Private Equity Survey: With adversity comes opportunity

With the global economy in recession and the resultant volatility in markets, the private equity community is divided on what the future holds. However, with adversity comes opportunity and private equity firms have proven to be dynamic, flexible and responsive in volatile markets. This has enabled them to respond to changing market conditions.

“The financial crisis and declining valuations should provide significant opportunities for private equity firms to acquire assets at attractive prices once expectations between buyers and sellers converge,” says Sean McPhee, Leader of the Private Equity Group, at Deloitte.

South Africa and the local banking sector have proven to be resilient but have not been immune to the global economic crisis and the “de-coupling” theory where emerging markets will “de-couple” from the developing economies has proved to be a myth. The credit crisis has had and will continue to have far-reaching implications for all economies, with the landscape being changed forever.

According to the sixth Deloitte Private Equity Confidence Survey (PECS) which is conducted in collaboration with the Southern African Venture Capital and Private Equity Association, among investment professionals in the private equity industry, 40% of respondents expect the overall economic climate to decline, 33% to remain the same and 27% expect the economic climate to improve.

“This is a more optimistic view since the last survey (quarter 3 of 2008) showing that some respondents believe we may have turned the corner,” continues McPhee.

This forward-looking survey which will be carried out twice a year in future (quarter 1 and quarter 3), provides insights on how fellow private equity and venture capital practitioners are viewing the landscape and, more importantly, what future expectations are.

Despite global uncertainty and the anticipated difficulty in raising funds, 62% of respondents are planning to raise a new fund over the next 12 months. Greg Benjamin, Deloitte Corporate Finance Manager comments, “In a world where competition for capital is increasing, this is going to be incredibly tough but respondents are under no illusion, with 76% acknowledging this challenge.”

According to McPhee, South Africa is still the favourite choice as a geographical source of raising capital followed by the US (29%) and then Europe (20%). A potential structural change is evident in the sources of these funds as more respondents are looking to other markets such as the Middle East and Asia to close their funding gap.

51% of respondents envisage investing all available funds in less than two years which is a crucial driver of the raising of new funds. 47% of respondents envisage taking up to four years to invest their current fund. It is these funds with their “war chests” already in place that will be best positioned to take advantage of the opportunities that are expected to emerge from this cycle.

Manufacturing and services industries remain favourites, as private equity participants focus on defensive sectors and businesses that are scalable and will benefit the most from the upswing. The healthcare sector is experiencing some renewed interest – up to 8% from 5%.

No respondents are looking to invest in start up companies and seed capital. 18% of respondents believe that the attitude and understanding of institutional investors is worsening which is the highest recorded in this survey. In line with respondents spending the majority of their time being internally focused on investee companies, the transaction focus will be on providing replacement/buy-out and expansion and development capital.

57% of respondents expect that competition for new assets will decline, while 79% of respondents expect entry multiples to decrease. This must represent a huge buying opportunity however, the big question is, when will the bottom be reached and will sellers’ price expectations converge with buyers?

80% of respondents expect deal sizes to decrease as the equity to total transaction capital ratios increase. As a result, Deloitte expects more activity in the mid-market space. 64% of respondents expect the availability of debt funding for transactions to decrease and Deloitte expects the equity component of deals to increase as deals are more conservatively financed.

80% of respondents expect exit valuations to decrease and 76% expect the volume of exits to decrease. This confirms that it is not a good time to exit.

“There is an opportunity for the emergence of a stronger secondary private equity market in South Africa,” says Benjamin. “A stronger secondary market would inject liquidity and has been successful in achieving this in markets such as the US, UK and Europe.”

“Investors remain confident that private equity returns will outperform returns achievable on the JSE. We are confident that the private equity industry will emerge stronger and will continue to play a significant role in capital markets and building better, more resilient businesses,” concludes McPhee.