NBR: Direct Capital on private equity being more friend than foe

Fiona Rotherham, NBR:

It’s well-known that New Zealand is a nation of small businesses but less well-known is the size of the private company sector.

Ross George, managing director of private equity investor Direct Capital, says the private company market is at least 10 times bigger than the listed company market in New Zealand although “a lot of people tend to think it’s the other way around.”

His company invests money from the funds it has raised from mainly institutional investors ($1.2 billion since it started in 1994) into high growth, later-stage private companies that are typically run by an owner-manager.

Mr George was asked to speak at the annual NZ Shareholders’ Association conference on whether private equity is a friend or foe to investors, and he was a little defensive despite describing it as a “good topic.”

The idea that private equity is a foe probably comes from when companies are listed on the stock market that, as it turns out, are “over-priced and under-prepared and often a little bit prepared for the purpose of sale,” he says.

And retail investors need to differentiate between what sort of private equity firms are behind a listed offer as they all tend to get lumped under the one umbrella.

They range from venture capital companies that invest in young companies before they are profitable, turnaround funds that come in and fix up a broken company, global leverage buyout groups that tend to buy big businesses using an enormous amount of debt and small amount of equity, and then companies like his own that raise funds to invest in private high growth businesses.

“There is an added level of due diligence on you as retail investors and institutions in New Zealand to look at those offshore groups coming in and make sure before you invest,” he says. “You’re not allowed to dump any other product, so you shouldn’t be able to dump companies in New Zealand.”


Doing due diligence

The floats of Dick Smith and Tegel are two examples that were handled badly from a retail investor perspective, he says.

Dick Smith was bought by private equity firm Anchorage Capital from Woolworths for $A112 million in November 2012 and was then floated in Australia in December 2013 with a market capitalisation of $A520m.

In January 2016, the company announced receivers and administrators had been appointed, prompting an Australian government inquiry. The failed chain’s founder, Dick Smith, reportedly described the float as “utter greed and seemingly unethical.” While most of the retail investors were Australian, there were Kiwi investors who lost money as well.

Mr George says it was reported that the business had been fixed up over an 18-month period but no one in the industry thought that. “The stock market should not have taken it on board,” he says.
“In our view, it wasn’t credible to turn around the company that quickly.”

The Tegel partial float in 2016 was made by leveraged buyout firm Affinity Equity Partners. The indicative offer price was between $1.55 and $2.50 a share but tepid interest saw it end up at $1.55.

Following a profit downgrade earlier this year the share price hit an all-time low of 81c and some weeks later private Filipino company Bounty Fresh Foods made a takeover bid at $1.23 a share, which is due to close soon.

Mr George says the New Zealand-founded Tegel is a great business, and one he invested in personally, but the float showed investors should be more critical of listings as they come on board.

“I remember, when it came to list, it raised a lot of eyebrows in the private company market at the price it was at. It’s not that it is not a good business but arguably the share price now is maybe about the right value for that business.”

But he says it’s a myth that private company listings in New Zealand and Australia are tougher or not successful. Rothschild research into Australian private equity-backed listings from 2013 to 2016 showed they accounted for 43% of all offers. They also delivered returns of 24.3% since listing, nearly 8% higher than non-PE sponsored listings. Similar research hasn’t been done in New Zealand.

NZX market

Direct Capital raised a $375 million fund last year which it is still investing. It already holds stakes in some well-known Kiwi companies such as Ezibuy and Bayleys and some less well-known ones such as NZ Pharmaceuticals and Moore.

The 73 companies it has invested in to date have collectively added an additional 3600  jobs that wouldn’t have otherwise existed.

It has floated a number of companies including Ryman Healthcare in 1999, horticulture businesses NZ King Salmon and Scales, and Sky City and Nobilo. The partnership firm’s first fund was also listed on the NZX board.

Mr George says it is “very much on the radar” to list a number of its private companies at some point in the future though none right now.

A number of the companies it invests in have older owners who want to exit and he says there are practical and financial reasons to float rather than opt for a trade sale.

“If we list at least some of the ownership, if not a lot, it will stay in New Zealand and the beauty of a listing from our point of view and owners’ is that we don’t have to sell it all, we can keep a bit. You usually have to float it a little bit cheaply to get it away but from our point of view you raise new capital in a float and sell some in the float and two years later you can sell the shares at a number the market sets and, if it’s a good business, it’s going to naturally be a bit higher.”

The total number of NZX main board listings has dropped slightly from 168 to 161 since the end of 2015, as a result of takeovers, receiverships and other delisting decisions outnumbering IPOs.

There has been a recent trend for Kiwi companies to shun the local bourse in favour of the ASX and the large pot of compulsory superannuation money available across the Tasman for investment.

But Mr George says most of the businesses Direct Capital has invested in are better known in New Zealand and would be floated here.

“I believe there is an appetite to invest in New Zealand businesses, particularly by New Zealand institutions.”

One positive step the NZX has taken in recent years is to acknowledge the stock market should mirror the New Zealand economy, which is made up of about 1000 private companies with turnovers between $50-400m, he says.

Those of the types of companies that have been trading successfully for some time under private ownership, Mr George says, and he’s pleased the NZX is now looking at companies with turnovers of around $250m which “back in the day it used to say were too small to be listed.”