International Construction Regional Report: Southern Africa

It has been a grim few years for South African construction companies, battered by tough economic conditions and a price fixing scandal, but indications are that the situation could be about to improve.

Two years ago, contractors were struggling to survive the slump that followed the construction boom ahead of 2010’s World Cup football tournament, and the industry was hit by a collusion investigation that threatened the survival of some of the sector’s largest companies.

It turned out to be the industry’s worst scandal in years and resulted in soured relations with its biggest client, the government, as well as taking up hundreds of hours of management time. Now, with all the skeletons out of the closet, fines paid and guilty companies admitting anti-competitive behaviour, the issue is drawing to a close.

A group of 15 contractors active in South Africa have agreed to pay fines totalling ZAR 1.46 billion (US$ 145 million) for anti-competitive behaviour. The fines were agreed with South Africa’s Competition Commission under its Construction Fast Track Settlement Process, and the allegations of irregular conduct stretch back decades on contracts worth around ZAR 47 billion (US$ 4.7 billion). The most recent transgressions were alleged to have occurred on the building of stadiums for the 2010 World Cup.

The issue also strained relations with the government to breaking point. As the single biggest buyer of construction services, the government felt that it was being ripped-off. In public, officials have expressed increasing levels of outrage as the level of price fixing became apparent.

“Private sector collusion and price-fixing cost the state many billions in previous infrastructure projects, including the 2010 World Cup stadia,” Economic Development Minister Ebrahim Patel said in parliament.

While the size of the penalties has left the industry stunned, the agreements also point to closure. The uncertainty is almost over and the industry can begin to move in a more positive direction. As far as business performance is concerned, early indications suggest that construction business is improving.

“There has been a complete mistrust between the private sector and government,” said Tumi Dlamini, executive director of the Masterbuilders of South Africa, the industry’s representative body. “Hopefully now that the process is coming to an end, we will have finally won a measure of understanding between the two parties.”

Slow payment

The competition issue also made it difficult for the industry to take up its own issues with South Africa’s government, including the slow implementation of contracts, and even tardier payment for work delivered.

Last year, for instance, contractor Sanyati closed the lid on its empty coffers and filed for bankruptcy after millions in outstanding payments for as many as 23 government contracts were not paid. More than 2,500 jobs were lost in the debacle. At the same time, promised projects are simply not happening.

“It does not bode well for the industry when projects are not being signed off,” Ms Dlamini said. “This is affecting growth because we depend on government to support industry.” She added that industry

leaders were keen to rebuild their relationship with government.
“This is something we need to talk to government about. The CEOs of the biggest companies want dialogue.”

The industry was relatively insulated from the credit crisis of 2008 by the race to complete infrastructure for the 2010 World Cup. But as the jobs were signed off, companies found themselves sitting with excess capacity and dwindling new contracts.

Earnings at South Africa’s biggest construction group, Aveng, fell -58% in the 12 months to June last year, reflecting industry-wide doldrums.

There are however signs of improvement. First National Bank (FNB) and the Bureau for Economic Research said that their latest construction confidence index had jumped from 36 index points in the last quarter of 2012 to 51 points in the first quarter of 2013. This was the highest reading of the index in four years. Sizwe Nxedlana, chief economist at FNB, said the surge was a result of restored profitability in the construction sector.

“Construction firms have been able to restore profitability following a prolonged period of intense margin pressure,” Mr Nxedlana said. “However, this could be constrained if construction activity growth continues at the slow pace seen in the first quarter of 2013.”

Ms Dlamini added that the numbers appear to reflect the mood on the ground, “We have not seen this kind of growth for a while now. We hope this will continue.”

Large projects

Much of the hope is pinned on large state-funded projects. The ruling African National Congress is under pressure to improve economic growth and, especially, to create jobs – a quarter of the country’s working-age population are unemployed.

Last year, it announced an almost ZAR 4 trillion (US$ 400 billion) infrastructure programme to be rolled out over the next two decades, with almost ZAR 850 billion (US$ 85 billion) to be spent within the next three years. The projects will be split between various government departments and state-owned enterprises, such as logistics company Transnet and national electricity utility, Eskom.

The government will also spend ZAR 430 billion (US$ 43 billion) to build schools, hospitals, clinics, dams, water and sanitation projects. The funds will also go towards expanding electricity networks and supplying electricity to over a million new homes, building more courtrooms and prisons and construct better bus, commuter rail and road links, according to Finance Minister Pravin Gordhan. These projects will mostly be carried out through municipalities and provincial authorities

The state utilities also have ambitious projects ahead. Transnet, for instance, wants to turn the old Durban airport on the country’s east coast into a new container facility, at a projected cost of ZAR 100 billion (US$ 10 billion).

Exploratory drilling on the site by Transnet is already underway, and the first phase is expected to be completed by 2019. By 2036, it will have a 16-berth container terminal that can handle 9.6 million standard twenty-foot equivalent units (TEUs).

A project of this size and complexity will put South African companies to the test, which will offer opportunities for international companies, says Andrew Robinson, head of the Admiralty and Shipping department at Norton Rose Fulbright South Africa.

“There are not many people here with experience in this sort of thing,” said Mr Robinson. “It will require special skills, such as understanding how concrete and sea-water react to each other over long term. It will also involve a huge amount of excavation. So a lot of overseas companies are watching with interest, and some have already begun setting up offices here.”

He added that foreign entrants to the South African market will have a steep learning curve. By law, all government contracts require the winning bidder to include black equity partners. While local companies have adapted their operating models to include black participants, first time entrants to the market will have to figure their way through the process – a daunting prospect for many.

Another hurdle is the glacial pace at which these projects get signed off. “We hear a lot of talk but as yet these projects are not coming to fruition,” Ms Dlamini noted.

Funding is the biggest fence to be cleared, but private sector asset managers holding funds controlling ZAR 4.6 trillion (US$ 460 billion) – almost five times the capital required – are in talks with the government to act as banker to the infrastructure programme.

The stunning success of the World Cup build, which saw five new stadia and a mass transit system put in place in the face of substantial international and local scepticism, suggests that once financing is in place, projects will go ahead.

Eskom, the electricity utility, is in the early stages of a long term process to double the country’s power output. It needs to add nearly 40 GW to the country’s grid, and plans five new nuclear stations and numerous renewable projects such as wind and solar farms. It is presently struggling to complete the Medupi power plant, the world’s largest dry-cooled coal station, which is two years behind schedule.

Due to the lumbering progress on this, and a sister coal plant also underway, sceptics have poured doubt on Eskom’s nuclear ambitions. But as the country’s need for power grows, and environmental concerns make coal plants ever more contentious, nuclear is likely to be viewed as the best solution

Outside South Africa

In the meantime, South African companies are looking further north; the continent is home to the six fastest growing economies in the world, and infrastructure spend is increasing rapidly.

“South African companies are setting up offices across the continent,” says Michael Vincent, leader of the Strategy practice at Deloitte Consulting in Johannesburg. “They are spreading their risk and looking for new growth in the rest of Africa. Many countries to the north of here have outperformed the OECD economies by a wide margin.”

Although Africa as a whole is a tough place in which to do business, local South African companies are running into operational constraints at home that are weighing on profitability. Union militancy and above-inflation wage increases, coupled with declining productivity, have impacted on the bottom line. “Companies are caught in the jaws of the crocodile – higher wages but lower productivity. This is largely absent in the rest of Africa,” Mr Vincent concluded.