If you’re new to private equity, you might think it sounds suspiciously like another new-fangled investment vehicle – the kind that turns into a bubble and bursts. We put your mind to rest by explaining the history and origins of private equity, South Africa as a market for these investments, and what prospects they hold for the future.
Politics and the origins of private equity
Although there are indications that early examples of private equity and leveraged buyouts date back to the 1950s or even earlier in the US, the first transactions on the South African market were in the mid-1980s and a product of the political moment.
When President PW Botha delivered his 1985 Rubicon speech, which failed to announce hoped-for reforms to apartheid, the international community resolved to impose sanctions on South Africa, triggering a massive exodus of foreign capital. Just a year later the US passed the Anti-Apartheid Act, pressuring multinationals to divest from the country.
As a result, banks, insurers and other captive investors (subsidiaries that source investment funds primarily from their parent companies) started developing in-house skills to manage private-equity-type buyouts.
The 1990s: Dawn of democracy and a new asset class
With the lifting of sanctions in 1991, as South Africa began dismantling apartheid and building up to the 1994 elections, large local conglomerates took the opportunity to expand into the international arena and offload non-core assets. This spate of corporate restructuring provided attractive targets for private equity. South Africa was off to a strong start with alternative assets.
As before, most of the market players were banks, which financed buyouts internally. But concerns about potential regulatory constraints on bank capital triggered a shift to the US third-party funding approach that entails raising equity from outside investors.
By the turn of the new millennium, the industry had widely adopted such independent private equity vehicles based on international best practice. To get a more detailed understanding of how it works, read our complete guide to private equity investing.
Over the course of the decade, initial investor jitters over South Africa’s transition to democracy gave way to optimism that fresh policy would drive economic growth and investment opportunities. Together with third-party fund structures, this confidence brought international investors knocking.
In addition to the influx of foreign, private-sector capital, public-sector equity from development finance institutions (DFI) also played a key role in the industry – and continues to do so to this day. Traditionally founded by governments and charitable institutions, DFIs such as the African Development Bank, the International Finance Corporation and the European Investment Bank aim to drive an environmental, social and governance (ESG) agenda, while earning returns.
In pursuing their development agenda, DFIs often act as cornerstone investors in private equity. Because DFIs conduct thorough due diligence, their commitment to a fund sends a strong market signal that often attracts commercial capital. This is just one reason they have had a significant influence on shaping the market.
The 2000s: Private equity, South Africa and the continent’s moment in the sun
One of the most decisive drivers behind corporate social responsibility in the industry was the enactment in 2003 of Black Economic Empowerment (BEE). Thanks to the private equity industry’s mechanics and approach, it has proved an ideal tool for empowerment, unlocking opportunities for involving black executives in the ownership and management of the target company.
With almost every deal in this decade featuring a BEE component, the industry has played a major role in catalysing transformation. Founded in 2000, IFSA Private Equity is part of the proud tradition of impact investing in private equity.
As global law firm White & Case explains, the years leading up to the global financial crisis in 2008 were the heydays for private equity on the African continent:
“Private equity funds increasingly turned to emerging markets for levels of growth that were simply unattainable elsewhere. On the back of a commodities boom, driven largely by demand from China, an ‘Africa rising’ narrative began to pervade the media.”
In those heady days, local players partnered with foreign consortiums to close very large deals. By South African standards, many of these transactions were heavily leveraged with high-yielding Eurobonds.
The 2008 financial crisis: Hitting the debt reset
While banks and loans had always been pivotal to private equity in South Africa, leverage multiples – a ratio (net debt/EBITDA) that compares a company’s free cash flow to its debt load and consequently its ability to service that liability – were low by developed-market standards.
In the five years prior to the crash, banks became bullish over the industry’s successes and debt multiples rose. But the 2008 financial crisis sent interest rates soaring and resulted in a 1.5% slump in economic growth. For the first time in 17 years, the country went into recession. This effectively checked the gearing trend in South African private equity.
Although many local deals collapsed and exits were slowed, the industry didn’t suffer the carnage seen in Europe and the US. Because the full impact of the crisis took a year to reach our shores, portfolio managers used the reprieve to tighten company cash flows and prepare for the storm.
Why there’s more to private equity than Edcon
Unfortunately, Boston-based Bain Capital Partners’ widely publicised acquisition of Edcon in 2007 runs counter to that narrative and is the reason many ordinary South Africans remain wary of the asset class. At the height of the credit bubble, the private equity giant borrowed R25 billion in foreign debt to delist the retail group in its first foray into Africa.
Even though Bain transferred ownership to the creditors in 2016, the retail group has never recovered and is currently in business rescue. As Simon Brown, host of the MoneywebNOW podcast on Moneyweb, explains:
“Bain … lost about 20 billion rand in the process. And you know what, that happens. But that is what the average South African walking the streets of Gqeberha or Sandton or wherever sees with private equity. So, they think it’s rich people and they think it’s rich people losing money. And neither of those are true.”
This is unfortunate because, although high rewards are inevitably associated with high risks in private equity, South Africa has an agile and resilient industry, as this history makes abundantly clear.
The post-2008 recovery: Private equity goes mainstream
In the wake of the financial crisis, a consortium of central banks drew up the Basel III Accords. Implementation of the regulations – which aim to strengthen regulation, supervision and risk management in the banking sector – began in 2013 in South Africa and is ongoing. The upshot is that capital requirements for private equity increased almost fourfold.
As a result, South African banks re-evaluated their exposure to the asset class. With a few exceptions, many closed their private equity divisions. Of course, in providing debt to finance transactions, banks remain an important pillar of the industry, albeit a more conservative one. The new approach to loans focused far more on the ability of the underlying business to service and repay debt.
By 2014 and 2015, private equity investing in South Africa had not only made a robust recovery but could also be considered to have reached a stable and mature stage of development.
Getting institutional investors in on the act
Although slow to initially take off, the 2011 amendments to regulation 28 under Section 36 of the Pension Funds Act unlocked an important new fundraising source by increasing the percentage of total assets that domestic pension funds can invest in private equity from 2.5% to 10%.
This significant allocation not only increased trustee confidence in investing in unlisted companies but also invited them to specifically consider their approach to the asset class.
The 2021 Southern African Venture Capital and Private Equity Association (SAVCA) industry survey reveals that pension and endowment funds accounted for 54.4% (R9.2 billion) of total funds raised. Of this R9.2 billion, 97% of funds were from South African pension and endowment funds, making this the largest domestic investment value in the five-year period.
With major institutional investors on board, private equity has truly become mainstream. In other words, while they may not be aware of it, many South Africans are already indirectly invested in private equity.
Reason enough to look at the asset class when investigating what to do with your retirement lump sum or inheritance.
2020: The fallout from the COVID-19 pandemic
With its lockdowns and restrictions, the pandemic resulted in the first contraction in economic growth since the 2008 recession. So, it is unsurprising that the SAVCA 2021 survey, which is based on data up to 31 December 2020, shows that private equity fundraising fell by almost 22.1%. That said, levels still exceeded those achieved in the 2016 to 2018 period.
Another impact was the decline in exits – the resale of portfolio companies in order to disburse profits to investors. There were only 14 exits in 2020 down from 30 in 2019. This is, however, very much in keeping with private equity’s approach to creating value. That not only means shepherding businesses through crises but also extending holding periods, if necessary.
As Simon Brown puts it: “Private equity is often more strategic about selling … If they don’t like the price, they’ll walk away. They’ll take maybe three months, maybe six months, maybe a year to find a buyer who works for them.”
When polled in 2020, 69% of the companies that participated in the SAVCA survey believed that the next 12 months would bring a rebound in deal activity.
As we move out of the pandemic, will private equity investing, South Africa as an economy, and the global business climate synch up to deliver a recovery?
While it’s well worth unpacking how the South African economy affects your investments, the truth is that strong businesses can outstrip it.
For a testimony to the strength of the local industry on that front, look no further than the SAVCA Impact Survey. In a comparison between JSE-listed businesses, UK private equity investees and local private equity portfolio businesses, the latter far outpaced the others in terms of EBITDA, capital expenditure and growth in employee numbers.
So how fast is private equity growing?
Historically, private equity has outperformed listed equities in the long term. And despite the pandemic’s challenges, the SAVCA survey records an increase in revenues earned by portfolio companies of 9.7% in 2020.
A partner at Bowmans law firm, Jutami Augustyn sums up the big picture of tenacious growth in a press release on private equity post-pandemic:
“The PE industry has shown its resilience over many years. Even in the face of sometimes weak GDP growth, the size of total funds has been a positive upwards curve that reflects the strength of the industry and the confidence of investors that venture capital and private equity are able to grow despite a lethargic economy.”
Why is private equity increasing?
The short answer is that private equity offers opportunities for diversification from an asset class that delivers high returns and low volatility. Although that alone would be enough, there is more to it than that.
In recent years, governments have championed both private equity and venture capital investing; South Africa is no different. The reason is that backing small- and medium-sized businesses delivers key social returns, above all in job creation. This is borne out by the SAVCA Impact Study, which indicates that the headcount at portfolio companies climbed by an average of 22% per year.
The ANC government hopes to harness such benefits while driving infrastructure development.
In 2021, National Treasury again drafted new amendments to regulation 28 of the Pension Funds Act that would allow private equity to attract 15% of retirement fund assets.
This change is being proposed in tandem with an investment allocation of up to 45% in domestic infrastructure development.
Journalist and author of the book Secure Your Retirement: How to Beat the Effects of Corruption, Ratings Downgrades and Economic Lockdowns, Bruce Cameron, cites the Transport Sector Retirement Fund’s private equity venture – which at members’ urging was made to adhere to ESG requirements for sustainable investment – as an example of how this could be a win-win for everyone:
“They initiated a private equity investment in what is the largest truck stop in Africa based in Harrismith in the Free State. It has three forecourts, overnight accommodation, wash and service bays, shopping, canteen and medical facilities for the 75,000 truckers of the Transport Sector Retirement Fund… The environment links to providing a secure and safe stopping area and even reduced emissions; socially, by providing jobs; and governance by providing the fund with a sound return on its investment.”
Contact IFSA to find out more about the benefits of this alternative asset class
While not without its risks, private equity is a proven investment vehicle with a solid track record. In fact, the most alternative thing about IFSA is our focus on people by building relationships with investors and our portfolio companies’ management.
To start forging a truly rewarding one, contact us for a personal consultation.
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