Private equity shells out for big returns
THE R63-billion Pepkor deal late last year and the R12-billion Virgin Active deal last month shone a spotlight on the big bucks that can be made in private equity.
But the struggling Edcon group, owner of the biggest local clothing retailer, Edgars, is an example of how private equity can go wrong.
The South African private equity industry, according to the 2014 KPMG-Savca private equity industry survey, with R162-billion in assets under management, is the largest on the continent, and with R46-billion available for future deals in South Africa and R12.5-billion earmarked for investment elsewhere in Africa, more big deals are to come.
Confidence in the industry is strong, according to a recent Deloitte Africa private equity confidence survey. In particular, respondents in “East and West Africa are noticeably more optimistic about the economic prospects in those regions than their counterparts in South Africa”, said Sean McPhee, a partner at Deloitte’s corporate finance unit.
Erika van der Merwe, CEO of the Southern African Venture Capital and Private Equity Association, said that with “the tremendous opportunity that Southern, East and West Africa offer for delivering steady returns . . . more and more private equity fund managers are becoming active here”.
The return in private equity over five and 10 years to December 2014 in South Africa was 17.7% and 19.1%, respectively, according to a RisCura report last month. This is ahead of the JSE’s All Share index, which delivered 15.79% and 18%. But over three years, the JSE per- formed better, with a 19.48% annualised return compared to private equity’s 14.1%.
The RisCura report shows that private equity deals done between 2000 and 2004 delivered the best returns. These include the purchase in 2003 of retailer Pepkor for R2.1-billion by a consortium including Brait and Old Mutual. With the sale to Steinhoff for R63-billion, Pepkor’s value has rocketed.
Other sizeable deals include Alexander Forbes, which delisted in 2007 when it was bought by a consortium that included private equity groups Actis and Ethos for R8.2-billion. It relisted at R7.50 a share last year, valuing it at R9.7-billion.
Afrox Healthcare delisted in 2005 and 75% was sold to a private consortium led by Brimstone and Mvelaphanda for R3.1-billion. It changed its name to Life Healthcare and relisted in 2010, valuing it at more than R14-billion. The value has nearly trebled to R41-billion.
But for US business Bain, which bought Edcon in 2007 for R25-billion and delisted the group, the returns have not lived up to the promise.
Abdul Davids, head of research at Kagiso Asset Management, said one of the big pitfalls in private equity was that “the mechanism to priva- tise typically involves a lot of gearing. The most notable example is that of Edcon.”
Edcon was a great company, “with Steve Ross, the outgoing CEO, doing a fantastic job of turning it around”, but the amount of debt used to leverage the balance sheet to cover the purchase price meant there was very little room to add value to the business, he said.
Despite Edcon’s troubles, businesses that target consumers and those that are highly cash-generative, where debt can be used to partly finance the investment, are popular targets for private equity funds.
According to Deloitte, private equity players in East and West Africa favour food and beverage businesses.
“A decade of high commodity prices, relative political stability, improved communications and financial infrastructure” had begun to create a middle class that was demanding consumer goods and services, said Rory Ord, head of independent valuation at RisCura.
Data from the Emerging Markets Private Equity Association show that although emerging Asia still attracts the lion’s share — 76% of the $20-billion raised in the first half of last year in emerging markets — sub-Saharan Africa gained the most ground. It accounted for 11% of funds raised during this period; the highest share the region has achieved to date.
Unsurprisingly, those in private equity rate their model higher than the listed market.
Rohan Dyer, head of investor relations at Ethos Private Equity, said: “We fancy our chances against the listed market over the next five years. Most fund managers would not expect returns on the listed market to be much more than 10% a year, but we think we can do a lot better. We don’t make investments unless we believe we can achieve at least a 20% internal rate of return.”
So, for investors on the JSE, what is the outlook?
Sasfin’s David Shapiro said valuations on the JSE were stretched. “We’re paying a lot more today than we were prepared to pay a few years ago. People don’t know where else to go, so we justify the valuations to ourselves.” That “doesn’t mean our companies are bad, but there’s a far greater choice of international companies doing business globally”.
The cumulative value of all shares on the JSE in March was R11 922.2-billion, with 393 companies listed, nearly double the value of 405 companies listed in March 2010, at R5 143.2-billion.
But Davids said the JSE had been one of the best-performing stock exchanges in the world, especially since the global financial crisis.
“We had nuances like currency weaknesses that have impacted — but for the past three years in particular, we’ve had the good fortune of having some of the best global companies like Naspers go from R173 six years ago to touching R2 000 recently.”
We fancy our chances against the listed market over the next five years