Private equity primed to pounce

By Fiona Robertson, The National Business Review

Market troughs and credit crunches are a headache for most investors but for private equity operators they create exciting times.
So, while it might seem like a difficult task to be raising money now, local private equity firm Direct Capital said the launch of its new fund was "very much pro-cycle."

The firm aims to raise $250 million over the next few months, including $60-120 million from retail investors via its second Pohutukawa fund run with ABN Amro Craigs.

Direct Capital investment director Gavin Lonergan said this was a really good time for private equity to be buying but he played down the idea that it would be scooping up bargains.

Instead, he said, it was more a case of letting off buying pressure, as the easy debt of past years dries up. "For us it's a return to what we'd describe as normal market conditions."

Bankers had been quite aggressive competitors in past years, Mr Lonergan said, but Direct Capital now expected de-leveraging and a swing away from debt deals towards more equity investments.

Although private equity firms might have had the image of being debt-loaded operators themselves, Direct Capital has relatively low leverage - two times ebitda (earnings before interest, tax, depreciation and amortisation) in the Direct Capital III fund.

It might be normal times for private equity but it was a difficult corporate environment, Mr Lonergan admitted. Even if their portfolio companies weren't able to achieve much growth there would be an opportunity for them to gain market share.

"Companies that are really well-funded and have good balance sheets will do well out of this market."

Direct Capital invests in privately-held mid-sized companies valued between $20-150 million - the "backbone" of corporate New Zealand, Mr Lonergan said.

The aim was to target companies looking to expand, domestically or across the Tasman, or those whose owners are looking to retire.

This private sector sector is more representative of the national economy and larger than the listed market, Direct Capital managing director Ross George said.

Private equity and venture capital association (NZVCA) chairwoman Franceska Banga said research showed there were good untapped opportunities in the sector.

The new fund is a repeat of the structure that raised $130 million for Direct Capital in 2004, and the company expects demand from those existing investors to bolster the new fund. Investors don't have to stump up their full commitment now - retail investors pay in 10% instalments, called up when Direct Capital is ready to invest.

But they will need a long-term timeframe. Pohutukawa I, for example, began returning dividends around three years after inception and is only now nearing the end of its investment phase. There is a secondary grey market in place for the shares, run by ABN Amro Craigs but in general private equity investors should be prepared to stick around for some seven to 10 years.

Ms Banga said this long-term horizon meant private equity hadn't experienced the same dramatic drops in value as other sectors this year. They didn't have to deal with runs by nervous investors, she said.

Historically, private equity returns about 5% above publicly listed investments and the years after major market falls turn in the best performances.

Pohutukawa I has made 20.3% gross returns a year for investors, after management fees, for the period to June 30 2008.