South Africa: A steady flow for private equity

The concept of private equity is not new to corporate South Africa, but it is only in the past year or two that it has been recognized as a force for change. Since the beginning of this year, private-equity firms have generated a significant amount of the flurry of corporate activity on the Johannesburg Stock Exchange. In March this year, as part of the JSE's reconstitution of its indices and in recognition of the growing importance of this asset class in the overall financial services sector, the exchange even launched a private-equity funds sector. It already includes nine small companies, most new market entrants. Some of the larger, more established private-equity firms are expected to seek listings.

There are some 30 private-equity funds in South Africa. The size of the private-equity market is estimated at R10 billion ($1.6 billion), up from around R200 million in 1990, and is expected to grow to R40 billion within five years.

The major providers - Ethos Private Equity (formerly FirstCorp Capital Investors), Brait Capital Partners, BoE Equity Partners, Gensec-NSA, Rand Merchant Bank and African Merchant Bank - are doing corporate South Africa a big favour by stimulating transformation and helping it catch up with the outside world after years of isolation.

Over these years, exchange controls and sanctions left cash-generative South African businesses with little option but to buy what local assets they could - with precious little regard for commercial fit - thereby creating sizeable, if unfocused, conglomerates.

But, disinvestment by multinationals in the late 1980s created a new supply of surplus assets and, to the extent that these were not snapped up by the conglomerates, they were often acquired through what were essentially the country's first private-equity deals.

However, it was not until South Africa's re-entry to the global community - which brought to an end the misguided stockpiling of domestic assets and the start of a process of reshuffling them to make better investment sense - that private equity really took front stage.

Fortunately, South Africa has reacted swiftly to the wake-up call of the many analysts that have lobbied for the unlocking of shareholder value. This market pressure on company managers has in turn created a feedstock of potential deals upon which the private-equity market can now thrive.

Practitioners enthuse that there is no shortage of opportunities as conglomerates restructure and dispose of non-core divisions and holdings, paving the way for management buy-outs.

There is little doubt that the private-equity culture has injected a new urgency into the streamlining of local business assets and provided an outlet for the vast accumulation of capital still trapped in the country by continuing exchange controls. The unlocking of shareholder value and management empowerment are at the heart of South Africa's new corporate credo and nowhere is this so fully expressed than among the elite of the country's private-equity specialists.

A headline-grabbing bid

In March, a R1.9 billion takeover bid for electrical and industrial company Reunert seized the headlines in the South African financial press. The surprise was not that another company should be bidding for Reunert but that the bid had been put together by a private-equity house, in this case Brait Capital Partners, part of merchant banking and investment group Brait SA.

The bid has since been rejected by Reunert's board, but it has put private equity firmly on the map in South Africa. It also elicited a further R2.05 billion of bidding interest from a consortium comprising BoE Equity Partners, the private-equity arm of Cape Town-based BoE Bank, and Allied Electronics Corporation, a rival of Reunert.

The competing bid was also rejected but industrial analysts concur that a bidder could still unlock greater value from Reunert's assets than had been achieved by the company's management, despite its recent progress in disposing of non-core assets. The company is now unequivocally in play.

South African investors have not had much exposure to hostile bids, but stock-market analysts predict that private-equity houses are about to provide them with plenty of opportunity to savour a phenomenon common in more developed markets. But the message has stuck with the investing public that the latest emerging-markets crisis has uncovered undervalued shares and left companies vulnerable to predatory interest from fast-moving private-equity fund bidders.

Retail investors, already under pressure from high real interest rates and faced with share values that remain well below entry prices, have been heartened by the bids. Institutional investors many of whose clients are retail investors, are having to learn how to react to hostile bids in the best interests of their clients.

The giant (for South Africa) Reunert bids come a year after Ethos, the country's largest and oldest private-equity provider, took the market by surprise by successfully leading a R1.8 billion buy-out of Foodcorp, the food division of former mini-conglomerate Malbak, on behalf of black-empowerment consortium Pamodzi Investment.

At the time, Peter Vundla, Pamodzi Investment's chairman, hailed the transaction as a "benchmark for future black-empowerment deals", endorsing private equity as a financing route for other empowerment groups to follow. Ethos maintained its big-ticket private-equity investor reputation in February this year when it proposed a R1.8 billion bid for SA Druggists' pharmaceuticals businesses. But investment-banking group Investec put in a separate proposal and ultimately walked off with a controlling stake in SA Druggists, which it promptly sold on to a consortium led by Aspen Healthcare comprising Fedsure and Macmed, a pharmaceuticals company.

BoE Equity Partners subsequently led a R160 million management buy-out of Prochem, the chemical-trading activities of SA Druggists, in mid-April. Rod Scott, Prochem's chief executive, who is South Africa's latest convert to the private-equity concept, says the private-equity deal was the ideal result for Prochem and its employees.