Private equity needs to adapt

The global credit crisis has produced a mixed bag of fortunes for private equity - the investment class in which capital is invested in private companies. On the downside, corporate earnings have declined but on the up, reduced company valuations have produced a range of investment ‘bargains’. Profitable exit from deals is likely to be delayed due to the downturn, however, with a slowdown in the number of companies listing on stock exchanges, companies which may previously have gone public are now good prospects for private equity investors.

This was reported by the South African Venture Capital and Private Equity Association (SAVCA) and Sanlam Private Equity (SPE) at a jointly-hosted media briefing in Johannesburg today which examined the state of private equity locally and globally.

Private equity currently…

What is certain, said Cora Fernandez, deputy CEO of SPE and chairperson of SAVCA, is that experienced managers have demonstrated their ability to adapt in a changing and challenging market. “Globally, merger and acquisition activity has slowed and mega deals have evaporated. Investors remain cautious since earnings visibility is a major challenge and debt markets have improved marginally. There is no shortage of debt for good deals, but the amount of debt offered has come down along with gearing levels. We have, in essence, gone back to private equity basics.”

She said that private equity players in developed markets were now looking to mid-size companies for investment opportunities, with a hive of activity currently underway in underperforming assets and secondaries.

“The private equity industry in SA is far better placed than its more mature counterparts in the first world. South African private equity deals have never been geared to the same extent as the gearing levels seen in developed markets. As a result, we don’t expect to see a high level of underperforming or distressed assets, work outs or turnarounds,” said Fernandez.

She said that South Africa’s industry may be small by international standards - it makes up only one percent of global activity - but it does contribute a significant 2.8 percent to GDP which contributes to expansion and development in the country. “It is sophisticated and well-organised with a well established network of highly experienced players, deep and liquid debt markets and solid legal framework.

“Currently, the biggest challenge facing us in the aftermath of the financial crisis is fundraising. Locally, investors into PE funds are largely pension funds and endowments, many of which are currently reviewing their asset allocation strategies in search of greater liquidity. More than 50 percent of capital raised by PE funds in the past two years was sourced offshore, principally the US and European countries. The full extent and consequences of this risk is only likely to be felt in the next 12 to 18 months.”

Fernandez said that, despite these challenges, private equity remains a great source of foreign direct investment and of growth and expansion finance. “This is very good news for the financial services sector and the economy. It essentially means that we can use foreign capital to finance and stimulate growth in SA.”

Looking ahead…

Looking ahead over the next few years, J-P Fourie, executive officer of SAVCA said that more equity-only deals were a strong possibility in South Africa and around the world. “But raising funds in a climate of depressed corporate earnings will be a challenge. We will also see the lifecycle of a private equity deal increase as companies take longer to convert investment funds into tangible business results.”

He said that it looked likely that huge write-downs would be made, particularly in the highly leverage Europe and US, and that highly profitable exits would present a massive challenge. “Private trade sales will far outstrip listing exits or sales to other private equity funds and, unfortunately, some new, young private equity firms could fall victim to a low appetite for private equity fund raising.”

On the plus side, many international players are still extremely interesting in the value which emerging markets can offer. “Because, unlike the stagnant or declining growth in Europe, the US and Australia, there is still good growth in China, Brazil and India and, to a larger extent, the African continent.”

The SAVCA KPMG annual private equity and venture capital industry survey results will be published later in May. For more information visit www.savca.co.za or www.spe.sanlam.com.