As the US subprime crisis is affecting debt markets everywhere, the large headline private equity transactions have evaporated. But mid-sized deals are still on the agenda, says David Jones, managing director of CHAMP Private Equity, although they might be concluded behind closed doors
Q: The fallout of the US subprime crisis seems to have caused a drop in large scale private equity transactions. How has the crisis affected your business?
A: For large transactions that require debt of above A$1bn you need to go to the overseas debt market and most overseas debt markets are closed. The large deals are pretty much gone, but for transactions below A$1bn, where CHAMP tends to play, the market remains open. The main effect on our business is that auction processes have diminished. It was clearly a seller’s market; now that the cycle has turned it’s a good buyer’s market. You don’t tend to sell in an auction when it’s a buyer’s market and so there are fewer sellers. Sellers also now tend to go through private negotiations and although the number of sellers has fallen, the quality of transactions is up.
Increasingly, we see people sell part of a business and work with private equity over the next three to five years and then sell off the rest. They take two bites of the same cherry; they take some money off the table now and work with private equity until the market has improved and then sell off the second half in a stronger cycle.
Q: Have buyouts become more expensive?
A: The cost of debt is up and the amount of debt is down. This means that if you want to get the same projected return out of your transaction, you just can’t bid as high a price. If you had to pay the same price … you’ll have a lower equity return.
You also probably have less debt and have to put in more equity. What that means is that because people in general don’t lower their return thresholds, you are able to bid only a reduced price.
Q: Challenging financial markets also present opportunities for companies with healthy balance sheets. Where do you see opportunities?
A: The stronger performing sectors have become more interesting: engineering, resources and infrastructure-related sectors, and also certain speciality industries, such as healthcare and ageing-related businesses, have strong dynamics.
In another area, the situation is reversed; they are businesses that are suffering through the current cycle. This presents opportunities to buy those businesses for attractive prices. Finance-related businesses fall into this category, because there are a number of businesses in that space that have been affected by the cost of debt going up. But also consumer-related business, retail businesses and wholesale businesses that have been affected by the current cycle.
Businesses where there is a distressed situation can also be interesting during this phase of the economic cycle, and then you have businesses that are straight out overexposed and need to restructure. Austar, which CHAMP bought in 2003, is an example of a company that got ahead of itself and not structured its borrowing appropriately for its stage of business development.
Q: Has the success of PE firms in the years before the credit crisis laid bare the shortcomings of a public listing?
A: I’ll give you a more balanced answer than you probably would expect from me. The public company model works very well and most of the time public companies are doing well. Where private equity is most relevant is when there is one or two factors missing.
One is when governance, or active board management, is missing. Particular in large companies with many divisions, some of the smaller or less central divisions can be under-managed by the board. They can be starved for attention, strategic advice and leadership.
The second area is where companies are under-supported with capital. What we find in a number of companies, particularly when they are not near the core of a company, is that private equity can support a business with fresh capital. This is capital beyond the purchase; it is capital for growth. Capital is what fuels growth; it allows you to spend money on R&D, marketing and training, and also on other acquisitions to boost the company and develop its opportunities. This is where some company boards can be risk-averse and focus on short-term earnings.
Most companies access both leadership and capital quite well and there private equity is not that relevant. It’s more in the minority of cases where one or both are missing that private equity is most relevant.
Q: What can we expect of the performance of the Australian private equity industry in the remainder of the year?
A: We will continue to see a smaller number of auctions, where companies announce that they are on the block or are selling divisions. The corollary is that we will see more privately-negotiated situations, where a sale is just announced.
We will also see a moderate number of public to private deals, and that is because the stock market is weak. Unlike a few years ago, institutional investors are now looking for performance and they are happy to accept good takeover premiums.
You will see also see a number of smaller deals. Compared to a few years ago, the deal size average will come down, because of the lack of debt availability for the large deals. Most of the players that will be participating in the market will be swinging down to some of the smaller-sized assets. The global [private equity] firms will be swinging down in other markets, such as China or Japan.
Q: Speaking of the Asian markets, CHAMP opened an office in Singapore at the end of last year. Is that where the money is at the moment?
A: Singapore is not necessarily where the money is directly. All of the money is in China and to a lesser extent in India. China is hot, but it is still a relative high beater, meaning high risk situations. We see Singapore as a lower risk way to get closer to China, without having to go directly into it. Obviously, Singapore has a Western-style, established legal system and accounting system with a much stronger precedence than China.
There are also many South Asian businesses, whether they are from Singapore or Thailand and Malaysia, which have plants in China. Therefore, you have direct exposure to China, but legally and managerially you are running the business from Southeast Asia rather than China.
Whenever you go into China, you notice that there is a lot happening. There is money to be made, but there is money to be lost, too. It’s a bit like a freeway where everybody is speeding and that’s okay, but if someone drives off the road many people can get hurt. Now, Southeast Asia is not without its risk, but we feel it’s a lower beater.
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THE AUSTAR ACQUISTION
CHAMP’s major success story is the acquisition of Austar in 2003. The private equity firm bought the publicly-listed pay TV operator when its shares traded in a range of 12-16 cents per share. It had listed five years earlier at A$4 per share.
Austar had a distant, distracted major shareholder, a set of lenders who were disappointed with the company and extremely focused on the next quarter’s results, and no capital for expansion. The company had acquired A$400m of bank debt which was in default as EBITDA over the calendar year 2002 came in at less than A$25m.
“CHAMP brought disciplined local leadership to the board table, re-set the banking arrangements to give the company a reasonable medium term runway, with appropriate head room for any bumpy air, and put new capital into the business,” says David Jones, managing director of the firm.
Around half of this new capital went to reduce the senior debt levels and around half went into working capital to growth funds. After three years, Austar’s EBITDA had increased to A$120m, the lending group had been refinanced, and the shares were trading above A$1.
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