The past week has seen the announcement of more than R7-billion in private equity deals — all funded by local banks.
Although international deals have ground to a halt as banks recover from the global financial meltdown, opportunity has opened up for South African banks.
South African banks have the lending capacity for deals ranging from private equity to major infrastructure projects.
“Ten months ago international banks dominated the debt space, now there is a complete power shift from international banks to South African banks,” says Andre Pieterse, head of equity investments at Absa Capital. This week Absa Capital announced the buyout of EnviroServ for R2-billion.
Garth Jarvis from private equity investor Actis, which this week announced the R5,16-billion acquisition of engineering company Alstom, says that local banks are getting the lion’s share of local debt opportunities.
Nedbank Capital underwrote the debt financing portion of the deal, yet two years ago Nedbank passed on the opportunity to participate in the biggest private equity deal in South Africa’s history when it turned down the financing for Edcon.
“We looked at the deal three times but we said no,” says Mark Sardi, joint head of investment banking at Nedbank Capital.
Sardi says the bank was not prepared to offer a deal at the price and risk that the global banks were offering. With the onset of the credit crisis, the value of Edcon’s debt has fallen. Rating agency Moody’s issued a negative report on Edcon last week, suggesting that it would not be able to repay the debt incurred in the buyout rapidly.
The South African banks’ decision not to participate in many of the bigger deals in 2006 and 2007 has placed them in a strong position now.
“These are potentially the golden years for the domestic banks to grow market share,” says Sardi, who believes it may take between six to 18 months before the foreigners return, by which time South African banks will have entrenched their position.
Sardi says Nedbank Capital will conclude financing deals of between R3-billion to R8-billion between now and the end of the year. This is materially higher than previous years and Sardi says it is a direct result of the withdrawal of foreign banks from both the South African and larger African markets.
Many global banks were able to undercut local banks because they were not using their own balance sheets to fund the deals. Instead they were selling the debt further to fixed income funds and hedge fund managers in the high-yield bond markets. This allowed the banks to offer cheaper financing, but they did not take appropriate risk measures. Requirements such as the level of debt relative to earnings and the ability of the cash flow to repay the interests were low or non-existent.
As a result of these “covenant light” deals, international banks now have around $400-billion debt they cannot place because fund managers are not convinced about the quality of the debt.
Until they are able to locate this debt, their capacity to do further deals is constrained.
South African banks, however, are not in the same position and are working together to provide finance for major infrastructural deals, which bring in a larger collective balance sheet and spread the risk across the banks.
Private equity deals will continue in South Africa but Sardi and Pieterse agree that we will not see the mega private equity deals that dominated headlines two years ago like Edcon, Alexander Forbes and Consol.
“For the bigger deals the funds are not available, there are capacity issues, with all four banks. You need international distribution to on-sell the risk into the offshore market and those distribution channels are currently not available,” says Sardi.
Pieterse says Absa Capital is involved in five private equity transactions at the moment, all of which will be financed locally.
He says deal capacity is limited to $1-billion and lending requirements have tightened significantly.
A year ago deals were done at around four times annual earnings, now it is closer to three times and pricing is more expensive.
“Debt is available from local banks for the right assets and the right exposure,” says Pieterse.
More delistings ahead
The intention to buy out and delist JSE-listed waste management company EnviroServ is likely to be followed by further delisting announcements.
Small capital companies which have become casualties of global market turmoil could spark a spate of delistings from the JSE.
Absa Capital is working on several private equity deals that may see further delistings from the JSE.
Mark Sardi from Nedbank Capital says the bank has received requests from companies for advice and funding to delist. Sardi says this usually happens when management has a different view on the value of the company from shareholders.
Although many companies are delivering returns, this is not reflected in their share price. They may use this opportunity to take the company off the market and then list again when market conditions are conducive.
The market saw a similar trend in 2003 when companies like Softline and Nando’s used cheap markets to buy back their companies. This created a great deal of anger among minority shareholders who were forced sellers.
Sardi says Nedbank Capital is talking to fund managers to continue to hold unlisted shares in the companies, so that shareholders who wish to can continue to participate.