Private Equity Review – Financial Mail
Only the tough and daring will survive
22 May 2009
By Razina Munshi
Fledgling private equity companies took a thumping from 2008's liquidity squeeze. To cope, they had to rely on experienced management teams and a big dose of creativity - and it hasn't always been enough.
The crisis has affected deals in ways that many refuse to admit. "At the midmarket level, firms are still open for business," says JP Fourie, executive officer of the SA Venture Capital & Private Equity Association (Savca).
But the price expectation gap between buyers and sellers is the biggest problem, says KPMG head of private equity Warren Watkins. He says sellers still believe in yesterday's prices, and there is not enough clarity on future profits - and this is causing deals to fail.
However, as much as the crisis has cramped the style of many middle-market private equity companies, there is still money to be made in this niche. "The midmarket is not always a sexy space," says Cora Fernandez, deputy CEO of Sanlam Private Equity and chair of Savca. "The egos of private equity fund managers who believe they can raise huge funds often get in the way."
Medu Capital is one example of a fund that has stuck to its mandate, in spite of tough times. Medu's first fund was incubated by Brait, the JSE-listed financial services company that holds 49% of Medu, in 2003.
Largely thanks to the Brait relationship, Medu was able to raise R250m in capital - and provide big returns for its funders. This cash was invested in such companies as Pepkor Holdings and Durban-based human resources company Capital Outsourcing.
Medu founder Nhlanganiso Mkwanazi says the second fund, which closed at R900m last May, is three times bigger than the first, and was raised independently.
However, he says the finance chaos over the past year has forced Medu to adapt its decision-making. "We negotiated some contracts with a particular economic outlook in mind," says Mkwanazi. But when things changed, those had to be reviewed, and some contracts did not materialise.
Medu has also had to lower its growth expectations for some of the companies within its portfolio. But, says Mkwanazi, these companies aren't under liquidity pressure - thanks to Medu's policy of selecting companies without significant debt, and with strong balance sheets.
He says the liquidity crisis can actually be a boon for midmarket private equity companies over the longer term. This is because investing in companies that are beginning to recover often provides better returns than investing in a company operating at the peak of the market.
A newer entrant to the private equity scene is Capitalworks Equity Partners, which says it is raising funds easily despite the global downturn.
Capitalworks managed to raise funds and nail down two investments last year. Director Darshan Daya says this was largely a function of sticking to Capitalworks' strategy of investing in the middle market.
Though Daya admits that investors have seen the value of their assets diminish, which has affected their ability to commit to private equity, they are still keen to participate.
Another small player, the black-owned Vantage Risk Capital, began doing business in 2001 on the steam of experienced private equity experts like Luc Albinski, its managing partner. But while Capitalworks ventured into the top end of the midmarket, Vantage played in a different space.
Vantage identified a shortcoming in SA's private equity space: little mezzanine capital is available. This finance sits between equity and debt. Interest payments are sometimes not paid for several years, but when they are paid, it is at a higher return.
By offering mezzanine capital, Vantage became the first independent player in this asset class. By November 2007, it raised a R1bn mezzanine fund from investors including the Netherlands Development Finance Company and the Transnet Pension Fund. Of this R1bn, it has already invested R980m in five investments, including the acquisition of 21% of Safripol by Thebe Investment Corp.
Horizon Equity Partners, one of SA's longest established private equity firms, has evolved from a technology venture capital specialist to a general mid-market investor. Horizon has raised more than R900m from investors. Good returns and a strong team have kept these investors happy - relationships its team would do well to foster in a tight credit environment.
RMB Corvest, founded in 1989, used to dominate the midmarket space. It was incubated by FirstRand's merchant banking arm RMB, and is a captive fund, which means it uses its own funds and not third party funds. Being a captive fund also means it does not have the same pressure to exit investments that other companies do. The company has completed about 130 deals, 30 of which are empowerment deals, valued at R5,7bn overall.
Another example is Treacle Private Equity, which built its reputation by providing solid returns to investors despite the dot-com bust. Treacle looks for investments in medium-sized businesses, particularly export and manufacturing businesses in need of capital to grow their operations. It also looks at businesses supplying goods and services to core industries in SA.
Though most small private equity players target medium-sized businesses on a general basis, others have taken a "sector-specific approach" - a strategy that Fernandez says could become more common.
Private equity funds that focus specifically on intellectual property (IP) are the most "exotic" of sector-specific funds, says Fernandez. Where others shy away from risky start-ups, these intellectual property funds deliberately look for early-stage investments in technology.
In the US, companies such as Ocean Tomo - a private equity firm founded by one-time US presidential candidate Ross Perot - have been doing this for years. Essentially, these private equity funds look to invest in companies with undervalued intellectual property rights, such as patents and trademarks. Over time, these private equity investors look to "unlock" the value of these intellectual property assets, and then exit the investments at a profit.
But this is a niche area and isn't always well understood, so it's often more difficult to raise cash for these IP funds. The SA Intellectual Property Fund (SAipFund) - started in 2005 and managed by Triumph Venture Capital - is a case in point. Triumph initially struggled to raise capital, but managed to woo the likes of the Industrial Development Corp and Sanlam Investment Management as investors.
According to its prospectus, the SAipFund looked for three to seven-year investments in "early stage" technology companies, where there was "any invention or innovation, patented or otherwise, that leads to sustainable differentiated products". The minimum investment was R3m.
Other private equity firms are catching on to intellectual property too. Last year, Johann Rupert's VenFin started an intellectual property investment fund known as InVenFin - "particularly interested in bio-tech, hi-tech, IT and product design" - with R50m in seed capital.
Fourie says that in tough times, innovation tends to increase. IP funds are also likely to be spurred on by government's Technology Innovation Agency, run by the department of science & technology. It's a tough sell, but if the likes of InVenFin or SAipFund are able to produce a few winners, the credibility of the investment niche will be strengthened.
Though sector-specific funds might be the right tonic for smaller private equity firms, it's often difficult for them to raise finance. "The risk appetite of SA investors is far too low," says Fernandez.
He says that in many cases investors completely shy away from these types of funds, with government entities and development finance institutions (DFIs) the only willing investors.
The understanding of this asset class is simply not there, he says, and without a different approach to risk, pension funds and general asset managers will stay away.
New Africa Mining Fund, managed by Decorum Capital Partners, is another sector-specific fund. Established in 2003 with R564m in committed capital, it has overcome a bumpy start. It took investors a long time to understand what the fund was trying to do, says Fernandez. This mining fund was established to invest in junior mining activities in SA and other African countries. It provides funds for exploration, including pre-feasibility studies.
It has had a number of notable successes, including the JSE-listing of Petmin (in which the fund held 25%), Jubilee Platinum, and SA Coal Mining Holdings. Most of these investments have been "realised" - private equity jargon for "sold" to other investors.
Another new niche fund is Agri-Vie, which was formed by Sanlam Private Equity last year. It focuses on agricultural businesses, and has already secured R330m in investments.
The fund is the first of its kind in SA and it's focused on entrepreneurs in the agribusiness value-add sector rather than directly in the farming business. Development finance institutions have invested heavily in the fund.
But the absence of new deals will keep the sector on the back foot for a while. Smaller private equity firms, especially, will have to be creative to ride through the tough patch.
KPMG's Watkins says the market will improve only late into 2010.
Fourie says that though there will be some tweaking of business models, there are still lenders looking for good deals. And because product innovation takes place at the developmental stage in a company, this is where private equity firms still see big returns for investors.
Private Equity Review – Financial Mail
Only the tough and daring will survive
22 May 2009
By Razina Munshi
Fledgling private equity companies took a thumping from 2008's liquidity squeeze. To cope, they had to rely on experienced management teams and a big dose of creativity - and it hasn't always been enough.
The crisis has affected deals in ways that many refuse to admit. "At the midmarket level, firms are still open for business," says JP Fourie, executive officer of the SA Venture Capital & Private Equity Association (Savca).
But the price expectation gap between buyers and sellers is the biggest problem, says KPMG head of private equity Warren Watkins. He says sellers still believe in yesterday's prices, and there is not enough clarity on future profits - and this is causing deals to fail.
However, as much as the crisis has cramped the style of many middle-market private equity companies, there is still money to be made in this niche. "The midmarket is not always a sexy space," says Cora Fernandez, deputy CEO of Sanlam Private Equity and chair of Savca. "The egos of private equity fund managers who believe they can raise huge funds often get in the way."
Medu Capital is one example of a fund that has stuck to its mandate, in spite of tough times. Medu's first fund was incubated by Brait, the JSE-listed financial services company that holds 49% of Medu, in 2003.
Largely thanks to the Brait relationship, Medu was able to raise R250m in capital - and provide big returns for its funders. This cash was invested in such companies as Pepkor Holdings and Durban-based human resources company Capital Outsourcing.
Medu founder Nhlanganiso Mkwanazi says the second fund, which closed at R900m last May, is three times bigger than the first, and was raised independently.
However, he says the finance chaos over the past year has forced Medu to adapt its decision-making. "We negotiated some contracts with a particular economic outlook in mind," says Mkwanazi. But when things changed, those had to be reviewed, and some contracts did not materialise.
Medu has also had to lower its growth expectations for some of the companies within its portfolio. But, says Mkwanazi, these companies aren't under liquidity pressure - thanks to Medu's policy of selecting companies without significant debt, and with strong balance sheets.
He says the liquidity crisis can actually be a boon for midmarket private equity companies over the longer term. This is because investing in companies that are beginning to recover often provides better returns than investing in a company operating at the peak of the market.
A newer entrant to the private equity scene is Capitalworks Equity Partners, which says it is raising funds easily despite the global downturn.
Capitalworks managed to raise funds and nail down two investments last year. Director Darshan Daya says this was largely a function of sticking to Capitalworks' strategy of investing in the middle market.
Though Daya admits that investors have seen the value of their assets diminish, which has affected their ability to commit to private equity, they are still keen to participate.
Another small player, the black-owned Vantage Risk Capital, began doing business in 2001 on the steam of experienced private equity experts like Luc Albinski, its managing partner. But while Capitalworks ventured into the top end of the midmarket, Vantage played in a different space.
Vantage identified a shortcoming in SA's private equity space: little mezzanine capital is available. This finance sits between equity and debt. Interest payments are sometimes not paid for several years, but when they are paid, it is at a higher return.
By offering mezzanine capital, Vantage became the first independent player in this asset class. By November 2007, it raised a R1bn mezzanine fund from investors including the Netherlands Development Finance Company and the Transnet Pension Fund. Of this R1bn, it has already invested R980m in five investments, including the acquisition of 21% of Safripol by Thebe Investment Corp.
Horizon Equity Partners, one of SA's longest established private equity firms, has evolved from a technology venture capital specialist to a general mid-market investor. Horizon has raised more than R900m from investors. Good returns and a strong team have kept these investors happy - relationships its team would do well to foster in a tight credit environment.
RMB Corvest, founded in 1989, used to dominate the midmarket space. It was incubated by FirstRand's merchant banking arm RMB, and is a captive fund, which means it uses its own funds and not third party funds. Being a captive fund also means it does not have the same pressure to exit investments that other companies do. The company has completed about 130 deals, 30 of which are empowerment deals, valued at R5,7bn overall.
Another example is Treacle Private Equity, which built its reputation by providing solid returns to investors despite the dot-com bust. Treacle looks for investments in medium-sized businesses, particularly export and manufacturing businesses in need of capital to grow their operations. It also looks at businesses supplying goods and services to core industries in SA.
Though most small private equity players target medium-sized businesses on a general basis, others have taken a "sector-specific approach" - a strategy that Fernandez says could become more common.
Private equity funds that focus specifically on intellectual property (IP) are the most "exotic" of sector-specific funds, says Fernandez. Where others shy away from risky start-ups, these intellectual property funds deliberately look for early-stage investments in technology.
In the US, companies such as Ocean Tomo - a private equity firm founded by one-time US presidential candidate Ross Perot - have been doing this for years. Essentially, these private equity funds look to invest in companies with undervalued intellectual property rights, such as patents and trademarks. Over time, these private equity investors look to "unlock" the value of these intellectual property assets, and then exit the investments at a profit.
But this is a niche area and isn't always well understood, so it's often more difficult to raise cash for these IP funds. The SA Intellectual Property Fund (SAipFund) - started in 2005 and managed by Triumph Venture Capital - is a case in point. Triumph initially struggled to raise capital, but managed to woo the likes of the Industrial Development Corp and Sanlam Investment Management as investors.
According to its prospectus, the SAipFund looked for three to seven-year investments in "early stage" technology companies, where there was "any invention or innovation, patented or otherwise, that leads to sustainable differentiated products". The minimum investment was R3m.
Other private equity firms are catching on to intellectual property too. Last year, Johann Rupert's VenFin started an intellectual property investment fund known as InVenFin - "particularly interested in bio-tech, hi-tech, IT and product design" - with R50m in seed capital.
Fourie says that in tough times, innovation tends to increase. IP funds are also likely to be spurred on by government's Technology Innovation Agency, run by the department of science & technology. It's a tough sell, but if the likes of InVenFin or SAipFund are able to produce a few winners, the credibility of the investment niche will be strengthened.
Though sector-specific funds might be the right tonic for smaller private equity firms, it's often difficult for them to raise finance. "The risk appetite of SA investors is far too low," says Fernandez.
He says that in many cases investors completely shy away from these types of funds, with government entities and development finance institutions (DFIs) the only willing investors.
The understanding of this asset class is simply not there, he says, and without a different approach to risk, pension funds and general asset managers will stay away.
New Africa Mining Fund, managed by Decorum Capital Partners, is another sector-specific fund. Established in 2003 with R564m in committed capital, it has overcome a bumpy start. It took investors a long time to understand what the fund was trying to do, says Fernandez. This mining fund was established to invest in junior mining activities in SA and other African countries. It provides funds for exploration, including pre-feasibility studies.
It has had a number of notable successes, including the JSE-listing of Petmin (in which the fund held 25%), Jubilee Platinum, and SA Coal Mining Holdings. Most of these investments have been "realised" - private equity jargon for "sold" to other investors.
Another new niche fund is Agri-Vie, which was formed by Sanlam Private Equity last year. It focuses on agricultural businesses, and has already secured R330m in investments.
The fund is the first of its kind in SA and it's focused on entrepreneurs in the agribusiness value-add sector rather than directly in the farming business. Development finance institutions have invested heavily in the fund.
But the absence of new deals will keep the sector on the back foot for a while. Smaller private equity firms, especially, will have to be creative to ride through the tough patch.
KPMG's Watkins says the market will improve only late into 2010.
Fourie says that though there will be some tweaking of business models, there are still lenders looking for good deals. And because product innovation takes place at the developmental stage in a company, this is where private equity firms still see big returns for investors.