Transnet Freight Rail, the South African rail logistics giant has few admirers lately. It has disappointed nearly all who rely on it to haul goods from where they are produced to where they are needed.

Infrastructure is critical for the flow of goods and services in an economy. Countries that have efficient infrastructure tend to find that goods and services flow relatively easily and, in a cost-efficient manner relative to their peers whose infrastructure is not in the same condition.

Where infrastructure is not optimally developed there, tend to be bottlenecks and constrictions that hamper the flow of goods and services in an economy. This is so important because you can almost predict how well an economy can and will perform from the state of its infrastructure.

Logistics are central to economic activity anywhere. This component of a country’s infrastructure needs to be in tip-top shape to support the businesses that rely on it. The case of Transnet Freight Rail (TFR) is a classic case study of the adverse impact of poor logistical infrastructure on a country’s economic activity. It also presents opportunities that providers of capital can play on to improve logistical infrastructure for the good of society.

The Department of Public Enterprises in South Africa describes the parastatal as, “…the largest and most crucial part of the freight logistics chain that delivers goods to each South African. As the custodian of ports, rail and pipelines, Transnet’s objective is to ensure a globally competitive freight system that enables sustained growth and diversification of the country’s economy.”

• Transnet is a state-owned South African ports and rail operator. It has come under a lot of flak for being unreliable when it comes to railing commodities for its clients especially in its Freight Rail division.
• Transnet’s troubles highlight the logistics sector’s importance and broader infrastructure to economic growth.
• The Freight Rail division’s poor performance has been a lag on the financial performance of specific mining companies that feel they would have reported better earnings if the parastatal was operating optimally.

The government through this stance acknowledges and reiterates the importance of a well-functioning logistics sector to the broader economy.

What exactly is Transnet and why is it important to the logistics and the economic health of South Africa?

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As a state-owned port and rail operator, the state-owned entity, according to its website, is “…currently transitioning from its Market Demand Strategy, characterized by accelerated capital investment, towards the Transnet 4.0 Strategy, which is focused on repositioning Transnet, and the country’s freight system, for competitiveness within the fast-changing, technology-driven context of the 4th industrial revolution.

The strategy’s main growth thrusts include geographic expansion, product and service innovation and diversification and expansion of the scope of Transnet’s manufacturing business. Transnet’s key objectives are to increase the connectivity, density and capacity of the integrated port, rail and pipeline network.”

The entity’s strategy aimed to achieve revenues of ZAR100 billion by 2020 (US$5.9Bl). Unfortunately, a media statement by the company reporting its financial performance in 2020 showed that it achieved revenues of ZAR75 billion (US$4.4Bl) which increased by a marginal 1.3 per cent from the previous year. The ZAR75 billion revenue though commendable, was still considerably short of the goal of its 4.0 strategy. Transnet’s strategy envisaged organic growth from freight transport and handling divisions.

An overview of Transnet’s website also shows the need for capital investment to do what the company calls, “modernize and expand the port, rail and pipeline network and operations will continue to be a key priority, as will continued development of our people.” The goals of the South African ports and rail operator are ambitious. The company has set its sights on growth from new markets predominantly in integrated logistics, the development of logistics hubs and clusters, natural gas midstream infrastructure, manufactured products, and new digital businesses.

• Transnet has on occasion engaged in unsustainable funding arrangements from financiers which have included banks in 2014/5 and in 2022.
• The parastatal’s funding strategy leaves it open to financial distress because its financing packages from financiers and banks are mismatched to its needs.
• Transnet needs to align its financing strategy to its investment in capital expenditure. The parastatal has announced plans to expand its ports railing capacity. It also aims to generate revenues of US$ 4.5 billion.

To achieve this the company has stated that it is open to strategic partnerships. It operates as an integrated freight transport company, formed around a core of six operating divisions. These are supported by several company-wide specialist units – Transnet Group Capital and Transnet Foundation according to the website. The group consists of the following divisions: freight rail, rail engineering, national ports authority, port terminals, pipelines, and real estate.

The challenges Transnet is experiencing

Despite the vast size of its operations, Transnet has been a somewhat of a disappointment to its most critical of stakeholders—its clients. So adverse is this situation that media reports began to appear in May this year that the parastatal’s flagship operation freight rail had lost more than 15 million tons of freight volumes in the year ending March 31.

This development was further compounded by allegations of corruption relating to the way it acquired locomotives. The first stakeholders to cry foul from Transnet’s poor performance were the biggest coal exporters in South Africa. The coal miners lament that they have had to forego sales in hard currency they would otherwise earn if Transnet managed to get its operations act together.

This problem is age old. In August, the leading coal miners in South Africa, Exxaro Resources and Thungela Resources reported their half year financial and operating results. The recurring theme from both companies is that their export market performance lagged due to the problems Transnet’s freight rail division is experiencing.

According to media reports, “In the 2021/22 financial year, TFR only had 1,656 locomotives, a 25 per cent decline from 2,215 locomotives, which significantly reduced its ability to move goods. Transnet said getting spare parts for certain locomotives had been jeopardized by the protracted application to review the acquisition of 1,064 locomotives, which had affected the reliability and availability of locomotives.” The company is experiencing capacity issues from its failure to secure locomotives and rolling stock.

The company has had to endure protracted negotiations with Original Equipment Manufacturers (OEMs) to secure rolling stock and locomotives; meanwhile, its operations languish. Additionally, Transnet has had nagging and persistent legal problems with theft of copper cables on a grand scale. As much as one thousand kilometers of copper cable has been stolen it is alleged. It went as far as to warn coal exporters that the company would have difficulties meeting its contractual obligations. Coal miners are not the only ones frustrated by the declining rail capacity of the rail operator. Bulk commodity producers like iron ore producers and chrome have reportedly lost as much as ZAR35 billion (US$2.1Bl).

Coal miners lost ZAR16 billion (US$1Bl) from Transnet’s reduced volumes of coal. In 2021 coal volumes reportedly fell to 58.2 million tons from 70 million tons exported the previous year. The rail operator has offered to collaborate with players in the most affected of its corridors to mitigate the risks of vandalism and theft.

• The big-ticket assets that Transnet needs to invest in require long-dated capital and funding whereas the parastatal is receiving funding packages from international banks with tenors of no more than 5 years.
• The financing strategy of the parastatal needs to focus on obtaining funding from debt capital markets through the issuance of rand-denominated bonds and Eurobonds.

Transnet’s woes though unfortunate, are an opportunity for banks, financiers, and other providers of capital. The company has ambitions referred to earlier to expand its ports and rail capacity. This will require large sums of capital to finance this aspiration which banking institutions can either provide from their own resources or can arrange from third parties. Infrastructure projects like the kind that Transnet is looking to engage in have long gestation periods as with any typical infrastructure project.  Therefore, the kind of financing model required to fund these will need to have a good dose of patient capital that can afford to wait out the long gestation periods before the capital outlays start to earn returns.

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Transnet did follow this strategy at various times. In November 2015 the company raised a sum of ZAR25 billion (US$1.4Bl) from a consortium of banks to fund its capital expenditure program which included the procurement of trains and expansion of port capacity. That round of funding was underwritten by several banks which included Nedbank, Bank of China, Barclays Africa, and the asset management unit of Old Mutual. Last month Transnet secured a US$1.5 billion loan again from a syndicate of international banks led by Deustche Bank for the same purpose as the last round of funding.

The loan would be for five years. This new loan would not only be used to finance expansion but also to refinance existing loan facilities. This is a boon for banks because they can look forward to creaming fees from arranging such credit facilities with a borrower that is eminently bankable and has a good financial standing especially in the case of Deutsche Bank.

Banks dealing with Transnet and other such state-owned enterprises on the African continent should innovate their financing models for such projects. The recent syndicated loan and the one advanced to the rail operator have the same thing in common. They are short-dated when compared to the gestation period of the projects they are funding. This is evident in the need that Transnet then has to refinance its loans every so often. Refinancing is when a borrower takes out additional loans to pay off loans they took out earlier that would have fallen due.

Refinancing normally arises when a borrower has loans coming due and they do not have the necessary cash to settle the loans. So essentially, it becomes a case of borrowing from Peter to pay Paul. The nature of bank financing naturally is short-term and as such is not appropriate to fund the kind of big-ticket projects that Transnet and any other rail operator engages in. Because of the short-dated nature of the loans, Transnet will either need to roll over the loans or refinance them continually.

A more sustainable solution to the Transnet financing model would be to employ the use of long-dated capital. Banks singularly or collectively through a syndicate can arrange for and float bonds whose tenure matches the gestation period of the projects that they are financing. This way the issuer, in this case Transnet, will not worry about having to either roll over their loan facilities or refinance them altogether. It is understandable why banks funding a massive borrower like Transnet would be more comfortable to advance credit as a collective through a syndicate than they would individually. The prospect of a single borrower on a bank’s loan book going bad with a loan exposure as large as US$1.5 billion is enough to cause any bank executive to lose sleep. Such a risk is best managed when its shared.

Banks can make a lot of money from managed lending to entities in the logistics sector in Africa and structured finance opportunities in the same sector. The banks that collectively lent US$1.5 billion to Transnet if they desire to monetize their loan exposure to the parastatal before it matures can securitize the loan by issuing a bond against it to investors in the debt capital markets who will exchange capital equivalent to the loan outstanding and then interest payments will then channel to them in the form of coupon payments. Debt capital markets are the most appropriate to finance logistics for banks.

In Transnet’s case it is spoilt for choice in the sense that it can issue bonds or notes that are either denominated in Rand or they can issue Eurobonds which are US dollar-denominated notes that are issued in a jurisdiction that is not the USA. All forms of debt financing have risks inherent in them. Credit risks ranging from default, financial distress, currency, and interest rates will be a constant for banks to contend with and contend with they will. The opportunities are endless. Should Transnet and other such rail and ports operators opt to privatize banks as financial midwives will realize opportunities bringing newly privatized entities to the public markets in terms of earning fees and capital gains from dealing in the various securities resulting from restructurings.

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