2020 Annual - (released February 2021)
SA's quarterly Private Equity & Venture Capital magazine
Patient capital to the fore
by Michael Avery
Forecasts may tell you a great deal about the forecaster, but they tell you nothing about the future, or so says Warren Buffett.
But with 2021 seeing COVID vaccines roll out across the world, businesses and whole economies move from their immediate response to the pandemic, to putting in place the levers for recovery, ahead of preparing for the next normal, whatever that is.
And there will be various opportunities and challenges within that for private equity investors. The fundamental principles which drive private equity investment strategy, such as investing in high quality assets, partnering with strong management teams and focus on exit strategies, are expected to support private equity, remaining a resilient asset class and certainly supporting the post COVID-19 economic recovery, which is so important in South Africa right now.
Active management has come to the fore during the pandemic. Private equity, the asset class that has patient capital, is often what is needed to weather economic storms such as the COVID-induced economic cyclone.
Catalyst spoke to John Bellew, Head of Private Equity at Bowmans; Langa Madonko, SAVCA Board member and Deputy President of ABSIP, the Association of Black Securities and Investment Professionals; and John Geel, Senior Managing Director at FTI Consulting, about what the industry and investors can learn from the events of 2020 that will shape the asset class in 2021.
“I do think that in March and the initial Lockdown, we saw a definite drop off in activity,” says Bellew. “We saw some deals continuing. Those were deals that really had a strategic imperative for the buyer. And it was a much more long-term view taken by the buyer. I guess the prime example of that would be the Adcock acquisition of Plush (Professional Leather Care, announced in March 2020). We also saw managers delving into their portfolio companies, trying to deal with banks, trying to adjust strategy, which meant that the deal environment did dip.”
But from about October, Bellew says the Bowmans team started seeing a marked uptick in deal activity and new briefs.
“ And I think there were a couple of reasons for that,” says Bellew. “I think that there were some good buying opportunities that were thrown up, companies that potentially needed cash. There were some restructurings that we became involved with. And then there were some African deals. I think a lot of the deals that we've been involved with do tend to take a longer-term view and tend to be companies where, perhaps, there's been less impact from the current pandemic. And, you know, that's the rear view mirror. I think the year ahead is looking much more promising from a different perspective, and I'm actually quite bullish for 2021.”
While Bellew is bullish for the year ahead, the deal execution environment has shifted markedly with remote working, travel restrictions and everything that is attached to this new normal of COVID-19, and it has not only impacted on General Partners’ ability to engage with investors like LPs, but their portfolio companies too.
Madonko explains that adapting to this operating environment has brought with it a significant number of challenges.
“I think in the act of transacting, you actually want to have those face-to-face interactions,” says Madonko. “You also want to have, for lack of a better term, some interactions that are of a social nature to get to fully understand the chemistry behind the team. You want also to understand fully the nuances of the businesses, but the human interaction is a key part of the ability of the fund manager to capital raise. Numerous interactions are important to explain the strategy, how you intend on rolling out your philosophy, and what you're investing in. And we had to go virtual. While, it does allow interactions, it's not the same, in terms of the significance of human touch. So it did, in many instances, set back some of the fund managers who had not yet started to engage with potential funders. They found themselves in a position where they were thoroughly on the back foot. But for some, it really began the introductions. As John said, transactions were concluded on the basis of the traction already in place and, in some instances, also to attract capital on the basis of historical relations.”
Geel was surprised at how quickly the industry adapted to the new normal of conducting parts of due diligence digitally via Zoom or Teams.
“In the latter half of 2020, I think there was a new norm, and people got used to doing due diligence. By way of example, I spoke to one of the large international investment banks, who said things like drones were now being used for site visits, things that he never would have done before,” explains Geel.
“And for the financial and legal due diligences, the technology that's now available for remote due diligence, such as the development of data room processes, makes that process so much easier that if we were forced to go back into remote due diligence again, I don't think that would be a hiccup any longer, in terms of holding up processes,” says Geel.
Bellew jokes that he is probably at that stage in his career where people invite him to give history lessons more than advice, because he’s been around since the very beginning of the private equity industry in the country. And looking back with that kind of historical lens, who could have ever imagined how the industry would have evolved and transformed to this point, where GPs can do digital due diligence with drones.
“I think that South Africa was an early starter in private equity, and it raised a lot of capital in the early days, and the sort of pioneers in the field almost seeded the industry,” recalls Bellew. “People would work for a private equity house and then spin themselves out and create their own firm. And as they did that, so the market matured. We ended up with sector funds, with funds targeting different market segments. I started out as a callow candidate attorney without any idea of how the industry would evolve. But I'm delighted with the way it has evolved, and I'm delighted also with the way the broader African industry is starting to evolve. I think that the asset class is firmly established. In terms of technology, I think, even for us as legal professionals, we've been amazed at how quickly the digital revolution took over from about March last year. And when I went into self-isolation, I'd never heard of Teams. I'd never been on a Zoom call. And within a week, I was doing both. So, even relics like me have had to drag ourselves kicking and screaming into the 21st century, and adapt to the new way of working. The use of technology to assist in diligences is definitely helping, helping to keep costs down and I think will continue. I'm not sure that it will ever replace the in-person, in-the-office kind of vibe that you really need to build a team, and to build your brand. But, I think the world of work has changed. I don't think it's changed fundamentally, but I don't think that we will ever be rigid, eight-to five people again; we will be much more flexible. And I think that's the same in every industry. I think we've all recognized that what counts is the intellectual output, and whether you do that remotely from your home office or in person, in the office, whether you communicate it in person, or through some sort of electronic medium, it doesn't really matter either.”
As we look into our crystal balls and we try to pick out which are those big themes, which are the areas that are going to drive activity in the private equity industry, what do you see as the big trends, looking forward into 2021, that are going to be attractive for private equity buyers?
“I think, carrying on from what John and John said,” begins Madonko, “that technology is definitely one of the big themes that is going to remain. We're still going to have pockets of excellence that are unearthed, in terms of making life in a remote working environment a lot easier. We're going to have the emergence of tech, in terms of assisting to facilitate a lot of other activities that we probably took for granted in the past, as being on site functions. We are seeing the emergence of, and the growth of A.I. funds and technology funds that are looking to invest in some of these meeting platforms, as well as what is probably, from a South African perspective, forced IR, rather than Fourth IR. From a South African perspective, some of the more fundamental and more traditional asset classes, such as infrastructure, will still play a key part because, I think, if COVID did anything, it showed a discrepancy in terms of the infrastructure accessibility throughout the country.”
Business rescue is a standout theme, and this year DealMakers is introducing a special category to recognise the work going on behind this growing trend.
Madonko believes that it’s not necessarily businesses that have gone into business rescue, but more players who are able to turn around and to make more robust businesses out of ones that may have been teetering on the brink of collapse.
“I think that we still need private equity to be saving jobs, alongside creating new jobs,” says Madonko. “So, labour intensive sectors being the focus of PE funds will attract a lot of capital as well.”
What we are certainly seeing on the JSE is a bevy of delistings. A lot of these are being driven by private equity buyers, obviously seeing a lot of value at current valuations for an exit, although, it doesn't look like the best window to exit into. How would you characterise the current Private Equity exit environment?
“Our sense is that there is likely to be, in the current year, some of those transactions that had been delayed and put on hold in 2020, coming back to the market in 2021,” says Geel. “While 2020 might have been difficult, we think that might be slightly different in the current year and that there may be some companies that will hold on for longer, because, as you know, the private equity industry gets the returns, ultimately, from cash flows during the period of holding the investment and then, eventually, on exit. And for some, to get the returns, they may have to delay the exit.”
For private equity General Partners, it's this issue of managing your cash flow, keeping a very highly skilled professional team together and incentivised over long periods of time when you're not harvesting, and delaying that even further creates more of a challenge. We have seen alternative structures arise like permanent capital vehicles, for example. How do you see all of this playing out and impacting on the fund structure into the future?
“I no longer see the entire industry moving to one model or another, but I do see the industry adopting a model which is appropriate for the particular industry sector,” says Bellew. “Many will adopt permanent capital vehicles, because it stops the need to keep going to markets. And we are still seeing a number of those coming through. We're also seeing people just continue to use the typical two and twenty model. We are seeing, in the current environment, that a number of funds that are coming close to the end of their lives are seeking extensions because, looking to realise the assets in the portfolio in the current market, there's definitely been, as John said, a kind of delay around some exits. And, I think that most private equity funds will want to exit in a coordinated way, rather than over a fire sale.”
“I think that it's becoming a question on structure, of what is the right horse for your particular course. For example, real estate infrastructure may well need longer dated funds.”
“The other thing that I think we are seeing in the industry is, a lot of private equity houses are saying to us that they find this business of raising capital every five years to be absolutely exhausting. And although that's potentially driving the permanent capital vehicle, I think it's also driving people to become more generalised, or to increase the number of assets that they have in their portfolio, with the number of funds that they have in the portfolios, so that they aren't dependent on just one fund and raising a successor fund every five years, because that makes the business very uncertain.”
What's the fundraising environment looking like?
“COVID brought with it additional uncertainty about the South African market in particular, on top of what have been historic themes around why international investors were slow to put investments into the country,” explains Madonko. “Amongst those were the issues of political uncertainty and corruption.”
“There's an increasing fascination with, and appetite for, emerging markets. Speaking personally, since the year began, there have been some intimations that some international investors would like to take a look at South Africa. But looking at our own local investment base, especially with the focus and with the rhetoric coming out of government that there needs to be a drive to invest in infrastructure, investors are all looking for a safe way to deploy capital into that space. And investors place a greater reliance on private equity funds being able to deploy the capital where they say they will deploy, than they do in a state mandated programme. That has been positive for those players in the space that are focusing on infrastructure.”
Obviously, COVID-19 set back the president's drive to recalibrate the state to start turning things around after the State Capture years. How confident are you about the prospects in South Africa?
“2021 is going to be a good year,” says Bellew. “I think that infrastructure is a bottomless pit. Private equity likes it. I think there will be structures, the number of listed infrastructure funds that will allow pension funds to use their listed share allocation under s28 to invest in infrastructure. Infrastructure will definitely continue to raise money and I think other sectors will, too. And we're going to see a lot more deals now that people have got used to the new normal and they can transact again.”
It’s clear that there are many reasons why private equity is one of the better placed asset classes to continue to weather the COVID-19 crisis. But the vaccine must be procured and rolled out with speed to provide further impetus to what looks to be a much more fruitful deal-making year than 2020.
The article is an extract from a Business Day TV interview.