CHALLENGE AHEAD

A test for private equity fund managers, writes Pedro van Gaalen

A test for private equity fund managers

Various indicators paint the private equity sector as vibrant and robust compared to other asset classes, but fund managers face a growing number of challenges to keep realising market-beating returns.

Amid persistent global macroeconomic uncertainty, there is also a high probability fund managers will soon have to navigate an economic downturn. Industry-specific structural challenges cited by global private equity fund managers also include high deal multiples, rising competition, excess capital and a lack of attractive deployment options.

Bain & Company’s 2019 Global Private Equity Report shows uncalled capital hit a record high of $2-trillion globally in December 2018 across all fund types, while the average multiple for leveraged buyouts in the US and Europe has hovered around 11 times ebitda in recent years.

While similar dynamics are at play in the local market, SA private equity funds aren’t always sitting on large capital piles. The Southern African Private Equity & Venture Capital Association’s 2018 journal of activity and trends in Southern African private equity and venture capital, highlighted fundraising as a significant challenge, due mainly to the economic and political environment.

“It can now take 18-24 months to raise capital for a first-time fund manager,” says

Craig Beney, co-CEO at Helical Capital Partners. “While second-time funds require shorter capital-raising periods of 12-18 months, it still takes five years to invest and another five years to disinvest. With so many first-generation funds in SA, the main challenge they face … is managing and retaining staff and paying salaries.”

Andrew Chananie, head of leverage finance at Investec, says though there is interest in SA from global long-term investors, they are generally waiting to see what happens after the May elections.

“With SA’s depth of entrepreneurial skill, there could be great opportunities for private equity investors with the right policy framework. However, it has been difficult … for private equity firms to generate high returns from SAfocused companies over the past decade, mainly because the weak domestic economy has [hit] valuations.”

A volatile currency has also made it difficult for fund managers to deliver dollar-based returns, while rising input costs such as electricity, and constrained consumer spending and low business confidence, have dampened markets.

“The uncertain political and economic environment affects the fundraising and investing environment. The nature of changes in the private equity landscape and the concept of blind funds also means the high returns seen in previous periods are now more difficult to achieve,” says Chananie.

He says large-scale transactions appear more elusive nowadays, with smaller transactions more favourable given current market conditions.

In terms of rising competition, numerous new players continue to enter the local market, including many funds previously classified as empowerment partners that are now looking to take a lead on deals.

“For a fund to be empowered, the fund manager needs to be empowered. These rules have allowed for empowered fund managers to establish private equity funds and raise capital from investors who do not themselves need to be empowered,” says Khurshid Fazel, banking and finance partner at Allen & Overy.

“The ability to create an empowered fund with its own capital, together with the reduced appetite for vendorfinanced black economic empowered private equity deals, has led to a proliferation of empowerment funds that compete head-to-head with established funds. This makes exits interesting as empowered fund managers with their own capital to deploy are reluctant to accept lock-ins, but the incumbents still require longterm empowerment partners.”

On the disinvestment side, Beney believes many local fund managers do themselves a disservice by hanging on to assets for longer than is necessary. “Managers sometimes become too attached to assets, even after reaching their initial targets. Sticking to an exit strategy is vital to realise strong investor returns.”

However, the ability to exit successfully is also becoming trickier. “The multiples asked for by sellers are, in general, not reflective of prevailing market and economic conditions, which is hampering exits,” says Chananie.

Khurshid Fazel