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South Africa: Private Equity Groups Face Funding Pinch as Crisis Bites

Renée Bonorchis

10 October 2008

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Johannesburg — MANY private equity funds, both in SA and abroad, are going to have a harder time raising capital, say the experts.

With debt now more expensive and assets being re valued, some firms could be in trouble.

"The more experienced players will outperform even more, but the newer players will struggle because they lack experience," John Gnodde, a director at local private equity firm Brait, said.

Mark Sardi, joint head of investment banking at Nedbank Capital, said private equity firms that were part of a listed company would have to mark to market. This means they will have to value their assets at current market prices -- and those prices have fallen. But, Sardi said, one benefit of the market turmoil was that although debt was more expensive, the drop in asset prices made acquisitions cheaper and meant the buyers could use less debt and more equity as funding.

He said that it would be harder and take longer to raise money , but the smaller firms with experience may find the money they need. "I think private equity companies within our borders should not struggle too much to raise funding," Craig Pheiffer, GM of Absa Investments, said, while noting that domestic interest rates were high and SA was not a nation of savers. But there should still be sufficient capital for private equity ventures, he said.

"Private equity ventures looking for any type of offshore funding, though, will find it much more difficult. Capital is at a premium and risk aversion is high -- so borrowing offshore is costly for a start, but you also have to add on to that the risk premium for emerging markets and that has widened considerably. This is exactly why Eskom is turning to the local markets for funding and not pursuing foreign loans," Pheiffer said. But given the credit crunch, companies are going to buy assets at lower price multiples.

"You've just got to find the high growth sectors," Gnodde said, mentioning sectors and sub sectors related to SA's high levels of infrastructure spending.

This was also where Sardi thought the returns were to be found despite the fact that government debt will become more expensive for the state to fund and infrastructure spending might slow.

"There will be a knock-on effect for the companies geared to that spending, but the risks are still to the upside," Sardi said.

Gnodde said Brait had focused on buying growth companies with good cash flows and had used relatively little debt, so was not overly concerned by the credit crunch. The company was still investing its $880m Brait IV fund.

In May, Gnodde said the investment of the fund would be concluded soon and the company would start to raise Brait V by the end of this year.

But yesterday Gnodde said his company had not yet started to raise the fifth fund. He did not say the capital-raising exercise had been delayed, but remained convinced investors who understood the private equity asset class would continue to look for exposure.

Sardi said the Edcon deal, which was concluded last year when Bain bought the retailer for R25bn, remained SA's biggest private equity transaction. But, said Sardi, the debt on the Edcon deal was trading at a significant discount to par value. In other words, the value of Edcon has fallen below its purchase price but Sardi said this had become something of a trend in international private equity deals and many managers were starting to do what is known as "double cropping".

It is usually an agricultural term but in financial lingo it means that the private equity companies that invest more of the equity than the debt in a deal and are the funders of last resort, are now stepping in to buy up the debt.

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