Mid-market appeal

In 2007, two deals in New Zealand got people to sit up and take note of private equity in the country. The NZ$2.24 billion ($1.6 billion) buyout of Telecom Corporation of New Zealand's Yellow Pages business by CCMP Capital Asia and Teachers' Private Capital, and Ironbridge Capital's acquisition of Media Works for NZ$780 million both boosted expectations and led many in the private equity industry to ask whether these deals could be a sign of the New Zealand private equity market turning a corner.

Not entirely, if you go by what private equity players in the country say today. To be sure, the acquisition of the Yellow Pages business in March was unique in that it was the largest ever private equity transaction in the country, and that Ironbridge Capital's acquisition of Media Works, which was completed in October, was also significant in terms of its size.

However, many practitioners also agree that big-ticket buyouts it is not where the buck lies in the near future.

The two large buyouts are viewed as examples of successful transactions, but transactions that will remain exceptions rather than become the norm.

Nevertheless, their significance is undeniable. The general sentiment one picks up in conversations with practitioners in the market is that deals such as these, as well as the acquisition of Independent Liquor in December 2006 by Pacific Equity Partners and CCMP Capital Asia for an estimated NZ$1.26 billion, have provided much optimism in New Zealand private equity, an industry that is still in its nascent stage.

Kerry McIntosh, New Zealand operational partner for Ironbridge Capital, says of the 18 months: “There have been a couple of key developments. Firstly New Zealand is now on the map as a [private equity] investment destination. We've seen increased activity from the Australian-domiciled private equity firms and we have also had regional funds investing in New Zealand for the first time. Secondly the size of buyouts increased and we saw the first $1 billion-plus transaction in the market.”

According to Hamish Bell, chairman of the New Zealand Private Equity and Venture Capital Association (NZVCA) and director of Capital Solutions at ANZ Bank, although there have been some large and high-profile leveraged buyouts, “the real heart of this market” is the opportunity that lies in the mid-market segment, in companies with an enterprise value of up to NZ$150 million.

LARGE BUYOUTS LIMITED
So why is it that despite the successful execution of a handful of large deals, the higher end of the buyout segment is still viewed as just a side story when discussing the status of the New Zealand private equity industry and its prospects?

Part of the answer is that New Zealand has relatively few companies with large enough enterprise values, so that opportunities to organise very large transactions are therefore limited.

In addition, the crisis in the credit markets has affected New Zealand like it has most other developed economies. Brent Lawgun, executive director at Maui Capital, which has garnered commitments of NZ$230 million for a NZ$250 million New Zealand-focussed fund it is raising, says that “a combination of the global credit crunch and economic slowdown has resulted in a tightening of debt availability in comparison to the last few years. ”This is certainly true also in the context of larger deals in Australia and New Zealand.

Richard Cutfield, executive director at Pencarrow Private Equity, established in 1993 and one of the oldest private equity firms in New Zealand, agrees. He says that in recent months, “the New Zealand economy has softened considerably, the housing market is depressed, the general retail climate is soft and the share market has dipped markedly since late last year. This has coincided with a definite slowdown in the number of larger, leveraged deals involving domestically focused businesses.”

The effect of these factors on large buyout activity in New Zealand is borne out by data from the NZVCA, which states that while the first half of 2007 saw two deals in the large buyout space, there were none in the latter half. (NZVCA classifies large buyouts as investments in businesses with an enterprise value of more than NZ$150 million.)

Tim Sims, managing director at Pacific Equity Partners, says that in order to get funding for larger deals, in the NZ$1 to NZ$1.5 billion range, private equity firms have had to tap the overseas money markets where today, as a result of the credit squeeze in the US, “international credit providers couldn't syndicate the debt and debt volumes from this source started to dry up”.

The smaller deals, on the other hand, were not as adversely affected, Sims says, as they were funded by domestic banks, many of whom rely on funding through retail deposits. He adds that “this market space has been more orderly and remained liquid as they use more traditional lend and hold structures” as opposed to syndicating the debt in the capital markets.

However, private equity managers point out that while funding for smaller deals was and is still available in the current market conditions, the cost of capital has increased and financing has become more difficult. Sims says that “in-market banks appear to have become more selective about who they'll fund”.

“They're rationing capital,” he says, based on “credit history, demonstrated record of performance, scale of equity funds in reserve, and committed presence in the local market.”

MID-MARKET PLAY
The mid-market segment of the economy continues to see a decent level of activity. According to NZVCA, there were 23 investments in the mid-market space in 2007.

This segment of the New Zealand market is large, as compared to businesses of other sizes. According to ANZ Bank's research, there are about 3,500 private businesses in New Zealand with revenues between NZ$10 million and NZ$150 million.

Bell says many industries are fragmented, which provides opportunities for consolidation. “In this segment, the numbers for private equity as a percentage of M&A are small – and M&A activity itself has been low but is starting to grow,” he adds.

Ross George, managing director at Direct Capital, which manages NZ$350 million, says that “the ownership of companies is changing hands as private companies look to fund the foreign expansion of their businesses and the banks are not as willing to provide debt for this. In such a scenario, private companies can get funding from private equity players.”

A theme frequently talked about is that of succession issues in businesses that operate in the middle-market segment. Bell notes the potential, with 45 percent of owners in this segment looking to retire in the next five year according to ANZ. Increasingly in New Zealand, owners nearing retirement are Considering M&A as a potential route to exit.

A majority of businesses are run by their founders, many of who are older than 50 years of age, and a sizeable proportion of which is more than 60 years old, according to Lawgun. “Private equity is well placed to help manage succession by partnering with management teams and positioning businesses for the next phase of their development,” he says.

Results from the ANZ Privately-Owned Business Barometer 2008 reveal that 31 percent of privately-owned businesses considered private equity a likely source of capital for growth funding; and 53 percent of owners said they would consider selling their business to a private equity investor as a succession route, as compared to 19 percent in 2007.

George sums up the views: “There's a very vibrant mid-market in New Zealand. It is the most attractive and the least serviced.”

VENDOR EXPECTATIONS
According to Nigel Bingham, another executive director at Pencarrow Private Equity, there is currently as much if not more mid-market activity as before the credit crunch. He attributes this primarily to deals being reasonably priced now. “We haven't made any investments in the last two years because we felt that the pricing and the terms to buy were not favourable, but that has changed now and we are now seeing a lot of attractive businesses at good prices,” he says.

According to Sims, it is possible that potential vendors whose businesses are not doing well may want to wait until performance and therefore valuations improve. Such vendors generally “confirm another couple of years of disappointing performance and then sell at modest multiples off prolonged modest performance, only to see the markets improve having missed the chance to hold and deploy cash in the current environment,” he adds. “Sadly history demonstrates that the majority will in hindsight hold on longer than they should.”

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