New engine on the block

Fund could create a new asset class

Independent mezzanine funds could be the next newish asset class, while at the same time playing a significant developmental role.

Vantage Risk Capital has launched a Mezzanine fund, with plans to close it at R500m, at their second closing.

The Netherlands Development Finance Company (FMO) with a total $3bn in assets invested, 10% of which is in mezzanine finance generally, is a significant investor at R100m as a ceding investment, with an undertaking to invest more, while Metropolitan is in for R60m, and Eskom and Transnet are each in at R50m, and then there is the PIC, who are in for another R50m.

The fund is happy to get the PIC in. They want to start with a lower amount, and if they are happy with the deal flow they may well enter into fund again in the second round. The PIC doesnt generally get involved in investing in other funds.

BEE is a happy hunting ground for mezzanine debt funding in SA, hence the launch of the first independent mezzanine fund which will be aimed at BEE and medium size business sectors.

The FMOs Arthur Arnold says that this type of fund is essential is developing and stabilizing countries and their economies. The mid and small businesses are the engine room for the development of a country.

Arnold says that at the core of the issue is that of ownership and control, and that it must be maintained by the entrepreneur. And while initially there may be some reluctance from businesses to use this funding mechanism to take their businesses to the next level, once they understand the details, the benefits become evident.

The FMO puts its money where its mouth is and they currently have a portfolio of investments in Africa of over e450m, e110m of which is invested in the financial sector.

Although it was mentioned that the agricultural and junior mining, as well as certain sectors of the retail environment, are not primary targets for this fund.

This type of finance is important source of capital for mid and smaller businesses, and its essentially the bridge financing or gap filler between senior debt and equity. The fund will be looking at the mid market those businesses with turnover of between R10 and R50m.

The fund is looking for between seven and 20 investments, in the region of R50m to R150m each. In fact they plan to perform their first transaction in the next 8 to 12 weeks.

The caveat is that they dont want to get involved in hostile take-over situations, cigarettes and arms. There are also not playing in the micro and SME sector, as the development funding sector takes care of that sector.

Internationally there are about 100 funds in the USA (investing $10bn), and Europe has in the region of 50 funds investing e8bn. Interestingly enough the deal sizes are bigger in Europe, than in the USA.

South Africa does have a brief history in the mezzanine finance sector, where several years ago Brait launched a captive or closed fund, and there was one listed fund Makalani.

Mutle Mogase, the executive chairman was talking up his book, mentioning that there is a market for this type of fund, and there was space for a new asset class. And perhaps the biggest reason that that the local fund is looking at the mid market, is the lack of competition from the banks, and the listed fund - Makalani.

Makalani initially started with a bang, and attracted a fair amount of interest, although it does appear that the FNB connection may well have limited more deal flow, due to potential perceived conflicts of interest. Added to which it competes with the banks for the large big ticket deals, which are few and far between.

Note: The private equity sector is fairly large in SA estimated at R42bn it generally follows that there is a mezzanine finance opportunity.

Mezzanine funds essentially only work in environments where interest rates and inflation rates are low, and there is no arbitrage opportunity, and thus the reason that the funds havent been established previously in SA.

Added to which the maturity of the current market and some of the financial instruments available locally is a challenge to the development of this type of funding.

The upside, according to its proponents, is that its different to private equity as 2/3 of the returns are contractually tied in, and there is no need to exit the investment to benefit. There is also a longer time delay in the private equity sector and possibly more risk attached.