Friday Letter: Gamble on growth

As debt markets constrict mega fund deployment, expect to see more growth capital deals of the kind Permira executed this week. It's no mean feat to get a deal done in this climate, the real trick will be to ensure they are profitable.  

Who would have bet on growth capital investments in emerging markets being the route out of the debt market malaise for the mega-funds? And yet Permira’s surprising deal yesterday to take a 20 percent stake in Galaxy, the Macao casino operator, suggests this may be the case.

In Asia, big ticket private equity is a tricky business. As a rule of thumb, large corporates and family owners in Asian markets are reluctant to hand LBO investors and particularly foreign funds the keys even to non-core portions of their businesses. The alternative for buyout investors is to trawl the public markets as a potential source of deal flow. However, PTPs are difficult to complete even at the best of times. Just think of sponsors’ travails in Australia earlier this year. 

That leaves growth-driven minority investing á la Galaxy as a strategy, where private equity mega fund executives have to make use of deal skills that haven’t been much in demand for years.  Indeed, Permira’s success in Macao must in part be due to its willingness to turn back the clock.

Martin Clarke, Permira’s lead partner on the deal, told PEO it was return to a private equity model of 15 years ago, a time he remembers before public-to-privates and mega buyouts. “If you are going to do deals in Asia you have to go in partnership with a family or a large shareholder group.”

Throw in sector knowledge such as Permira’s experience from past and current investments in gaming, hotels and other leisure groups, and you may be on to a winning formula. Indeed the proprietary lead for the Galaxy deal came from an adviser the firm had worked with in the past on a number of deals, Clarke said.

And good timing too: it is in part a coincidence the deal comes just as Permira’s more standard buyout strategies falter under circumstances outside of the firm’s control.

It is nonetheless a most emphatic statement of intent. Permira executives have to look back to December 2004 for the firm’s last growth capital deal, when they bought a 25 percent stake in Marazzi Group, an Italian tile maker.

But here they are again: a large bet on a business without majority ownership of the equity, and without any additional gearing. In fact, the financial structure after Permira’s injection of capital actually deleverages Galaxy’s balance sheet.

That does not mean the deal is risk free, however. Asian private equity has been here before with disastrous results from the minority investing at the beginning of the 1990s. The appetite of the likes of Blackstone, Permira, KKR and Warburg Pincus for growth capital deals in the region in order to put meaningful amounts of capital to work is no guarantee of success.

Permira is confident its corporate governance on the Galaxy deal is good. It has two board seats, dilution protection, some veto rights and undertakings from the majority family shareholder. But the firm is still a minority investor in a foreign land.

And it is still six to nine months away from opening its Hong Kong office, the better to oversee the investment – although in the context of a medium-term investment, this is a short delay.

More serious is the market risk. The growth and popularity of gaming in Macao has been nothing short of astonishing, but Permira’s investment is far from a one-way bet. The number of mainland Chinese visitors to Macao fell by 16.5 per cent last month after neighbouring Guangdong province brought in visa restrictions in May  – although according to Hong Kong-based China Primary Research, overall visitor numbers grew. The world’s largest gaming market could be vulnerable to further tightening measures from China.

Still, Clarke and his team have enough confidence in the vision they share with Galaxy’s founding family to bet almost $1 billion on the deal.

Expect more of the same from Permira, a source close to the firm says. Expect, frankly, more of the same from the firm’s competitors as well – especially now that conventional LBO action in these firms’ core markets is slowing down.