The odd couple

The fates of two European aluminium businesses raise questions about the combination of private and sovereign capital, writes Toby Mitchenall.

Sovereign wealth funds are set to become the most potent forces in private equity. With their abundance of long term capital and growing appreciation for the asset class, they stand to become one of the most important elements of the limited partner universe.

Problems can arise, however, when these giants decide to go direct.

In a bid to track sovereign wealth funds’ direct investment behaviour, a research paper published last year by Harvard Business School examined deals executed by sovereign wealth funds between 1984 and 2007. The paper concluded that these funds tend to “engage in a form of trend chasing” and are more likely to invest when prices are at their highest. If the funds involve politicians in their decision making processes, said the report, they are more likely to invest in their home markets and more likely to see their investments decrease in value in the first 12 months.

The report should make interesting reading for investment professionals at Apollo Global Management. The US distressed debt and private equity leviathan last week teamed up with the €20 billion Fonds Stratégique d’Investissement, a French sovereign wealth fund in everything but name.

The two investors submitted a joint bid to for 61 percent of Alcan Engineered Products, an aluminium producer owned by mining conglomerate Rio Tinto. If successful, Apollo would own 51 percent, the FSI would own 10 percent and Rio would keep the rest.

The FSI was launched by French president Nicholas Sarkozy in 2008 to protect the capital structure of what it calls “strategically important companies” by making direct minority investments. Alcan is headquartered in France, where it employs 10,000 people. Bernard Finet, executive board member of the FSI, described the proposed acquisition as “emblematic”.

The raison d’être of the FSI is clear: sovereign ownership of strategic assets, keeping French business French.

The pairing with Apollo is, therefore, a curious one. Apollo also has very clear goals, but they all relate in some way to generating a return for investors, not protecting French industry.

While the two entities are currently aligned in their aim to own Alcan, this situation could conceivably change. What if Alcan had to be restructured and jobs needed to be shed? What if it made fiduciary sense to locate certain business divisions outside France? It is doubtful that such measures would sit well with both sides of the partnership.

The developments at another European aluminium business – Almatis in Germany – provide a cautionary tale.

In July 2009 Dubai International Capital, an investment company founded by Dubai’s ruler Sheikh Mohammed bin Rashid Al Maktoum and the owner of Almatis since 2007, announced it was “partnering” with its one of its largest lenders, Oaktree Capital Management, to restructure its debt.

What started as a partnership, however, ended as anything but. Almatis filed for bankruptcy in April and after a bitter battle between DIC and Oaktree a court ruling last week backed DIC’s plan to refinance the business with $100 million of fresh equity and $600 million in new debt.

The battle for Almatis was ostensibly based on two institutions with the same aim: control of the business for financial gain. Both institutions declined to comment further than their public statements on the process, but critics siding with Oaktree have suggested that DIC paid a high multiple for the Almatis’ refinancing and was happy to pay over the odds to “save face”. Those siding with DIC quite reasonably counter that it – along with the judge in the case, independent valuation firm Capstone and the five new lenders – were all satisfied with the new capital structure.

Whatever motivations were at play, the battle was vicious. The fact remains that sovereign capital and private capital do not operate under the same pressures and often have divergent priorities and time horizons. They could make for uneasy bedfellows.