With hindsight it seems extraordinary that in 1994 three young men aged in their early 30s were taken seriously when making the following proposition to New Zealand’s institutional investors.
“We want to raise a fund that you commit to for at least ten years. We’ll invest that capital into private companies but we can’t tell you which ones because we don’t know yet. We can’t tell you when we’ll make those investments. They will be minority shareholdings with no liquidity and limited control rights. And we can’t tell you when you’ll get your capital back or what the returns might be. But trust us.”
To be fair, other than amending the minority shareholding mandate to now include majority shareholding investments, very little in that proposition has changed in the thirty years since Direct Capital was established. The trust placed in Direct Capital by our investors has always been humbling.
How on earth did Direct Capital’s founders: Ross George, Mark Hutton and Bill Kermode ever succeed?
A stellar board that included some of the most respected independent directors of the time - John Fernyhough, Ian Farrant, David Chetwin, Tony Frankham, Gareth Morgan and Professor Wayne Cartwright, certainly helped balance the question of age and experience.
A clear strategy: invest in private companies pursuing a step-change in either ownership or growth, for which Direct Capital’s investment could assist, and with a clear understanding of the firm’s role as an active shareholder, rather than an operating manager.
International evidence was clear - successful economies are built on successful private companies. Private companies have distinct features that deliver positive shareholder gains - higher rates of growth, narrowly focused ownership that aligns the interests of both management and shareholders, and an ability to adopt long-term strategies without the burden of short-term public financial reporting.
It was a compelling investment theme, but nonetheless, a difficult one for institutional investors to get comfortable with, hence a very non-traditional private equity structure: the requirement that the fund be listed on the New Zealand Stock Exchange to enable liquidity for institutional investors and provide them an ability to “mark to market” the investment daily. Somewhat questionable benefits, but nonetheless, sufficient to get investor support, led by AMP Capital.
And so Direct Capital Private Equity was born.
Our beginnings were modest, raising just $53 million in capital, but that capital went a long way - a cornerstone shareholding in Ryman Healthcare, the pre-IPO of Sky City, and investment into some of the famous names of 1990s New Zealand business world: PC Direct, Nobilo Wines, Robinson Industries, Airwork, and EFT-POS NZ to name just a few.
As necessary as it was to have Direct Capital’s first fund listed on the NZX, it also very nearly led to the firm’s demise. In 1998 with the fund established and the portfolio complete, the fund was the subject of a successful takeover offer. The liquidity discount on which it traded an open invitation to acquire cheaply, an extraordinary portfolio of long-term value. 25% of Ryman Healthcare for just $7.5 million, anyone?
By the late 1990s the only game in town was venture capital and investing into the tech boom. The steady-eddy private company space was considered boring unless the name contained “.com”. Nonetheless, Direct Capital II managed to raise a modest level of capital with a less formal investment structure, but one that enabled investment into the likes of Pacific Flight Catering, the Australasian subsidiaries of Moore International (the acquisition of which deserves its own article), Image Centre, and EziBuy.
By 2005 the investing world had returned to normal whereby earnings and cash generation were once again valued by investors. Direct Capital III was raised with capital of $130 million and the family of companies into which Direct Capital had invested was expanded to include Max Fashions, Express Logistics, Triton Hearing, Innovair, Stratex, Shears & Mac, Rodd & Gunn, Go Bus, and New Zealand King Salmon.
Not all companies travel in a straight line to success. In fact, very few companies avoid periods of challenge – a change in industry dynamic, recession, or government policy. And sometimes we simply get it wrong. Dealing with failure is inevitable. Where investments have gone wrong, we have always acted to preserve the business and jobs, even if our shareholding goes to zero.
Thankfully, these failures have been few and, as an aside, it seems a particular New Zealand trait that when talking about our experience the questions are almost always of the failures, rather than the successes.
Raising capital has always been challenging, and rightly so. It takes time to build a reputation for trust and common-sense investing, and to provide a track-record that demonstrates consistency rather than luck. By 2009 our typical period for fund raising was well over twelve months. 200 meetings with investors and 185 of them “No thanks – no liquidity, too hard for our investment committee to understand, and you can’t replicate the performance”, and a long list of other reasons to not invest in private equity.
But, in business as in life, there are the occasional individuals who have the courage to simply back a thesis and a team. We have been extraordinarily lucky in this regard. Martin Goldfinch of ACC, David Plummer of NZ Super and the investment team that has followed, Neil Craig who led the way establishing the Pohutukawa family of funds for retail investors to access private equity, Ovidio Iglesias of Continuity Capital, and Pete McCaffrey of Annuitas. There are of course, a great many other names who deserve our thanks, but for which an article as brief as this cannot do.
In the aftermath of the global financial crisis, Thursday the 2nd of July 2009 stands out as a remarkable day in Direct Capital history. Not simply due to it being the occasion of our mid-winter Christmas party, but for a simple phone call that may have been business as usual for the caller, but for the team at Direct Capital, it meant everything. After many months of investor meetings, and the long list of reasons declining investment into our fourth fund, Direct Capital IV (a naming convention that avoids the marketing department), Pete McCaffrey phoned to provide feedback on that morning’s board meeting of the Government Superannuation Fund Authority (for which Annuitas was the manager).
It was a call that we awaited with every mix of anxiety, apprehension and trepidation. In our open plan office, the phone call brought immediate silence. “Hi Pete, how’s it going?” (The niceties being conferred as quickly as politeness would allow). “Hi Gavin, I have some good news and some bad news”. The dropping of the head leading to looks of pained anguish throughout the office. “We proposed an allocation of 1% of GSFA’s total funds into Direct Capital IV,” (mental arithmetic going mental), “but they suggested we go up to 2%, I hope that’s ok”.
With a commitment that exceeded the entirety of our first fund, it was most certainly “ok”. An unbusinesslike word of relief may well have been expressed to Pete, along with many thanks before working through some minor details. It was one heck of a mid-winter Christmas party.
With the additional support of NZ Super, ACC and 25 valued investors, Direct Capital IV was raised with $325 million in capital, and for the first time in our history we felt like we had a grownup fund, capable of investing across the spectrum of private companies.
From the Direct Capital IV fund came investment into outstanding New Zealand companies: Transaction Services (an understated payments business which has gone onto billion-dollar status in the US), Bayleys Real Estate, Scales Corporation (subsequently listed on the NZX in 2014), PF Olsen, and Hiway Group.
Ownership succession is something we regularly talk about with business owners. Indeed, it is one of the main decision factors in most of the investments that we have made. And by 2016 we were confronting our own succession decisions. Private equity has a unique characteristic in that when asking investors to commit long-term capital, we as a management group also have to ask ourselves whether we can each commit to a similar time frame. Naturally, there comes a time when that answer may be “no”.
In 2014, we wished one of our original founders, Bill Kermode, all the best as he embraced a new challenge in leading the Next Foundation, an extremely generous endowment established by Neal and Annette Plowman to create a legacy of environmental and educational excellence for New Zealand. In 2016, long-time colleagues, Tony Batterton and Simon Plowman – stalwarts of every Direct Capital fund, headed off to establish their own firm. Mark Hutton, another of our “originals” took a step back from full-time executive life but remains with us to this day as a key member of our board and provider of wise experience on our investment committee. Each of them remains a firm friend of Direct Capital.
In 2017 Direct Capital V was raised with a capital base of $375 million marking the successful navigation of the firm’s leadership into its second generation – a milestone that few funds in Australasia have achieved. That is unquestionably a result of the continued leadership of Ross George. It was Ross who returned to New Zealand in 1994 from Hong Kong, having worked in both law and then private equity, to establish Direct Capital with friends, Mark and Bill. Thirty years later he remains the head of our firm and is deservedly recognised throughout Australia and New Zealand as a true luminary in the industry.
In 2020 we raised our current fund, Direct Capital VI with a capital base of $425 million – our fund growth matching the growth of the private company market that we follow. Our team has also grown to a total of eighteen including five partners. In an industry where experience matters, nearly half our team has been with Direct Capital for more than ten years. We also benefit from a team structure that provides for long-term progression and succession.
From our Direct Capital V and Direct Capital VI funds we have been proud shareholders in some truly iconic New Zealand companies including Beca Group, Perpetual Guardian, Mondiale VGL, AS Colour, Wet & Forget, Qestral Corporation, TR Group and Caci Group. And, while New Zealand has always remained our primary focus, Australia continues to feature through direct investment in the likes of Marvel Packers, and the trans-Tasman and global expansion of our New Zealand companies.
We are especially proud to have recently re-invested into both Hiway Group and Bayleys Group, and to once again have joined Ryman Healthcare founder, John Ryder, in developing the next generation of retirement villages in New Zealand, through Qestral Corporation.
Every two years or so Direct Capital hosts a conference for its portfolio company owners and executive teams, past and present. Formalities for sure, but we also seek to provide a day out that our colleagues will remember. We have hosted thirteen “DC Conferences” and it’s difficult extracting highlights when each, on its own, has been one. But it’s fair to say the emergency landing of a helicopter on the way to Awhitu Peninsular was one, and few of us will ever forget our day of being hosted by the NZSAS team - a unique privilege to see the combination of humility and leadership from our unsung heroes. There may also have had been the odd kidnapping along the way. And of course, bonfires - no party is complete without one. These are functions that bring together the experiences and friendship of our extended Direct Capital family and a chance to celebrate their business success.
The standout though is not the event itself, nor simply the fun of it - it is in seeing so many of our company friends from 1994 still attending our big day out thirty years later. Sharon Hunter of PC Direct, Mark Thompson and Peter Marshall of EFT-POS, David Nathan of Pacific Flight Catering, Sir Noel Robinson of Robinson Industries, Hugh Jones of Airwork, and Derek Campbell of Open Group. That they continue to choose to join us so many years later is a valuable insight for our younger team members.
Thirty years later, and with $1.7 billion in capital raised we have now invested in more than 80 companies. These are companies that during our shareholding employed close to 14,000 staff and, with the benefit of new capital, enjoyed average revenue growth of 57% and employee growth of 40%. The benefit of private equity has been clear.
If there has been a singular reason for our success over thirty years (other than common sense investing), it has been our belief in maintaining a genuine partnership with the owners and managers of the companies in which we invest. While that belief was initially borne out of necessity (a minority shareholding provided no practical ability to act unilaterally), over time, that necessity has morphed into something even more simple, a belief that business, and business relationships, should be trustworthy and enjoyable.
And in that regard, we have been thirty years successful.
Gavin Lonergan
October 2024