Private makes profit

Brendon Thomas

Brendon Thomas wanted to find a good home for his "pet".

He started his business, Express International Logistics, in a one-room office at Auckland Airport in 1989. Over the next 16 years, he built Express - which makes sure orders are delivered to the right place, at the right time and in the right quantity - into a $100 million-plus operation.

It now employs 250 people and has branches across Australia and New Zealand and serves well-known firms such as childrenswear manufacturer Pumpkin Patch and lingerie producer Bendon.

It was a ride Thomas, 43, describes as "exciting and great fun".

But a year ago he decided to try his hand at something else. He wanted to spend more time with wife Katrina, daughter Madison, 9, and son Joshua, 5. He was also not prepared to make the commitment to take Express to the next level - a business turning over $300 million.

Thomas, who exchanges hands-on running of the business at the end of next month for a seat on the board, says: "I had achieved all the goals I had set and wanted to move on. There is also an element of wanting to take some of my chips off the table."

So he sold out to a consortium led by Auckland investment fund Direct Capital, one of a relatively new breed in New Zealand - the private equity house. These are funds which, typically, raise cash from pension and insurance funds and, sometimes, retail investors and tip the money into private unlisted ventures.

Their bets - often boosted by large chunks of debt - can deliver returns as high as 40 per cent a year and, as a result, they are growing in stature and influence.

Investment bank Goldman Sachs JBWere reckons Australasian private equity fund raising has grown from just over A$100 million in 1996 to about A$2.5 billion last year.

But New Zealand private equity funds represent just a fraction of that sum. Moreover, the investment class in Australasia represents a fraction of 1 per cent of the region's GDP, well below America where private equity fund raising has often exceeded 1 per cent of GDP.

Thomas will not disclose how much the consortium, which included another fund, Waterman Holdings, and staff, paid. Only that he retains a 10 per cent stake and that he got less than he would have had he sold it to one of the two competitors who were interested.

There was more at stake.

He and his business partner, Graeme Mann, were anxious to preserve the future of the company. They had put a lot of energy into developing the company culture and investing in people.

Express allowed its staff to see the financial performance of the operation in order to motivate them. It ran in-house education programmes, including courses such as life skills. A doctor visited for staff checkups every couple of weeks.

Thomas and Mann feared that if Express had been sold to a competitor, this culture, a major point of difference from the competition and perhaps one of the more important ingredients of its success, would have been lost.

"We came to the conclusion that the best owners of the business were our managers and staff. The private equity partners allowed this to happen," Thomas said. "It is like your pet, you want to see it go to a good home."

Mann, who takes control as managing director, retains a 5 per cent stake.

No private equity fund operates the same as another, but Thomas' story is typical of the way they work.

Private equity investors can provide capital for businesses lacking the financial clout to fund their own growth plans through acquisitions or organic growth.

They can buy troubled businesses and install a management to turn the business around. Their dominance on the share register allows them to make bolder moves than public sharemarket investors would stomach.

And they can provide specialist skills to help firms list or expand into markets such as Australia that they know little about.

Ross George, managing director of Direct Capital, one of the first major private equity players in New Zealand, illustrates the point: "Companies know that we have [floated] companies really well such as [retirement home operator] Ryman Healthcare and [winemaker] Nobilo.

"And we have a large institutional base in our funds, so these guys see...an easier route to listing."

George says Direct Capital can lend its expertise to let businesses expand overseas.

"We have been to Australia 13 times. The risk in moving to Australia with a group like us that has done it a lot of times is low. The risk in moving to Australia for the first time is actually quite high."

By dealing with a financial buyer rather than floating on the sharemarket, business owners can keep their affairs out of the public eye. It is also a cheaper way to exit the business.

Investors in the funds benefit from all of this and can invest in sectors of the economy not represented on the utility-dominated NZX.

Each house also has its own investing criteria. Wellington's Pencarrow Private Equity looks especially for businesses making well-designed products. It is a key investor in tap-maker Methven, which floated on the sharemarket last year. And, in opposition to many in the industry, it typically does not use debt to generate the expected returns.

Quitting investments is one of the more complicated hurdles private equity funds face. Listed companies can be sold on market, but private equity has to sell the firm outright or pursue a complex and expensive public listing.

But Goldman Sachs JBWere private equity head Paul Chrystall says businesses sell themselves. "I am of the view that when you buy a business you buy into it forever. If you have a good business, there will be a number of ways to exit."

This sometimes includes other private equity funds. Goldman Sachs JBWere's private equity fund sold resthome operator Guardian Healthcare to Australia's Private Equity Partners for $190 million. Less than a year later, PEP sold the business to Australian heavyweight aged-care operator DCA for $300 million.

George agrees: "When we invest, our objective is not to get out. These things are profitable. You can stay in for a long time and earn fantastic returns out of the business. If you get your capital structure right, you can get your money out and retain ownership of the asset."

Exit is also a problem for retail investors. Typically, retail private-equity funds are closed; returns are paid only as the investments are liquidated. As a result, funds largely suit those who can salt cash away for long periods.

The New Zealand market is fertile ground for the industry.

It is a new and, therefore, undeveloped asset class. Overseas pension funds now see it as a mandatory component of investment portfolios, but some big pension funds in New Zealand do not have assets invested in the class at all. Over the longer term, they will follow suit.

Meanwhile, the sharemarket represents a smaller proportion of the economy compared with overseas markets. This means private capital predominates and creates plenty of opportunity for funds.

"New Zealand is the land of the private company," says George. "We have a market bigger than the listed market to play in and there is a real shortage of capital in it."

However, it is not all plain sailing.

The funds have to fight against bad press. Two episodes fresh in investors' minds are the flotation of carpet manufacturer Feltex and plastics packaging group Vertex.

Australian private equity funds Credit Suisse First Boston Asia Merchant Partners and Private Equity Partners respectively sold out of the companies to the public.

However, Feltex and Vertex never delivered on their prospectus forecasts and their shares sank to depths from which they never recovered. Investors lost millions.

New Zealand funds agree some investors have been burned, but believe tarring the whole industry with the same brush would be a mistake.

Chrystall says: "People look at our returns and they say we must have bought cheaply, but they do not see the risk we have put into it."

Pencarrow executive director Richard Cutfield said in the past there was an opportunity to simply clean up operations and sell quickly but those days were coming to an end.

"The market is now more sophisticated."

Meanwhile, Australia's compulsory superannuation scheme has created a river of funds to be invested and they are often competing for deals with New Zealand funds. Lawyers and investment banks here reckon merger and acquisition activity will remain robust despite the slowing economy, thanks to these funds.

Australian private equity funds cannot match locals' knowledge of the New Zealand market. They stick to the big deals that will make a meaningful difference to the performance of their funds and often partner with local private equity funds.

"There is a huge supply of money," says Chrystall. "The amount of money coming out of Australia is phenomenal. The savings schemes are drowning in vast amounts of money. That supply of savings will drive down returns and drive up prices."

Acceptance of the private equity asset class is taking a long time and, even if large funds agree with the concept, they want a record of performance before they allocate cash to a fund.

George says: "If you have a good track record, funds are attracted to you. It is a case of just getting a track record with realisations at good profits." 


A spectrum of investors

Boundaries between the different classes are blurred but here is a rough guide to the panoply of investors that fall under the private equity umbrella:Private equity investors: Investors that predominantly take shares in companies that are not quoted on a stock exchange.

* Venture capitalists: Financiers predominantly for start-up companies and new or turnaround ventures. They generally take an investment risk with the expectation of above-average future profits.

* Angel investors: Affluent individuals who provide capital for business start-ups, usually in exchange for an equity stake. They often organise themselves in networks and pool investment capital.


New Zealand's major private equity firms

I-Cap Partners
* Australasian head: Tony Hannon.
* Assets under management: $400 million.
* Favoured sectors: Healthcare, tourism, agri-technology and brands.
* The firm has offices in New Zealand, the UK, the US and Bahrain.
* Advisory board includes: Former Prime Minister and WTO director-general Mike Moore; former Finance Minister Ruth Richardson; Graham Scott, former Treasury secretary; and Laura Tyson, London Business School dean and former national economic adviser to the Clinton Administration.


Goldman Sachs Jbwere Private Equity

* Executive director: Paul Chrystall.
* Funds under management: $325 million.
* Manages the retail funds Hauraki No 1, Hauraki No 2, Mezzanine Fund.
* The Hauraki private equity funds specialise in leveraged buy-outs, management buy-outs, providing expansion and development capital.
* Assets include mower-maker Masport and engineer A&G Price.


Direct Capital

* Managing director: Ross George.
* Funds under management: $350 million.
* It runs its own private equity fund, which invests in mature, profitable companies, most commonly through buy-outs, buy-ins and development capital. Its portfolio has ranged from aircraft maintenance to wine.
* It also manages or jointly manages the venture capital fund TMT Ventures and Bio Pacific Ventures, a retail private equity fund.


Pencarrow Private Equity

* Executive chairman: Mark McGuinness.
* Funds under management: $200 million.
* Created to manage the Greenstone Fund, a $25 million private equity fund whose investors are AMP, AXA, National Provident Fund and the New Zealand Government.
* In 1998, Pencarrow formed a joint-venture agreement with AMP Capital to undertake and manage private equity investments.


ANZ Capital

* Head: Mike Bradley.
* Assets under management: $400 million.
* Seeks companies with trading histories, a competitive advantage and a path to grow. It backs strong management teams.
* Will not do: Start-up or early-stage venture capital, turnarounds/distressed situations, high-tech industries or property investments.

AMP Alternative Investments

* Head: Murray Gribben.
* Funds under management: $200 million.
* Specialises in mature companies.
* Investments include software-maker Zeacom and investments with Pencarrow.

Sources: The New Zealand Herald and the New Zealand Venture Capital Association and company websites.