A recent report published by investment bank Merrill Lynch suggests that South Africa presents an attractive destination for global private equity. The report identifies three fundamental characteristics that make South African companies suitable for private equity investment: strong earnings growth, attractive valuations and low levels of debt.
Bill Ashmore, partner at Johannesburg-based Ethos Private Equity, highlights some interesting differences between South African companies and those in the US and Europe. He says: “Companies on the Johannesburg Stock Exchange have produced an average earnings growth rate of 20 percent per annum for 2006 – substantially more than companies on US and European stock exchanges – and this growth rate appears sustainable given the positive macro economic landscape in South Africa.”
In terms of valuations, South African companies appear more attractive than their counterparts elsewhere. Ponders Ashmore: “We in South Africa think our private equity valuations are ridiculously high, but of course compared with valuations in Europe and the US, they are still very reasonable.”
On the leverage front too, South African companies have much to recommend them to would-be private equity buyers. David Lewis, research analyst at Merrill Lynch, says: “While the average net debt/equity ratio is 45 percent in Europe and 32 percent in the US, in South Africa it is just 7 percent.”
Retail is one of the most attractive sectors for private equity players. There have recently been some high-profile South African deals in the sector, not least the buyout of listed retail chain Edgars Consolidated Stores by Bain Capital for 25 billion rand (€2.7 billion; $3.5 billion) – the biggest South African buyout to date. Bain fought off competition from rival buyout firms KKR and The Blackstone Group to win the auction.
Domestic GPs have been active in the sector too. Johannesburg-based Brait Private Equity is currently leading a bid to buy Shoprite, the country's second-biggest grocery chain, for 14.2 billion rand.
Ethos Private Equity, meanwhile, bought national sports goods retailer Moresport in September for 681 million rand. Founded in 1984, Ethos closed its fifth fund in October on 5.5 billion rand – the biggest private equity fund raised for investment in Africa to date.
Reflects Lewis: “Companies in the retail sector are particularly attractive because they have stable cash flows, inefficient cash-rich balance sheets and securitisation possibilities.”
The natural resources sector is another space seen as ripe for private equity investment, largely driven by high commodities prices. Says Lewis: “The perception of cyclicality has historically resulted in limited private equity participation in the sector. However, the huge cash flows being generated at current high commodity prices ought to change this.”
Despite the apparent suitability of many South African companies for private equity investment, potential investors are faced with some obstacles. One of these is the uncertain political and regulatory backdrop. Explains Lewis: “The collective bargaining power of the South African unions together with the current lack of clarity on the impact of future legislation [such as Black Economic Empowerment requirements] are potential challenges – particularly for the resource sector.”
Another threat is currency volatility. Reflects Lewis: “South Africa's relatively low FDI/GDP ratio could explain why rand volatility remains high compared with other emerging market and commodity currencies. From a private equity perspective, this currency volatility is not something to be ignored, but nor does it present an insurmountable risk.”
Overall, the investment proposition for many South African companies appears compelling. It would not be surprising, therefore, for the Edgars buyout to become a blueprint for bigger and more high-profile South African buyouts during the rest of 2007.
DFJ LAUNCHES BRAZILIAN FUND
US venture firm Draper Fisher Jurvetson has teamed up with Brazilian rival FIR Capital Partners to raise a $40 million (€30 million) fund for investments in Brazil. The fund, the DFJ FIR Brazil Fund, is DFJ's 17th regional affiliate fund. Guilherme Emrich, partner at FIR, said: “This marks the first time that a leading Silicon Valley venture capital firm has entered the Brazilian market.” The two firms will also launch a $100 million fund, DFJ FIR Brazil Fund II, which will invest in Brazilian companies in high growth sectors. Tim Draper, founder and managing director of DFJ, said: “Brazil is a leading emerging economy with favourable macroeconomics and a highly entrepreneurial culture that is creating a significant number of attractive high tech investment opportunities.” DFJ has offices in more than 30 cities and $4.5 billion under management.
ORIGO RECRUITS SOUTH AFRICAN MANAGING DIRECTOR
Beijing-based private equity firm Origo Sino-India has hired John Blake as managing director of mergers and acquisitions. Blake will be responsible for finding and closing South African deal opportunities that have a particular relevance to India and China. Blake founded Hyperion Capital Services, a provider of consulting and corporate finance advisory services, in 2003, and is on the board of Smartplan Consulting, a provider of business intelligence services to South African companies. Chris Rynning, Origo's chief executive officer, said: “There are significant business opportunities arising between resource-rich South Africa and the resource consuming economies of China and India. As established and well connected investors in China and India, we are advantageously placed to leverage such opportunities and, with a highly experienced senior executive now in place in South Africa, we will be able to identify such opportunities more quickly than we could from Beijing or Mumbai.” Origo's flotation on London's Alternative Investment Market in December raised £12.8 million (€18.7 million; $25.3 million).
INVESTOR CONFIDENCE IN EMERGING MARKETS INCREASES
A new study published by the Emerging Markets Private Equity Association (EMPEA), indicated that emerging markets are becoming more popular with institutional investors, driven by improved performance and perceived maturation of fund managers. The study found that 78 percent of LPs who participated expect to increase allocations to emerging markets during the next five years. It also found that 63 percent of LPs expect outperformance relative to developed market funds during the next five years. 61 percent of LPs expressed an interest to invest in Russia in 2007, and 20 percent in Africa, up from just 4 percent in 2006.
EMP SELLS STAKE IN SOUTH AMERICAN MARINE COMPANY
EMP Global, which manages the AIG GE Capital Latin America Infrastructure Fund (LAIF), has sold a substantial part of its stake in Ultrapetrol, a marine transportation company with operations in South America. The fund received about $121 million (€89 million) from the sale of 68.2 percent of its stake. LAIF originally invested in the company, which was founded in 1992, in 2000. Katherine Downs, partner at EMP, said: “The substantial appreciation of Ultrapetrol's stock since the IPO allowed the company to move ahead with a follow-on offering just six months after the IPO, generating proceeds which the company will use for new growth initiatives.” Since its inception in 1996, LAIF has invested about $800 million in telecoms, transport, energy and natural resources. EMP Global manages $7 billion through eight emerging markets private equity funds.
TEACHERS BUYS CHILEAN WATER COMPANIES
Ontario Teachers' Pension Plan has bought two Chilean water supply and sanitation companies from Southern Cross Group. The deals are Teachers' first two infrastructure investments in South America. Jim Leech, senior vice-president at Teachers, said: “Chile is an excellent country for us to invest in because of its growing economy, openness to foreign investment, and mature regulatory environment for water and wastewater services.” Southern Cross bought the two businesses for $369 million just 14 months ago from RWE Thames Water. Teachers also has a 25 percent stake in Northumbrian Water Group, a UK-listed water services company, which it bought in 2005. The Ontario Teachers' Pension Plan is one of Canada's biggest pension funds with about $96 billion under management (see p. 92). Teachers' Private Capital, its private equity business, recently opened an office in London as a base for its future European direct investment activity.