Ironically, the credit crunch could bring much fortune for the private equity industry in the black economic empowerment (BEE) space.
With banks putting the squeeze on credit lending and liquidity (free cash) drying up, private equity could emerge as the financier of choice for BEE over the next seven years.
"It's not impossible in the near future," says JP Fourie, CEO of the SA Venture Capital Association (Savca).
There has always been a strong symbiotic relationship between private equity and BEE - without private equity, arguably, there wouldn't be as many BEE deals and vice versa.
Fourie says that private equity is a better route through which to do empowerment deals, rather than the typical equity-based deals.
"The bottom line is, using private equity to do a BEE transaction is way better than the structures used in JSE-listed BEE deals where it's more pegged on share price fluctuations and mark-to-market valuations," he says. "I'm not saying private equity BEE deals won't be under pressure (because the cost of raising debt will mean a slowdown in deal activity), but they will be more cushioned than listed BEE transactions because of long-term capital flows."
But as the value of shares on the JSE has plummeted, many BEE deals that relied on steady dividends and an increase in share prices are under water. In some quarters, the BEE implosion is being referred to as SA's subprime crisis.
Not surprisingly, there are concerns that BEE deals funded by private equity will also hit the wall. But KPMG's annual private equity survey shows the opposite is happening - empowerment deals are still taking place in the middle market with sizeable private companies.
The survey shows that while the total investments made in the private equity industry dropped 18,4% from R26,1bn in 2007 to R21,3bn in 2008, BEE investments rose significantly.
According to KPMG, there was a 38% increase in BEE investment in 2008 to R16,3bn from R11,8bn. The average deal value rose from R30m to R49m, helping offset a fall in the number of BEE deals made - from 390 to 331 during 2008.
However, it is interesting to contrast the 38% rise in private equity-funded BEE deals with the 71% drop in overall empowerment deals in SA. According to Ernst & Young, total BEE deals in SA fell from R96bn to R61bn.
The KPMG survey shows that the proportion of private equity funds invested in empowered companies (more than 25% black-owned but less than 50%) increased from 24,1% to 34,3%. This underlines the point: the industry is investing more in black companies than ever before.
Of the total R103bn private equity funds under management, R54,9bn of that has some type of BEE component - a 17,6% increase on 2007's R46,7bn.
The allure of BEE investment can also be seen in the fact that more than half the R103bn under management is allocated to empowerment, whereas in 2003 less than a third of the R39bn was put in black companies.
One reason for this is obvious: industry charters have spurred empowerment investment. So it's no surprise that most of the BEE investments took place in the infrastructure, manufacturing and mining sectors.
When investing in BEE projects, the private equity industry uses the criteria laid down in the financial sector charter. These are:
- More than 50% of voting rights must rest with BEE investors;
- More than 50% of profits must accrue to BEE investors;
- The private equity fund manager must be a BEE-owned company; and
- Over a 10-year period more than 50% of funds must be invested in companies that themselves are at least 25% BEE-owned.
Though KPMG's 2009 survey shows that private equity is an attractive funding mechanism for empowerment, it hasn't always been this way. Its popularity began to rise only in the late 1990s, after many BEE buyouts of JSE-listed companies collapsed.
The private equity industry subsequently became hot news, luring many BEE players to them for funding. One reservation, however, has been the image of private equity groups as ruthless asset strippers, quick to close down businesses if they are not able to provide the investment returns needed. But as investors have become more comfortable with private equity, this perception has eroded, to some extent.
So how concerned are private equity firms with whether the companies in which they invest are empowered?
Deloitte does a private equity confidence survey of 400 companies every few months. Deloitte head of private equity Sean McPhee says: "Black empowerment still remains a focus at these individual companies, but the extent of this depends on which industries those companies operate in and which charters govern those companies."
Zola Fubu, a director at SizweNtsaluba VSP, a firm of accountants, auditors and business advisers, believes the private equity industry will score big after 2010 when the majority of large BEE deals will be finalised in terms of the charters.
This is likely to herald a new era dominated by the restructuring and refinancing of empowerment deals. Fubu says the likely proliferation of BEE deals will make it tougher for participants to raise conventional funding to facilitate those transactions - so more companies will turn to private equity.
"After 2010 we will observe a lot of deals that may not be easy to finance, partly because the stock market will no longer be used as a benchmark for funding BEE deals."
This is where private equity entities will gain, says Fubu, as some banks won't be keen to finance these deals. "It is in this new era [after 2010] that private equity entities could be sourced to cofinance these deals. Some of the smaller private equity entities today would have advanced to a level where they have significant balance sheets, and are therefore able to syndicate the restructured and refinanced BEE deals."
If this scenario plays out - SA is already seeing some consolidation and restructuring - the fairytale relationship between private equity and BEE is set for a profitable marriage.
