Summary of World Economic Forum 2007 on PE

This serves as a summary of key issues from the WEF on Private Equity in Africa.Of interest is that most contributors are from South Africa. Is SA becoming the PE mecca of the region?

Leslie W. Maasdorp, Vice-Chairman, Absa Capital and Barclays Capital, South Africa, a Young Global Leader, opened with the remark that it is very clear the private equity industry has experienced unprecedented growth. But this activity is also attended by concern, he said, both from regulators and those who foresee the possibility of newly acquired companies becoming saddled with debt.
Nick Pagden, Head, Investment Banking, South Africa, Citi, South Africa, said the key question is: "How sustainable is all of this activity?" A secondary inquiry asks why all this money is coming to this asset class. Private equity far outperforms other asset classes. The boom in private equity has even seen participation by governments. An interesting and important characteristic is the correlation of private equity with debt: for every dollar of private equity investment, four to six dollars are raised on the debt market.
Jon Hamilton Zehner, Senior Country Officer, JPMorgan, South Africa, noted three characteristics of private equity: low interest rates enabling the leveraging up of returns to equity; its attraction to areas of strong economic growth, such as South Africa; and conservative balance sheets of target companies in the case of South Africa. Zehner said that public market investors are not inclined to invest in companies exhibiting a large degree of leverage. Private equity, on the other hand, will accept this and the risk that goes with it.
Brian Molefe, Chief Executive Officer, Public Investment Corporation, South Africa, a Young Global Leader, commented that in the United States, with the advent of private equity, regulators tightened the screws and then required more disclosure. The outcome was that going private became more attractive. Molefe also said that Africa stands to gain from any capital inflow, but the question arises: "If private equity comes and takes over a listed company in order to enhance that company’s performance, then why was the current board managing the company not taking measures before that to achieve the same object?" He said that, chances are, shareholders are turning a blind eye to problems within the companies in which they have invested. Molefe suggested that a frenzy of activity in private equity is taking place now but, in the future, there might be a spectacular collapse.
John Gnodde, Director, Private Equity, Brait, South Africa, said that private equity represents investment of a long-term nature, typically seven to ten years. It is a model that usually results in growing the particular business, not necessarily taking money out of it, and the creation of jobs. Private equity can grow companies faster and stronger, Gnodde said. When going into a business, Brait investigates every aspect of concern. Furthermore, because 70% of the capital to be injected into the business is foreign, foreign standards have to be followed.
Gnodde also referred to the takeover of the Kelly Group. The company had been mismanaged

Private equity participation through Infrastructure funds

Zimbabwe’s economic development depends critically on well-developed and organised infrastructures. Transport and communication services link people, firms, cities, and countries in the global economy. In developing countries, provision of infrastructure has been generally the domain of the public sector, probably due to its perceived strategic ‘political’ importance to the economy and partly because of the large investment costs and also the long gestation periods usually associated with investment in infrastructure projects.

On the contrary, in developed economies, provision of some services by private participants has shown that private financiers are able to mobilize resources necessary to finance infrastructure projects.

In general private participation offers enormous potential to improve efficiency of infrastructure services, extend delivery to the poor, and lessen pressure on public budgets that have long been the only source of infrastructure finance. Hence, private equity financing can play a role in the private provision of public infrastructure.

Zimbabwe can set up a specialised debt structured infrastructure development fund which can seek to deliver investment returns by providing debt financing to local authorities and investing in social and commercial projects. The proceeds from investors will be utilised to fund capital projects like bulk water supply and telecommunication infrastructure. Local authorities can borrow funds from and repay back at a rate of interest below the market rate.

In order, to realize the benefits of such a structure, there is a strong need to establish infrastructure funds of an equity nature which will invest in non-listed companies that develop, own or operate infrastructure facilities and projects. Synergies with multi-lateral institutions such as the International Finance Corporation can be extremely beneficial. And financial institutions that are trying to piggy ride on such multilateral institutions i.e. ABC holdings stand to play an active role in such initiatives going forward.

Of Risks and Private Equity

As alluded to in previous posts, the private equity market matches medium- to long-term capital with companies that are not quoted on a public equity market and which need financing to fund growth, development or business improvement.

The capital takes the form of both equity and debt. The equity elements are typically provided by private equity funds, which in turn raise their capital from investors such as funds of funds, pension funds, investment funds, endowments and high net worth individuals. The debt is typically provided by banks, including investment, commercial and retail banks. Large proportions of this debt are often distributed to other entities, either other investment, commercial or retail banks who were not the primary finance provider or institutional debt market participants. The private equity business model is not constrained to capital provision, rather it extends to the application of expertise and strategic vision to the privately owned companies.

In reviewing risks inherent to the private equity sector, a distinction has to be drawn on risks that are peculiar to privately owned companies and those that relate to private equity managers. Risks peculiar to privately owned companies include vulnerability to macroeconomic shocks such as deep recessions, to sector cycles, to poor strategy, to weak management etc. All of these factors can obviously damage a company’s trading performance and profitability. In cases were firms rely on debt, this leverage means that affected firms have less of a cushion should costs rise or revenues fall.

In terms of risks to the private equity fund managers, the failure of a cluster of large privately owned companies could obviously weaken the performance of the funds that had invested in
these entities. As fund performance weakened, so could the ability of the private equity fund managers to raise new funds. Even if fund performance were still good despite a credit event, it is possible that investors could still become concerned and reduce their exposures. Related to this, private equity fund managers are concerned about the reputational risk arising from another fund
manager making a significant mistake in an investment or behaving inappropriately and tarnishing the sector and therefore the reputation of the firm’s competitors. In summary, in developing a forward looking regulatory, risks arising within the private equity market are a
consequence of specific market practices, structures or products.

In Zimbabwe, the regulatory framework is silent on private equity. This obviously creates a channel for innovative fund managers to use public funds i.e. pension funds to set up private equity investments. Market intelligence indicate a major fund manager in Zimbabwe has already started canvassing for business from pension funds with specific intentions to set up a private equity fund. There is also strong possibility of synergy among banks and corporates to invest in unlisted corporates through Special Purpose Vehicles, and who would be grudge then given the existing under valuation of equity in Zim??

The Abdiding curse of Leaders Who Outstay Their Usefulness

This is an excerpt from an article by renowned Economist, John Kay, published in the Financial Times 14 February 2006, which I found insightful. The intention is to stimulate debate on business leadership.

Kays indicates that people have a well evidenced tendency to overestimate their own abilities. This characteristic, common in the population at large, is particularly marked in business and political leaders. Examples picked include George Washington who left office to spend the three remaining years of his life at Mount Vernon. In retiring, he sought to emphasise the difference between a president and a king. Thomas Jefferson, one of the ablest men to hold the presidency, refused to stand for a third term despite strong pressure.

The number of leaders that go on too long far exceeds the number that finish too soon. Gamblers often stay in the casino until they have lost. So do statesmen and chief executives, and for similar reasons. Whenever there is a component of luck, people who have performed well in the past tend to perform worse thereafter, while people who have performed badly tend to do better.

Most people leaving a job are surprised to discover that others can do it equally well. And if they do not discover that others can also do it, they are probably less than averagely honest and impartial in judgment. Such honesty and impartiality is hard to maintain in high office.

From the earliest days of hierarchy, leaders were surrounded by flattering courtiers. Few people can hear a chorus of approbation every day of their working lives without suspecting there may be some truth in it. Frequent reassurance that one’s decisions have been wise increases the confidence with which one makes decisions in future – often to dangerous levels.

And so Henry Ford, the greatest businessman of the 20th century, ended his life a sad and risible figure. He remained in charge because he owned a controlling stake in his company, but only his chief of security was sufficiently deferential to be his confidant. He railed against Jews and tobacco as he issued peremptory commands.

Jack Welch postponed retirement to enjoy the triumph of a deal with Honeywell and instead experienced the humiliation of seeing its failure. Few match the recent self-discipline of James Crosby of HBOS. Appointed as one of the youngest chief executives of a British public company, he retired from the job while still under 50 and passed the baton to an even younger successor. Jefferson shrewdly perceived that it was in the interests of the individuals concerned to take the decision out of their hands.

Corporate Venturing in Zimbabwe

Large pools of funds necessary for PE perfomance, create another investment alternative for corporates. This is through corporate venturing whereby corporates (read Delta, BAT, Interfresh) directly take up equity in unlisted companies. Alternatively corporates can indirectly take up equity through investments into a private equity fund, which then buys equity on the funds behalf. The advantages of this approach is outside hetting shareholder approval, restrictions vis a- viz regulations are minimised as compared to banks for example. With pension funds there is also the aspect of prescribed assets which can be changed at the government's whim. next time we will look at structuring of PE vehicles in Zimbabwe and teh regulatory issues if any. later

Private Equity in Africa

Private equity investing means putting capital into a business to expand, develop new products or fund changes to ownership and management. Private equity investors do more than buy the rights to share in a company’s return – they provide working capital. As respected investor Warren Buffett puts it: “Buy a business, don't rent stocks.”

Private equity investors generally provide their capital in exchange for a sizeable stake in the business. They also invest their expertise – in management, finance, marketing, strategic direction and networks. By exercising some control through board seats and management agreements, private equity investors can protect and grow their investment. This alignment of interests and the ability to add value to the business often means that private equity investors can generate higher returns than those available from traditional ‘hands-off’ equity investing.

In Sub-Saharan Africa, private equity (PE) is still to take hold, possibly due to the onerous regulatory requirements for standard financial services. It is really not a function of a lack of high net worth clients. Another aspect for consideration is entreprenuirs are still in 'love' with the traditional financing means i.e. bank loans, exchange listings etc. however, PE does provide a viable alternative financing arrangement. A key challenge for any potential PE setup will be the need to harness funds from cash rich pension funds. Outside listed equities and government securites and bonds there is a dearth of alternative investment schemes for pension funds. in the case of high net worth investors consideration will be property investments but the challenge is obviously liquidity considerations.

The is a very strong case for PE funds in Africa. As an investment vehicle, global PE perfomance has has been more superior to the stock market. Between January 1986 and June 2002 the pooled internal rate of return (key performance measure for private equity) of the international private equity funds average 21.7%. In contrast, listed international equities (as measured by the All Ordinaries Accumulation Index) gave investors a 12.7% return over the same period. A similar, if less extreme, return differential is much larger in the American market.

It provides for more effective divesrification. Investors have long known that adding more assets to an investment portfolio can add to returns and reduce risk. Private equity offers investors a similar benefit. Private equity is a long-term, illiquid investment and it is valued infrequently. Because private equity is so different to listed shares the two asset classes are lowly correlated and therefore don’t tend to rise or fall at the same time. Private equity returns are not tied to the performance of a market or index. Most of the return is generated by the manager’s skill in selecting, directing and then exiting their companies. As a result, adding private equity to your portfolio can increase returns while reducing overall risk.


Columbia’s Amar Bhide (Glaubinger Professor of Business) did a long study of business growth and concluded that “most successful entrepreneurs start in unstable markets”. A sluggish economy makes it hard for companies to list on the market or achieve a trade sale. Seeking a private equity partner can quickly become the most logical alternative. Tough economic conditions also pressure larger companies to divest non-core or underperforming businesses, providing opportunities for private equity investors. The doyen of world share market investors, Warren Buffett, is using a private equity strategy within his investment vehicle, Berkshire Hathaway, a long term holder of large chunks of companies like Coca Cola and American Express.

Welcome to My World

Private Equity is the latest buzz in the financial arena at the moment, what with the recent demerger of DaimlerChrysler, record breaking deals by the Blackstone Group and Carlye. Essentially though, private equity is about pooling investor funds (to be continued....)