the group to reach R2 billion in sales by 1990 – an ambitious undertaking, as sales for the year to end February 1982 reached R279 million.

Soon it became clear that Pepkor saw groceries as a big source of future revenue. On food the profit margin was significantly lower than on clothing, which partly explains Wiese’s optimistic sales target: a grocer would have to generate much higher sales than a clothing store to show similar profits.

Wiese was willing to prune in order to grow and he soon closed Hotline, a Cape Town-based grocery delivery business. Hotline, acquired by Pep only a year earlier, had some growth potential in the long term, according to Wiese, but he wanted his management’s energy to be spent on more profitable ventures.4

Shoprite by now had 15 stores, all of them in the Cape, but the group had plans to expand and Pepkor’s managing director, Tom Ball, said he saw potential for another 200 such outlets countrywide.5 Checkers, OK Bazaars and Pick n Pay were the market leaders at this stage and none of them could boast 200 supermarkets.

Within six months of taking over, Wiese announced his plans for a new convenience store format aimed at the growing buying power of the middle-income groups. Pepkor kicked off in the Cape Peninsula with three Hyperette stores – smaller than a supermarket, but larger than a café – which, according to Wiese, could ‘literally go to hundreds of stores’. The Hyperette carried a smaller variety of goods than conventional supermarkets, but this ‘souped-up neighbourhood café’, said Wiese, would be ‘on the housewife’s doorstep’.6

The move carried some risk, because competition was intense. Two other chains had already set their sights on this section of the convenience market and had opened a host of stores: Clicks with nearly 50 shops focused on non-perishable goods; and Score, which took over a batch of outlets with the catchy name Save Cave from OK Bazaars.

Groceries might be the future, but in the here and now Pepkor’s biggest cash cow remained its chain of Pep clothing shops. Again Wiese had plans. He believed it was time to take Pep to the next level. While it was very popular in the Cape Province, especially on the platteland, he saw lucrative opportunities in expanding the business to the centres of large cities in the north of the country.7

Eloff Street in its heyday had some of the most sought-after commercial property in Johannesburg. It was in fact the most expensive street on the South African version of the boardgame Monopoly. But in the early 1980s city centres were changing and Pep was part of the new era. Acquiring a shop of a thousand square metres in Eloff Street, the chain made a play for the spending power of thousands of black workers in the CBD who used the bus and train station nearby.

The new Pep Metro stores were set up in locations close to commuters on their way home to places like Soweto. To reach these consumers was not as simple as it might look, as white-owned retailers were not allowed to set up shop in black residential areas. The government of the day was still committed to grand apartheid and its market-distorting regulations. Shops such as the one in Eloff Street offered the next best thing.

But to overcome the restriction on stores in townships, Pep also had plans to start a company in which black shareholders would hold a majority stake. This was along the same lines as Pep Peninsula, a venture with shareholders from the coloured community started in the 1970s in line with the dictates of the Group Areas Act. The business had since grown to more than 20 stores in coloured areas in and around Cape Town.

Wiese knew, however, that it would take a few years before the black-controlled company got off the ground. ‘Pepkor believes in not focusing on the spending power of one specific population group, but much prefers to concentrate on all the different low-income groups in South Africa,’ he said.8

Some of the other retailers followed a less direct route to reach black consumers. They started cash-and-carry businesses. Spaza shop owners and other traders then bought from them in bulk to sell the goods in the townships. Companies like Metro Cash & Carry and Score grew rapidly thanks to this business model.

Black consumers were the future. And Wiese, like most of his competitors, knew this.

Black spending power might have been in vogue, but black political power was not. Late in 1983, South Africa’s white minority headed to the ballot box for a referendum on a new constitution. Wiese’s father-in-law was a vocal supporter of the new dispensation that would see coloured and Indians represented in the so-called tricameral parliament. He was, after all, a member of the President’s Council that had made these recommendations. Voters gave the nod and the tricameral parliament started life in the last decade of government in South Africa without participation by the black majority.

Wiese still had a lively interest in politics, but he was not actively involved as he had enough other balls in the air. Page through the 1983 edition of South Africa’s Who’s Who and you will notice his entry is longer than those of Anton Rupert or Harry Oppenheimer. And in between it all he also found time to be a diaken (deacon) of the Dutch Reformed Church in Three Anchor Bay. ‘Yes, I have my doubts about things such as the church’s stance on apartheid, but I felt I need to ignore that and serve where I can.’9

Another important part of Pepkor’s restructuring was to stitch the most recent acquisition into the rest of the business. For years the group had been building up its manufacturing capacity, steadily supplying more of the goods that it sold. By the time Wiese took over, Pep Stores had been at it for a decade. What started with a shoe-manufacturing plant in Durban had grown to twelve factories and included school clothing and blankets.

In 1981 Pep Stores bought the clothing manufacturer IL Back from Rupert’s Rembrandt group. Wiese, by then a full-time Pep Stores executive, was quite closely involved in the deal to buy the company.10 This acquisition constituted literally a change in style, because even though IL Back had been struggling for years to turn a profit, it was still the manufacturer of well-known brands such as Alba, Carducci, Yves Saint Laurent and Monatic.

IL Back had a massive factory of more than six hectares.11 In contrast to some of the other manufacturing businesses in the Pep Stores stable, the new plant was very capital-intensive. This also meant that it relied more on debt as a source of finance. ‘Despite its recent bleak profit history, IL Back was one of the blue chips in the South African clothing industry and its brand names have remained household words,’ said Wiese.12

By the time Wiese announced his first set of results as executive chairman – with bumper profits – IL Back’s number were not yet included.13 Six months later, it was a different story, because it had become clear that the IL Back deal saddled the group with a huge pile of clothing stock, which weighed on profits. The results also revealed that Pepkor’s interest payments had doubled as the acquisition of the manufacturer was to a large extent financed by debt. A high debt burden was an expensive exercise as interest rates had more than doubled in the previous few years, reaching 20% in 1982 and climbing to 25% by the middle of the decade. Wiese would soon find a way to pay less interest – a move that would haunt Pepkor for years.

To get IL Back back in black was clearly a big task, complicated by the fact that its clothing ranges were much more sophisticated than the blankets and shoes that Pepkor was manufacturing in other parts of the country.14 Later that year, Wiese appointed Selwyn Kantor as head of Pep Manufacturing. Kantor, a seasoned factory boss, had previously been with Rex Trueform. He was the one who had to solve IL Back’s under-utilised capacity and low productivity. But the restructuring eventually took longer than planned and was marred by cost overruns.15

There was, however, one thing Wiese and his team could use to great effect: IL Back’s earlier losses could be written off against taxable income. ‘A side effect of the restructuring is a lower tax rate, and it is expected that the average tax rate will continue to be lower for the next few years,’ said Wiese.16

Buying struggling companies – with substantial tax benefits due to a history of losses – would become a trademark of Wiese’s approach to business. IL Back was the first public example of the sort of financial engineering that he would, according to David Meades, ‘in later years develop into an unrivalled artform’.

But not even the most favourable tax structure was much of a cushion for the blow that was to follow. In 1982 the economy ground to a halt. The rest of the world’s frenzied demand for gold, which had pushed the price of the precious metal to $850 per ounce, tapered off. South Africa was at this stage by far the largest producer and exporter of bullion and was extremely vulnerable to swings in the gold price. The metal’s recent run had boosted economic growth to 6,6% in 1980 and 5,4% in 1981, but in 1982 the economy contracted by 0,4%. A big factor in the sudden downturn was the Reserve Bank’s decision to increase interest rates sharply to prevent the economy from ‘overheating’ and to keep inflation in check.

The recession hit the consumer hard. But Wiese optimistically believed that the downturn wouldn’t affect Pepkor’s target market too badly.17 Pepkor was largely recession-proof. When the economy was in the doldrums and shoppers couldn’t afford to buy from Edgars or OK Bazaars, Pepkor’s clothing and grocery chains gained customers. Middle-class consumers who tighten the belt never stop shopping completely; they just trade down. Moreover, Pep and Shoprite did not sell on credit, so they had no need to worry about collecting debt or writing off customers in arrears, a problem that often plagues other retailers in a downturn.

There were no debt hassles – unless Pepkor itself was the borrower.

To reach the target of R2 billion in sales by 1990, Pepkor needed to expand aggressively. But opening a fleet of new stores every year wouldn’t cut it. A dealmaker has to scan the horizon for possible acquisitions.

Not long after Wiese took the reins, in 1983, he was in talks with Malbak, an industrial group, about bringing the two companies together. No deal was made, but the discussion did herald the start of a long relationship with Malbak director Arnold (Nols) Louw.18

That same year, Pepkor bought the Bloemfontein-based retailer Kloppers, and its property, so as to enter the market for household appliances.19 It also acquired a 51% stake in the technology company Deqtime and took over Elvinco Plastics, a zipper supplier.20 The next year, it bought Ackermans from Edgars.21

Ackermans, which was founded by the father of Pick n Pay boss Raymond Ackerman, had been acquired by Edgars for R30 million only a year earlier, but was soon a loss-making problem child. Edgars then decided to merge it with its Jet chain, but before it could execute the strategy, Wiese offered R21 million in cash. Edgars accepted.

Ackermans fitted nicely into Pepkor’s plans for a larger footprint in the inner cities. The acquisition shortened a five-year expansion programme by four years, said Wiese.22 And so he got control of another business that had turnaround potential and losses from previous years that came in handy to keep Pepkor’s tax bill as low as possible. Within a year Ackermans was a profitable division.

Later that year Wiese and Shoprite’s managing director, Whitey Basson, approached Grand Bazaars, a retailer straining under a heavy debt burden. The chain had several shops in the northern part of the country, which would complement Shoprite’s footprint in the Cape Province. Wiese’s offer was rejected. ‘It was always agreed that our business was not for sale; people may make us an offer we cannot refuse, but it is still not for sale,’ said Grand Bazaars managing director Manny Sachar after talks reached a stalemate.23

Basson, when telling the story years later, said the transaction was torpedoed by Sachar’s insistence on remaining chairman of the merged retailer’s board. This did not sit well with Shoprite founder Barney Rogut, who had clashed with Sachar in the past. The food had already been dished up at the cocktail function to celebrate the transaction, joked Basson.24 But the deal was called off.

Not too perturbed by Grand Bazaars, Wiese looked further afield. He saw opportunities in foreign markets and soon Pepkor was exporting to the United States. The plan was to sell clothing, especially IL Back’s wares, in the world’s largest consumer market. IL Back had in the meantime been renamed House of Monatic. In 1984 Pepkor opened a store in Atlanta, Georgia, and soon added another four outlets.25

The following year, Pepkor bought the clothing manufacturer M Bertish for R8 million from the Veka group. This brought the brand names Embassy and Consulate into the stable, but Pepkor was more interested in the company’s factories, which could be used to produce more House of Monatic products for export.26

With Wiese at the helm, the group financed its operations to a large extent with debt.

In an effort to escape rising interest rates, in September 1982 Pepkor started borrowing abroad, where it could get cash at a much lower interest rate. By mid-1983 it looked like an excellent move. Not only were interest rates lower, but Pepkor also turned a profit of R4,5 million on its foreign borrowings, thanks to an appreciation in the value of the rand.27

This, however, did not last long. Towards the end of 1983 the first foreign exchange losses showed up on the books.28 ‘In the medium term, it is expected that the total cost of foreign borrowings (i.e. the interest paid and exchange rate fluctuations) will be lower than the cost of local borrowings,’ announced Pepkor in its results for the half-year to the end of August 1983.

By the middle of the following year, as much as 80% of Pepkor’s debt was in the form of foreign loans, in an attempt to benefit from the lower interest rate in the United States – at that stage 13% compared with 21% in South Africa. Although Pepkor’s profit from its actual operations was still growing despite the recession, the firmer dollar caused the group to suffer forex losses of R8,2 million.29 These losses, at first, were only on paper and did not affect the group’s cash flow. Wiese believed the rand was undervalued and therefore Pepkor decided not to pay back its foreign loans, but to extend them.

Unfortunately for Wiese, South Africa’s image abroad was suffering serious damage. And the rand’s slide continued owing to weak economic growth, tougher sanctions by foreign governments, the withdrawal of prominent multinational companies, consumer boycotts and political violence that some feared would escalate into a civil war. By the middle of 1984 the dollar was trading at R1,35. Within four years South Africa’s currency had lost nearly half its value.

Pepkor initially did not take out forward cover for its foreign exchange obligations, but after the rand’s steep decline in the second half of 1984 the board decided to take precautions to limit possible losses. The company took out currency options and foreign exchange contracts to cap losses, due to the rand’s volatility, at R19 million.30 ‘If we take a loss we are sure that it can be sustained without jeopardising the company,’ said Wiese in August of that year.31

Pepkor borrowed in dollars and had to settle the debt in dollars. The problem was the ever-weakening rand, which meant the company’s interest-bearing debt ballooned to R141 million by the end of August compared to R94 million a year earlier.

To reassure investors about its debt ratio, Pepkor swiftly sold down its stake in some of its properties, realising capital gains of R35 million. Unfortunately its remaining holdings in these properties were placed in a joint finance company, but owing to its structuring Pepkor was obliged to list these as losses in its income statement, which had the opposite effect of what the company had intended.32

Meanwhile, the company’s actual operations – sales of clothing and food – chugged away with steady growth despite intense competition from other groups and a drought that weighed on disposable income in the rural parts of the country. Although the company was having a hard time, its shops were doing well.

Pepkor started taking a more cautious approach to foreign debt. Early in 1985, Wiese announced that all forex transactions were now fully covered and that this would be the company’s policy going forward.33

Ever the optimist, he explored the opportunities suddenly presented by the weaker rand. Pepkor tested the market in the United States and United Kingdom and increased the turnover of its export business to R1,5 million in the year to end February 1985, eyeing R10 million the following year and as much as R30 million within five years.34

But many South Africans didn’t see opportunities, only an increasingly unstable society. Political unrest became more visible, even in so-called ‘white’ areas. Bomb blasts hit civilian targets, such as the explosion that ripped through a shopping centre in the seaside town of Amanzimtoti, killing four people. Emigration rose sharply. It was big news when Pep Stores founder Renier van Rooyen put his Durbanville mansion up for sale and emigrated to Portugal.35

One could try to predict the rand–dollar exchange rate. And one could try to position oneself for the direction in which the exchange rate was expected to move. Especially if, like Pepkor and several other South African companies, one sat on a mountain of foreign debt. But no one could predict what would happen in August 1985. Indeed, if company bosses were well prepared for the events to follow, it was more a case of luck than wisdom.

On 15 August President PW Botha addressed the National Party’s congress in Natal. It was the sort of event that would under normal circumstances not have attracted much attention. But that evening a worldwide audience of more than 200 million expectant people were tuned in. The chatter in diplomatic channels in the preceding weeks had billed the speech as a momentous event, hinting at a big announcement.

A comprehensive behind-the-scenes account of the reasons for what turned out to be a disaster, which soon became known as the Rubicon Speech, is expertly presented in Hermann Giliomee’s book The Last Afrikaner Leaders.36 What the rest of world was expecting to see is open to speculation. Perhaps a clear framework for negotiations to thrash out plans for a democratic election, maybe the unconditional release of Nelson Mandela and other political prisoners, or maybe just a reasonable man willing to lead a nation valiantly into the unknown. What they got was something completely different. The best description, in a catchy tune, is given by Johannes Kerkorrel and the Gereformeerde Blues Band: ‘’n nare gesig … ’n moerse klug’ (a terrible face … a hell of a farce).37

Botha, not the most charismatic of 69-year-olds at the best of times, told the world, with a waving forefinger and a heavy Afrikaans accent, that he and his government would not bow to pressure to do what they did not want to do. ‘Don’t push us too far’ was the quote that had the longest echo after the speech.

No significant change of policy was announced – at any rate, nothing that would resonate with an international audience. The consequences were catastrophic. That same day the American bank Chase Manhattan announced it would terminate borrowing facilities and call in all maturing loans, citing South Africa as a too risky place in which to do business. Other financial institutions would soon follow. Suddenly it was not only expensive to borrow abroad, but nearly impossible.

Within two weeks the rand lost a quarter of its value and the authorities announced a ‘standstill’ on about 58% of all foreign loans. The purpose of the standstill was to buy time. South Africa would only be able to repay its debt to foreign institutions in an orderly fashion if the time frame was achievable and acceptable. The crisis also gave the authorities the chance to enforce stricter exchange controls. This was to make it more difficult for investors, both local and foreign, to take capital out of the country and to prevent the rand from losing so much value that it became impossible to repay debt.38

Companies with foreign borrowings were, however, not part of the standstill and Pepkor had to take its own measures to manage its debt.

Less than a month after the Rubicon Speech, Pepkor announced that it would raise capital from shareholders. Pepkor planned a rights issue of R55 million. Pepgro, which housed Wiese’s controlling stake in Pepkor, announced its own plans for a rights issue of nearly R30 million and declared that Wiese would take up his rights.

Wiese forked out millions of his own money in this recapitalisation exercise. He said it had been decided much earlier that the company’s debt-to-equity ratio needed to improve to 1:1, and that forex losses were not the reason for the move.39 Clearly the company wanted to reduce its debt and wean itself off foreign loans, which had proved so vulnerable to fluctuations in the exchange rate. ‘All borrowings are being brought onshore as soon as possible. The company has already started paying back some offshore loans,’ said Wiese.40

It later became apparent that part of Pepkor’s foreign exposure had not been covered because it seemed as if the rand might stabilise at R2 to the dollar. ‘However, the disastrous slide in the rand after [the] declaration of the partial state of emergency, followed by the declaration of the moratorium on the repayment of foreign loans, caused the group to suffer further extraordinary foreign exchange losses,’ the company declared in its half-year report.41

The board decided that it wanted to get forex losses out of the company’s system once and for all.42 Pepkor made provision for R25,9 million to cover all future forex losses. ‘We’ve made a mistake, but we’ve now learnt a good lesson. This will be the last time that we suffer losses such as these,’ said Wiese.43

Even if it was a big mess, the rest of the economy was also in dire straits, so, comparatively speaking, Pepkor did not look too bad. In 1985 it still ranked 8th in earnings on the JSE and generated the 25th best return for its shareholders.44

But the capital the company raised45 from its shareholders was not enough to lower the company’s debt ratio sufficiently. The interest burden became heavier and heavier, and the damage done by forex losses was difficult to repair.

By 1986, the interest Pepkor paid on loans had ballooned to R40 million and forex losses to R52 million – basically, enough to erase the company’s operating profit. Long forgotten were the few millions in forex profits that Pepkor had boasted about after its first year of borrowing abroad. ‘The forex profit the group initially made on its foreign loans is the most expensive profit it ever made,’ said Wiese.46

At Pepkor’s annual general meeting that year he denied in the strongest terms that the group was teetering on the edge of the abyss and that it needed to be rescued. Die Burger quoted Wiese as saying that nothing could be further from the truth. He did say, however, that Pepkor wanted to achieve a more acceptable debt ratio. The problems the company still had would be eradicated before the end of the financial year, he said.47

The year 1986 was a tough one. ‘Christo is coping, though most businessmen are having a tough time due to the political climate,’ his father-in-law wrote to a friend in the US.48

How long the political turbulence would last, no one knew, but Pepkor would need another bout of restructuring to get back on track.