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EQUITY INVESTMENTS GOING PRIVATE

PUBLISHED: 8 August 2010, Investor Monthly, Business Day

More retail investors are turning to private equity –but patience is required

Private equity is not that private anymore.  There sweeping demand from retail investors, typically but not exclusively wealthy clients, to diversity into private equity.  It’s fast being seen as the fifth asset class alongside equities, bonds cash and property.  At the same time some investment houses are trying to make private equity investments more accessible to retail clients.

On the institutional front private equity activity is fairly muted among the large private equity (PE) players such as Brait, Ethos and Meiter.  They point to post credit crunch economic conditions and a fall-off in mergers and acquisitions.  But all expect an uptick in 2011 and beyond, fuelled partly by growing interest in direct PE deals from the east, including Japan. 

For individual investors PE is becoming more alluring for various reasons.  On the sell side many smaller private businesses have been shaken up by the global credit crunch and are deciding to call it quits, using PE as a convenient exit route.

The Baby Boomers, many running successful business started in to 1960s are now in their 60s and looking at retiring.  Many don’t have succession plans in place as children don’t want to run the business or have moved to overseas, so PE is an efficient way out. 

Buy side activity from retail investors is more complex and interesting.  Increased portfolio diversification is often cited as the reason, and it makes sense as long as the individual fully understands the nature of PE with its illiquidity and the long-term, J-curve cycle of the investment.

The risk profile of PE is higher than more conventional investments, but so too are the potential returns when distributions are paid and investments realised.  But retail PE investors have to understand it’s a long-term play, sometimes 10 years or longer, and there are no guarantees.

There’s also that close-to-obsessive fixation many high-net-worth clients have with investing in a physical asset they can see, linked to a distrust of equities.  Private client houses will tell you that most of their clients made their initial money in property.  They are sophisticated investors and accept the need for a diversified portfolio, including equities.  But as soon as share price turn down they revolt and want to get out of enquiries.  PE is often seen by them as more compelling investment case.  Historically it has been, with returns for patient investors often far better than equities. 

PE fund managers say there are plenty of possible deals, but a potential pipeline is one thing and done deals another. 

Share ratings on the JSE aren’t helping as many private equity company owners, using the stock market as a proxy, expect too much for their businesses—or prices they could have realised a few years ago but can’t now.  “I think it’s fair to say there’s there some disequilibrium in the stock market at the moment, because the market moved up very strongly resulting in unrealistic price expectations from sellers,” says Andre Roux, CEO o Ethos Private Equity.  “Sellers seem to think they can get what they would have got prior to the global crash.  The consequences of all this are that buyers and sellers are not quite seeing eye to eye at the moment.”  

Ethos is currently investing its fifth pool of PE capital and is raising investments, globally, for its sixth fund.  “Like fund five we want to raise $750m,” Roux says.

It’s no secret that Brait is also raising funds abroad but we could not get details as CEO Antony Ball was “out of the country” when Investors Monthly tried  to contact him. 

Brait Fund IV, the largest pool of PE capital in Africa, is also being invested.  The last significant investment was a 24% equity stake in Buildmax in May last year.

According to a joint survey by the South African Venture Capital Association and KPMG, the volume of local PE funds declined by 2,6% from 2008 to 2009, but still shows  a “healthy” value of R107bn. The survey points out that at end-2009 this represented 3% of GDP, higher than the international norm of 2,7%.

Warren Watkins, head of PE for KPMG, says the market in sub-Saharan Africa over the past two years has been characterised by caution.  “As a result, the appetite for deals has been reined back significantly.  But while market participants remain cautious about 2010, a consensus is building that 2011 is likely to show a robust increase in activity.”

This is roughly in line with Roux’s thinking.  “I don’t think activity levels will change soon.  Maybe when we see earnings come through that meet share ratings, but recent earnings, for example from the banks, have not been too encouraging.”

He says Ethos is on the last lap of investing five.  “We’re confident to wait for the right deals.  You have to go through process of price discovery.  Generally, at the large end of the market, it’s more difficult to get price discovery.”

Freeworld Coatings is cited as a good example of owners, in this case shareholders, expecting too much for a company.  Shareholders voted against a Brait-led PE consortium offer and the deal fell away amid talk of a competing PE offer.  It’s believed the so-called competing bid came from a Japanese PE player.  But in the end it amounted to nothing as there was no firm offer, nor price, on the table.  Freeworld has since withdrawn the cautionary announcement it was trading under and plods along on the JSE.

Thierry Dalais, chairman of Metier Private Equity, says there has not been a lot of activity in PE, which is a reflection of the lower volumes of merges and acquisition and subdued economic activity.  “It has been tough.  Often people say the PE market is not correlated to the public market.  Yes, in terms of volatility there’s less in PE but it’s still correlated.  It’s our job to develop companies over the long term.  But there’s a disconnect when you look at the JSE, and with oversold position in small companies owners are unlikely to sell.”

He says Metier is always working on deals but it has been a slow period.  “Typical our full cycle is five years to invest and five years to invest and five years to develop a company.  But in period like this, one should have unrealistic expectations of how long it’s going to take.”

Like many of the large PE players Metier did several deals around 2005 that should be getting close to the realisation stage, but Dalais says the group has “pretty much sold these”.

When does he see the PE market improving?  “I think it will improve, but (we’re in) a period of austerity.  People don’t want to borrow as much, banks won’t lend as much.”

Turning the growing appetite from retail investors of PE, he says:  “The diversification issue is very interesting.  When these investors get in and out en masse it cause volatility.  I think the volatility in the stock market has scared people, even the blue chips. These investors get out of equity and the buyers come into PE, which pushes prices up.   Retail investors diversifying into PE is as good thing, but they have to be careful.” 

There’s little doubt though that the PE market is becoming more accessible to retail investor and some investment managers are making PE more accessible and not only for the wealthy top end.

There are at least three examples of what look alike credible retail investor PE funds.

Earlier retail offerings were successful with funds by Momentum Wealth and Old Mutual Private Equity now fully committed and closed to investment.  But both have opened a new funds and Barnard Jacobs Mellet Private Equity Services has launch a retail offering. 

New PE operations are also entering the market.  Citadel recently established a new division specialising in PE.  It is largely a sell side business for clients, taking them through the PE cycle to a successful exit.

“Our clients have access to PE investment but don’t really want to work with the big guys,” says Colin Vallis, a PE specialist at Citadel.  “The deals we’re working on would not be considered big transactions, but smaller business of

around R50m to R25m.  Often it’s the Baby Boomers looking at retiring.”

Citadel is busy on about 10 deals, he says, working with management and owners to increase the value of their businesses.  “We’re looking  at four-to five years holding period.  Platforms are lower in smaller business and we can increase valuation by 25% to 30%.  When the business is sold we want 2,8 to 3,5 times our money back.”

All exit strategies are employed, but he says a lot about half will be trade sales.  “There may be consolidation going on, or often the business will be bought by a competitor or supplier, someone who knows the business.”

Vallis says most client’s wants to sell out completely.  “They would rather walk way than seeing somebody else running the business.  The risk in these deals is emotional.  When an offer is on the table they realise they are selling the baby”.

Another new PE fund is Trinitas, an independent third party fund with its three executives-experienced PE players Andrew Hall, Soteris Theorides and John Stipinovich – invested in the fund as well as Sasfin as a partner and anchor investor.  Peotona Group Holdings is the fund’s black empowerment partner.

But why enter the PE market now?  “From a deployed perspective the market is looking excellent,” says Hall.  “Our mandate is mid- cap, mid-market sector and there are some excellent opportunities.”

But the investing side was not easy, with Trinitas going out to market on road shows about 18 months ago, as Lehman Brothers collapsed.  “It was a very tough environment to raise money.  However, we had commitments of R430m at first closing and hope to double that over the next 12 months.”  Hall says the fund is working on a couple of deals.

“We’re not sector specific, except for resources which we avoid.  I suppose we're bottom up investors, just looking for good companies with strong management teams, cash flows and brands.” 

RMB Ventures was on the other side of the Chinese wall in what has been the most successful PE exit year, the listing of Life Healthcare.  It was a great deal for PE investors..According to a trading statement from FirstRand in June, the listing netted a profit of about R800m for RMB’s PE division.

Retail investors had access to the listing through the closed Momentum PE Fund of Funds.  Capital commitment by the funds to its direct investment Life Healthcare was just over R64m.  The valuation plus capital returned to investors was R303,6m.

Eutychus Mbuthia, co –head of RMB Ventures, says its gets the bulk of its deal flow the group and is always working with clients typical management, employees and empowerment partners of private companies.  “If we are comfortable with the business we will invest.  The time of the exit depends on when opportunities arise.” 

Andrew Aiteken, also of RMB Ventures, says:  “Our business model makes us more passive investors, we back managements and employees.  We’re quite selective about the deals we do –the business must have an established track record of at least five years.  We’re looking for risk – adjusted returns.  By definition in PE is a higher risk investment.”

Mbuthia believes that in PE there has to be a trigger for someone to want to sell a business.  “The deal pipeline always looks good.  The harder the part is getting the buyer and seller getting together.”  However RMB Ventures says that it’s “quite bullish” about the PE market going forward. 

So too is the growing number of retail investors wanting a stake in the PE pie.  Five or so years ago the retail market did not know about the PE.  Today retail investors know a lot more. 

But even armed with more knowledge, investors must realise they are far in for the long haul, where returns will initially be negative and in the investment illiquid.  That’s the PE trade-off retail investor’s face- no liquidity during the investment cycle in the hope of higher returns over the long term.