Making the best of it

Deal flow has slowed in recession-hit New Zealand, but there is still plenty to keep GPs busy finds Siddharth Poddar.

When the economic downturn put paid to large buyouts in Australia, things were no different in its neighbour to the southeast.

In 2007, private equity firms invested NZ$1.22 billion ($800 million) in New Zealand across 85 deals. While the number of deals stayed almost constant in 2008, there was a sharp dip in total deal value to $178.1 million, according to data from the New Zealand Private Equity & Venture Capital Association and Ernst & Young (see chart).

The fall in investment value was primarily due to the absence of large LBO-style deals. While in 2007, two top-end deals drew investments worth NZ$938 million, one being the Unitas Capital-led acquisition of New Zealand’s Yellow Pages Group, there have been no such deals since.

Even if one is to look at deal flow in the mid-market, where most of New Zealand’s private equity activity is concentrated, the decline in the total value of investments was significant. Last year, private equity firms invested NZ$112 million in 30 mid-market transactions. The number of deals compares favourably to the 23 mid-market transactions seen in 2007, but the total investment volume in this segment of the market dived from NZ$205 million in 2007 to just NZ$112 million in 2008, a decline of 45 percent.

Things seem likely to remain this way for a while. “The investment climate is still reasonably pessimistic,” says Paul Chrystall, managing director of Auckland-based Maui Capital, which manages the NZ$250 million Maui Capital Indigo Fund. He points out New Zealand’s economy is small, exposed to global forces and dependent on exports as it does not have a very large domestic base.

However, the effects of the financial crisis have not been as severe in New Zealand as they have been in many developed countries. Ross George, managing director at Auckland-based Direct Capital, which has raised NZ$200 million for the first close of its fourth fund targeting NZ$250 million, says: “New Zealand doesn’t have the pendulum swings that other economies have – we didn’t experience the bull-market from 2005 to 2007 in the same way as others, but we are not experiencing all the effects of the down-market either.”

Neighbourly ties

One key difference between the Australian and New Zealand markets, which are often clubbed together, lies in the style of investments. In Australia, much of the private equity activity in the last few years was focused on the increasingly large end of the buyout market, whereas investments in New Zealand have primarily focused on the mid-market with the aim of achieving a growth in earnings. As such, while the scarcity of credit has had a major impact on dealmaking in Australia, it hasn’t had the same impact on New Zealand.

However, New Zealand is serviced by the same banks as Australia. As such, though the country’s banking system remains well-capitalised and open to financing deals, Chrystall says banks in New Zealand have had some of their liquidity lines squeezed, and this has led to a much more rigorous capital allocation process.

That said, New Zealand players use less credit in their deals and private equity players investing in the country’s mid-market can still buy big companies, relative to the size of the country’s economy. “It is a smaller market, so you can buy more market power for your dollar,” says George. That is the biggest difference between the two markets, in his opinion.

Despite a slowdown in the country’s economy, GPs say there are certain sectors which continue to present opportunities. Gavin Lonergan, an investment director at Direct Capital, says food has always been a good investment area and it comprises a significant part of New Zealand’s economy. Another sector with good investment potential is specialist manufacturing. Lonergan says transport investments are leveraging off a growth in government expenditure as well. These are the three sectors that Direct Capital has been actively investing in. The firm also naturally has a focus on export-oriented industries. “New Zealand had a very high exchange rate with its trading partners and that put pressure on our exports,” he says. However, the New Zealand dollar depreciated significantly against the US dollar from February 2008 to March this year, assisting exporters. Although the New Zealand dollar has begun appreciating in value once again, it is still considerably weaker than it was 18 months ago.

It is difficult, though, for fund managers to maintain a sector-specific strategy in New Zealand. “We try to keep an open mind about investment sectors and industrial sectors and try not to pre-judge what is coming through the door,” Chrystall says. Being such a small economy, New Zealand “doesn’t lend itself well to specialists who want to specialise in one sector, because there just wouldn’t be the depth of opportunity here”.

New Zealand’s small market also means that managers investing in the country are constantly on the lookout for opportunities to invest in companies that either have an Australian connection or the potential to expand in Australia. “It is not always the case, but more often the case than not,” Chrystall says.

Maui Capital itself has made one investment so far – the acquisition of a 17.6 percent stake in Norfolk Group, an industrial services company based in Australia, for about A$15 million ($12 million). The firm typically invests in minority stakes and mid-market buyouts, limiting itself to about NZ$50 million per investment.

Direct Capital’s George agrees. He says the firm is seeing companies that have good opportunities to acquire competitors, particularly in Australia. In his opinion, the opportunity to grab market share is much stronger in this environment than it is when markets are stronger. This is primarily because in today’s environment, a number of companies are not well capitalised and hence are easier to acquire.

Managers are also seeing opportunities arise from the transitioning of business ownership in the country. The average age of business owners in New Zealand is generally higher than those in other countries, says Lonergan, and that presents an opportunity for private equity to step in. Growth investments in companies exhibiting this characteristic are popular, he says.

GPs in New Zealand say a pick up in activity is likely in the coming months. Chrystall, for instance, says up until recently, Maui was seeing good businesses with poor capital structures. However, now the firm is seeing good businesses with better capital structures as well.

His firm is looking at four companies at the moment, but he says it is difficult to say whether anything concrete will come out of it. “That’s the trouble with this business,” he states. “It is hard to predict.”