A cautious momentum . . .

The strong finish and positive trends in 2017 signal a good year ahead for our private capital markets — despite private equity concerns over exit options, write James Hawes and Andrew Matthews.

On the whole 2017 was a more modest year in the private capital markets with deal values only half that of 2016 (US$8.6 billion versus $3.5 billion).

The difference can be ascribed, in part, to a general decline in market confidence during the first half of the year — driven by uncertainty in the global capital markets. But it is mostly due to the absence of a few more higher value deals, like Sistema, Sky/ Vodafone and Fairfax/NZME, which had propped up performance in 2016.

However, despite the inconsistent performance, we observed some positive trends over the past year.

From an “NZ Inc” perspective, it was good to see our credentials as a leader in innovation bolstered through transactions such as Apple’s acquisition of Power by Proxi — Auckland’s worldleading wireless charging company.

its latest fund Pencarrow V at $250 million, well above the target of $200m.

Fundraising was completed in eight weeks and the fund was significantly oversubscribed by leading New Zealand institutions, iwi, foundations and community trusts, and pri-

The power of the “Made in NZ” badge was also once again proven, as offshore buyers paid significant multiples for those assets that rest strongly on the quality associated with New Zealand products. The acquisition of Macpac by Super Retail Group and of Icebreaker by VF Corporation were prime examples of this trend.

Last year also saw the continuation of the previous year’s move toward a rationalisation of non-core assets. This trend was particularly evident in the insurance world, with CBA’s disposal of CommInsure and Sovereign.

It’s evident that quality assets will remain the focus for private equity. Our domestic PE firms in particular demonstrated success over 2017 in actively hunting proprietary deals.

These trends, and perhaps some vate investors. Pencarrow said the fund’s focus was on investing in MBOs, succession deals and expansion capital opportunities among privately-held companies in the midmarket segment.

Withers says that, in New Zealand, 25 per cent of owners with businesses more than $25m turnover were thinking of exiting within the next five years. For businesses between $2m and $25m turnover, 47 per cent of the owners were looking at selling within that period.

“You will see a huge structural ownership change in New Zealand, but many businesses aren’t ready for the transition,” says Withers.

“The owner (looking to exit) needs to create an alignment with management and staff to maximise the sale process. The owner has an emotional connection after building the business over 20 years or so. It can take three to five years to shape a conversation with management and develop a clear (exit) plan.” pent-up frustration over general inertia in transactional volume, resulted in a significant bounce in deal volumes in the second half of 2017 — which has continued into 2018. Examples include the deals already mentioned, but also Paymark, the Mad Butcher assets, and trust company Complectus.

However, we’ve seen this increased momentum tempered with a degree of caution within the private

Typically, management would buy into the business with the backing of a private equity firm, which takes a 25 per cent shareholding. The existing owner retains 20 per cent while the transition is managed.

“The owner takes money out on day one but still retains an invest- markets, particularly for private equity buyers around future exit options. Especially given increasing concerns with the Overseas Investment Office regime.

Having regard to our colleague Michael Pollard’s thoughts on the public capital markets (DX), we continue to believe that private capital provides a critical source of finance to our local companies which are displaying strong growth but are not ment over a three to five- year horizon,” says Withers.

“The private equity firm comes in and incentivises the management to create a more active and accelerated growth story.”

Withers says a lack of succession planning is a concern for some companies.

“The founders started their businesses 20 to 30 years ago and have been very hands-on.

“As they have got older they may strike health issues or are looking for a lifestyle change, and they don’t have the energy to take the opportunities to grow.

“The private equity firm can play an important role in growing the business and creating jobs by utilising the expertise and knowledge of the management team.

“Investors look for a strong track record and a clear strategy that is being executed.

“There are number of aggregation/ consolidation opportunities for buying a similar business in a different region. If you can increase turnover from $5m to $20m over a five-year period, the valuation uplift creates value for management and bankers, and the business can be sold at larger earnings multiples,” says Withers.

He says in the case of MBIs the level of due diligence is higher.

The investor needs to be sure there is a clear business plan and strategy in place and the work has been done. The owner needs to articulate the value proposition and the investor needs to be certain the new management has a good understanding of the industry and the relevant skill set.

“Private equity firms backing a management team to buy into a business is a viable proposition and anecdotally an easier way to do deals,” says Withers. yet ready to spread their capital base further.

There remains plenty of private capital interest in New Zealand, and large portions of investable “dry powder” ready to be deployed. Combined with the aforementioned trends, there is every reason to expect a strong year.

● James Hawes and Andrew Matthews are partners in Simpson Grierson’s corporate team.