Business Day (Johannesburg)

7 December 2006

South Africa: Corporate Predators Or Source of Fresh Finance?

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Johannesburg — SUSPICION haunts the private equity consortiums that are making a play for some of SA's blue-chip companies, with Finance Minister Trevor Manuel expressing concern recently about the effect of these deals on the market.

While critics portray private equity groups as shadowy raiders, others see the surge of interest in local firms as a welcome sign that foreigners are pumping more money into the country.

The list of takeover targets has surged in recent months, with Alexander Forbes, Shoprite and Edcon just a handful of companies on the private equity radar.

Not all of these groups will be bought and delisted. Transport group Super Group fell off the shopping list this week as potential bidders decided to walk away.

But the mystique and reputation of private equity has fanned the fear that the cavalier tactics of private equity companies could be setting the market up for a fall.

The truth is, there is little evidence to suggest this will happen, at least according to a study last month by Britain's Financial Services Authority (FSA).

The study finds that concern about private equity has been overplayed and there is no major market risk -- although there are some red flags.

The first concern it notes is that banks may be "overlending" to private equity firms, which were doing deals at such a rate that a large-scale default could whack markets. The FSA says: "The amount of credit that lenders are willing to extend on private equity transactions has risen substantially. This may not, in some circumstances, be entirely prudent."

Another concern is that "material conflicts arise in private equity fund management", in effect that private-equity groups are often just looking to maximise profits in the short term, which could often be counterproductive to a company.

It also notes a high risk of "market abuse" through price-sensitive details of private equity deals leaking into the market, given the large number of parties involved in private buyouts.

Notably, the FSA says there is a "low risk" of private equity deals reducing the efficiency of the market by reducing the size of the public investment market.

Many South Africans think the gains of private equity outweigh the ill effects. RMB chief economist Rudolf Gouws says he views this development "positively. Even though it is part of a worldwide trend -- and one mustn't become overly excited because there seems to be a bit of a bubble building -- what is heartening is that it points to a new view that is being taken of SA's corporate ... prospects."

Gouws says private equity investors believe there will be growth in companies they buy. Unlike traders in listed shares, which can be sold at the "click of a mouse", private equity investors are in it for the long haul.

Nedbank CEO Tom Boardman says the foreign money flowing into local private equity deals may simply be replacing other foreign shareholders. "But if there's a net gain in foreign ownership then there is a net inflow of money into SA, and I would regard that as positive."

Boardman says there is no single answer to whether these deals are good or bad -- each has to be viewed on its merits.

He says companies list on an exchange to raise capital, allowing investors to trade shares in a regulated environment. However, if the company no longer needs to raise capital and is generating strong cash flows, private equity is a route off the stock exchange.

"One has to just be very careful of what the different reasons are for the companies going private and to guard against something not just becoming a fashion that will lead to a hangover at a later stage," Boardman says.

Brait CEO Antony Ball says that private equity has been a successful asset class globally as strong growth in the US has led to larger funds being formed, with investors getting good returns.

"That has fuelled growth in the asset class, and they are now looking globally and expanding internationally," Ball says.

Ball says private equity funds undervalue companies and create the sort of value that the public market may not be able to.

"You are able to direct the activities of the company to get more value (by) gearing the balance sheet differently," Ball says.

While some companies disappear from the JSE as they are bought by private equity groups, institutions can still invest in private equity funds, Ball says.

Pension funds are limited in how much they may invest in private equity right now. Ball says these rules are likely to be relaxed.

Malcolm Segal, past chairman of the SA Venture Capital Association, rejects the view that private equity firms are amoral scavengers that rip apart companies.

"These associations are regrettable and unwarranted," he says. "We have a competent and professional industry in SA that is run along the lines of private equity in developed capital markets across the world".

Segal says private equity firms are not stripping the JSE of its best assets. "Companies come from the market, and they go to the market as part of a cycle."

Andile Mazwai, CEO of BJM Securities, says while delisting large companies is negative for stockbrokers such as BJM, growth in private equity has created opportunities for corporate action.

"In the medium term there is the loss of the company, but in the longer term once these private equity firms realise (what) value they can, they may very well want to exit out of them, and the equity capital markets are certainly the avenue for that."

He says there have been more listings than delistings recently, though many of the new companies are tiny compared with those targeted by private equity.

While market makers such as Mazwai given a cautious thumbs-up to private equity, it remains to be seen what view the regulators take of this phenomenon.

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