A proper meal under the Pohutukawa

By JENNY RUTH

Kiwi investors have had plenty of experience in giving venture capitalists such as Sydney's Private Equity Partners enormous profits, but now they're being offered opportunities to participate in the main course rather than just getting the crumbs.

The Pohutukawa Private Equity fund, a joint venture between retail stock broker ABN Amro Craigs and private equity specialist Direct Capital, is aiming to raise up to $80 million - and at least $40 million - from retail investors.

My main question is whether Kiwi investors, with their well-known appetite for dividends or other forms of regular income streams such as those obtainable from capital bonds, have the patience to support such vehicles.

Investors in this type of fund must be prepared to wait at least three years and possibly five or more before they see any returns.

Earlier returns are possible, but the nature of the underlying investments means they can't be relied on.

AMP struggled in 2000 with the first such offering to retail investors.

It had aimed to raise up to $75 million from retail investors and a further $100 million from institutions for AMP Private Capital.

It managed to raise $56 million in total, which was at least sufficient for it to proceed.

But recent examples are more encouraging. The Australian Gresham Private Equity's second fund has raised A$100 million ($105.8 million) and expects to get to A$300 million by early next year.

It was that fund which recently bought the Noel Leeming, Bond & Bond and Big Byte retail chains from Pacific Retail Group for $138.5 million.

And closer to home, Goldman Sachs JB Were's second Hauraki Private Equity fund, started in April, has raised $75 million.

Its first fund, started in 2002, raised only $22 million, so it seems investors are warming to the concept.

The first fund's highest profile investment was in the Hirepool management buyout in mid-last year as part of a consortium.

Such funds focus on investments in private businesses, from providing seed capital for startups and venture capital at an early stage of development through to financing management buyouts, established companies looking to expand and those with ambitions to become listed companies.

Because their investments tend to be long term, they shouldn't be liable for capital gains tax in New Zealand, although any investments Pohutukawa makes in Australia will be subject to that country's 30 per cent capital gains tax.

Neil Craig, ABN Amro Craigs executive chairman and a Pohutukawa director, is upbeat about his float's prospectus.

"This is flying out the door," he says. The float is set to close on October 8.

The Pohutukawa fund has no track record, but Direct Capital's record is about as long as it gets in New Zealand.

It was founded in 1994 and its funds have invested more than $150 million in 34 separate investments.

Fifteen of these have been realised. They include the Ryman Healthcare float, the Nobilo Wine float and eventual takeover by BRL Hardy, and the trade sale of whiteware manufacturer Robinhood.

Both the floats were successful and profitable for their investors as well as for Direct Capital - in contrast to Private Equity Partners' chequered record, particularly with the disappointing Vertex float, from which PEP extracted maximum profits on forecasts which proved to be wildly optimistic.

Vertex shares were issued at $2.05 but have traded below that ever since. They are now around $1.65.

Direct Capital invested in Ryman in January 1997, paying 37c a share. The company floated in July 1999 at $1.35 a share and the shares were trading yesterday at $3.25.

"The difference is that we live here," says Direct Capital managing director and one of its founders, Ross George

Adjusted for the same management and other fees applying to Pohutukawa, Direct Capital claims to have produced an annualised portfolio return of 21 per cent.

The Pohutukawa prospectus shows that between December 1994 and last December, the Top 40 gross index achieved an 8.6 per cent annualised return and the broader sharemarket produced a 9.4 per cent annualised return over the same period.

The prospectus also gives international comparisons. Private equity funds in the United States achieved an annualised 12.7 per cent return over the 10 years to last December, compared with the S&P 500 index's 9.1 per cent.

European private equity funds achieved 11.7 per cent compared with the FTSE Eurotop 300 index's 5.4 per cent returns.

But Direct Capital and ABN Amro Craigs services won't come cheap.

Investors must pay 40c in the dollar of capital up front, and will face two further calls of 30c a share each within the next five years.

They will also have to pay a 2c in the dollar application fee and a further $250,000 in offer expenses will be taken out of the money raised.

Then they will pay 2.25 per cent plus GST a year in management fees.

On top of that, the management company will get an "earnout" fee of 20 per cent of returns greater than 8 per cent a year before tax.

One protection for investors is that the management company can't take the earnout until the investors have received back their original investment plus the 8 per cent annual return.

By comparison, the two equity funds which listed this year, Kingfish and Salvus, charge annual management fees of only 1.25 per cent a year and their "earnouts" kick in at much higher levels - in Kingfish's case, the CSFB 90-day bills index plus seven percentage points, and in Salvus' case the small companies index.

Craig calls Pohutukawa's fees "wholesale fees to retail investors", and says they match international norms for private equity funds.

Direct Capital's 14 investment professionals have to get involved in analysing investments, including high levels of involvement at management level, to a much greater extent than someone investing in listed shares, he says.

Pohutukawa won't be listed, although the prospectus says it will if the four directors unanimously vote for a listing. ABN Amro Craigs will try to provide a "grey" market, matching buyers and sellers informally.

Craig says that to begin with, Pohutukawa will be only a cashbox so it is inappropriate to list it.

While equity funds such as Kingfish and Salvus can invest their money relatively quickly, private equity funds typically take considerably longer to build up a portfolio, he says.

But once Pohutukawa does have a portfolio, it might then be appropriate to list it, he says.

Investors are being offered another carrot - once Pohutukawa's investments become mature enough to go public, its investors will be given preferential access to the float.

But not all Pohutukawa's investments will be floated. Some are likely to be sold to trade buyers.

Pohutukawa

Private Equity Management company: private equity specialist Direct Capital (managing director, Ross George).

Major shareholders: Direct Capital and stockbroker ABN Amro Craigs.

Amount to be raised: up to $80 million; at least $40 million.

Minimum investment: 10,000 shares; $4000 is payable up front and the rest in two payments of $3000 at the managers call within five years.

Management fees: 2 per cent application fee, annual fees of 2.25 per cent plus an "earnout" of 20 per cent of any returns achieved above 8 per cent a year.

Pohutukawa aims to produce superior returns to stock market indices through investing in private companies.