Southern Africa’s PE landscape: In conversation with Mike Donaldson

JOHANNESBURG — The latest available South African private equity performance report, compiled by SAVCA and RisCura, showed that a representative sample of SA’s private equity funds delivered a 10-year internal rate of return of 12.9% at the end of September 2017, which beat both the FTSE/JSE All Share Total Return Index (compound annual growth rate of 9.5%) and the FTSE/JSE Shareholder Weighted Total Return Index (10.6%). It also outperformed these indices over five-year and three-year periods. RMB Corvest plays in this space and is an on-balance sheet provider of PE. Biznews founder Alec Hogg chats to Mike Donaldson, a director of RMB Corvest, discussing the group’s more recent transactions, and how the playing field has improved since Cyril Ramaphosa came into power. – Stuart Lowman

This special podcast is brought to you by RMB Corvest and it’s a warm welcome to Mike Donaldson who’s a director of RMB Corvest. Private equity is a field that you specialise in, which has had a very active past 12 months. Now, many other parts of the economy have been struggling. Before we go into the happier 2018, have you seen much of an impact from the politics we experienced in 2017?

Very much so, I think 2017 was a very active and interesting year for us. Certainly from a portfolio point of view – where we manage about 60 odd different businesses – we get a good sense of earnings coming through. I think 2017 was challenging for the majority of our portfolio amid the uncertainty, especially in terms of where it was very challenging for consumer spending. The capital expenditure from companies was limited and I think from a portfolio performance point of view, it was very difficult, and very flat on the prior year. But I think from an M&A point of view, it was very active. I think it was driven by a number of factors and one of which was uncertainty.

Mike Donaldson

Amid the uncertain times, there was also a drive to take money offshore by many entrepreneurs over the last few years and that certainly played into the market last year, and we took advantage of that to a certain extent. Therefore, there were many disposals and there were many acquisitions. But there was much more on the disposal side. Our partners saying, “Yes, it’s time to realise money. I’ve founded the business 30 years ago, given where South Africa was politically, I would like to take out 20%, 30% or even 50% in some cases, and put it into the bank and take it offshore”. But I think during the first quarter of this year there was really a dramatic change in sentiment. Unfortunately, from an earnings point of view that hasn’t filtered through to the portfolio just yet.

So, would there be a lag effect as far as optimism is concerned? Because in private equity you work very closely with the management teams of the companies, so you get to really have a finger on the pulse?

Very much so, I think there is a lag and we expect the lag to be at least six to nine months. Everyone would love a crystal ball but I think from an earnings point of view, it should pick up in the second half of this year as sentiment and confidence builds. The order books in many of our companies now are starting to get a lot stronger. I think that always bodes well from both a commercial and retail perspective for the second half. However, there is this lag and unfortunately the lag seems to be longer and longer as the years go by, but yes, I think the second half will be better than the first.

You mentioned that there’s been a dramatic improvement in sentiment in the first quarter of this year. Is this all down to what happened at the ANC Elective Conference on the 18th of December?

Yes, I think it’s 100% to do with that, Alec. Certainly, if you had asked to take a poll within our management teams, I think there was a lot of negativity and there was a lot of conviction that it was going to go the other way, whereas it surprised many corporates in SA. While nothing has changed dramatically in SA, from a business confidence point of view that sentiment comes with a lot of positives and certainly for us we see that being directly related to those elections.

We know that South African corporates are sitting on R1trn in cash. From what you’re seeing with the 60 companies that you work closely with; do you think that we’re starting to see the first signs of maybe those purse strings being released?

Yes, definitely, I think many of the decisions over the last few months have been made. It’s now about actually spending the money and getting the conviction to make those investments. I do see it changing and I think many people are sitting long on cash, but you know, you can’t sit on cash too long. Obviously, with markets, you are left behind very quickly and I do see those corporates starting to open up over the next 12-18 months.

Mixed denomination rand currency banknotes are arranged for a photograph at a First National Bank (FNB) branch. Photographer: Nadine Hutton/Bloomberg

So, if I understand you correctly last year was a year of some people just giving up and saying, “I need out of my business, I want to exit, I want to try and put some cash in the bank to protect myself against the uncertainty that I’m seeing” whereas this year the mood is almost 180 degrees.

Absolutely, 100% agree with that and that’s certainly what we’ve seen on the ground. As we said, we work with many different management teams and I think the attitude, the sentiment, the conviction in terms of where SA is going over the next five years is a completely different story and it’s fantastic to watch. Where previously management were all looking to realise, now it’s all about growth; how can we extract and how can we build businesses over the next five years to extract value on a much longer term rather than short-term and that story can be planned out.

How are they doing that from a practical sense within a management team: how would they employ this new approach?

I certainly think that over the last 24 months we’ve seen corporates quite resistant in making their own acquisitions, and that drives a lot of the growth. Organically now, if you look at where we’re placed from a growth perspective, we’re sitting at one or two percent annual growth. Ideally over the next three years we would need to pick up a little bit more, but even that’s not enough to sustain a good private equity deal. If you really want to extract proper value, you need to look beyond that and where else we can get the growth from. There are only a couple of places. One, is from organic growth, whether it’s through SA or further afield in terms of Africa and secondly, from M&A or bolt-on opportunities where they can acquire or diversify the business.

I think with both of those over the last 24 months, you’ve had management resistant to change, resistant to taking any risks in Africa or going out and look for M&A opportunities. Up to last year I think there was resistance – there was no way that management teams were going to take that risk with the equity they have and there is always risk associated in those endeavours. But I think that it is definitely changing now where teams are saying, “Let’s rather take a longer-term view on SA.

So, it’s a good time to invest, it’s a good time to take your product offshore into Africa or further afield and I think those initiatives and investments should hopefully start panning out over the next 24 months. But that will drive the market and obviously drive growth.  From an equity value creation point of view, you will get a proper equity gap where you get the business growth, not only organic growth, but through diversifying as well. Ultimately it becomes a better company to sell. That’s what private equity is all about.

We are not manned managers. We don’t go in on a day-to-day basis to manage our businesses. We rely heavily on management teams and we try to give them the capital and the confidence to go out and take risk. Obviously, it’s a measured risk, but with that, if you get that right you get  a multiple kicker that you get from a larger business that goes into Africa. You can imagine internationals love the story of Africa, if you can get it right. I think one needs to have a presence in Africa if you really want to put yourself on the global map.

In what countries in particular in the rest of Africa are South African businesses – or your clients showing the most interest?

I think the countries that are closest to home in Southern Africa – the border states. But that is also largely done through the head offices or corporates in SA anyway. But I think the real appetite is in the bigger countries like Nigeria and Kenya to a lesser extent. East Africa is very competitive as well. Therefore, the real focus has been on West Africa, being Ghana and Nigeria because those markets are just so enormous and one can’t ignore them. If you can get those countries right it can be an absolute game changer for a relatively mid-cap or small-cap SA business.

In the past year, I know you did the Kwikot transaction, a name that’s pretty well known to most South Africans, and a very strong brand. Do you think that transaction would’ve been done in this different climate?

To be honest I think if we had done that closer to the year-end, I think it would’ve been very challenging. But the buyer, a big international player took a much more bullish approach to SA. I think that was theme, it’s all about Africa. How do they get expertise from South Africa to launch into Africa? That’s exactly what the attractiveness for Kwikot was. It’s a fantastic base in SA, it’s a big dominant player here and a household brand, but more meaningful for them was how they take that now, and extend that reach right into Africa? That’s what the Kwikot team was certainly starting over the last few years to develop.

That’s the theme: internationals come and look for a footprint in South Africa. But they need that footprint to be able to extend into the continent. Without that, I think the opportunity to sell a business to an international with just a South African play would probably be very limited. I think that definitely was part of the thesis for the buyer, but as Electrolux, that was their key theme, how do they get a base? We do see that continuing as well with other internationals coming in.

It’s interesting if you look at the South African market, there are many cranes, there’s a lot of construction going on, which means there are many businesses that must be doing pretty well and yet they seem to be in your market. In other words, not listed on the stock market, more private equity plays, more below the radar where they’re just getting on with things and presumably getting more excited now and making it more exciting for the private equity sector when you have an improved outlook.

I agree and I think those cranes are largely driven by the law firms that seem to be springing up all over the show. So, someone’s clearly feeding the legal teams and I think that is the feed from private equity and M&A. But it is that small-cap, mid-cap in South Africa that I think have the opportunities at the moment and which are investing, carrying on regardless of the political uncertainty. I think with the right partners, if you have a good product, you can produce a good story.

If you’re still competitive on the global stage, there’s a lot that South Africans can do to take that product offshore and that’s certainly the type of businesses that we look at. That’s what we look for: local expertise that ultimately you can take that and replicate it around the rest of the globe. And I think Africa is a logical place to start and the population is there to create another layer of risk for local businesses but it takes time. So, I think over the next 10-15 years South Africans will get much more involved in Africa and it takes time to build that confidence.

That’s your game as well, private equity; you’re prepared to give it time.

Correct. There are some private equity businesses that are built around third party funds, which have a 7-10 year life cycle. I think we’re very fortunate that by being part of the RMB Group and FirstRand stable, we’re on balance sheet, so we don’t have those extra time pressures. Its RMB’s cash and we have the ability to wait out the cycles and so then we believe it’s the opportune time.

With Kwikot, we held it for a long time ( close on 20 years); the Fidelity Group for close on 29 years. Fidelity has a fantastic management team, keeps deploying cash properly, keeps buying the right businesses, and keeps performing. So, from a group that is largely stable, we have no desire to exit those assets that are giving us a very good return because it’s hard to find assets to replace those with  new management teams that have the same capacity and same potential. South Africa is a very small market.

How do your clients find you?

We’ve built up the brand over many years. So, RMB Corvest is now a brand, and it’s standalone to RMB. We’ve done north of 200 deals over the last 29 years, and that in itself creates a very big market where word of mouth is probably 80% of the deals we get. Someone has referred them to Corvest and obviously the phone does ring. Secondly, we have a relatively large transaction team of about 13 and the team get out there, knocks on the pavement, and puts ideas out to the various management teams.

It’s a really a marketing team front. That is, do good deals and look after your teams and your exits are normally your best point of reference. Success breeds success and I think those management teams that we’ve long said goodbye to over the last 29 years are probably our biggest reference point to be honest and that does create the pipeline that obviously we need to feed the business.

The size of deal; where do you start and how high will you go?

We’re probably starting at the mid cap stage in terms of EBITDA. You know EBITDA is always a rough guide: anything north of R40m are the businesses we typically get involved in and that can go right up to an EBITDA of R300-400 million. Once you get bigger than that it becomes more competitive. With the range I mentioned, we can add a lot more value from a private equity team and the capacity to grow those businesses is far more exciting. Once you go into the market cap businesses north of R2-3bn, it’s very challenging to sit on those boards and add value.

The bigger companies have in-depth management teams that probably don’t lend themselves as well to private equity as the smaller ones. With the smaller company management teams, probably a large portion of them would be family driven as well. You know they’ve grown up in the business; they’ve never had independent skills sitting on the board and given a much more financial oversight or strategic kind of vision to the strategy. That’s where I think we can add a lot of value to partners that are running the businesses that are now looking to elevate them.

Is listing on the stock market still an option that you look at?

Unfortunately, it’s not. It’s a very poor reference point or exit for most private equity teams. Again you need to price the value well north of R3bn if you really want to look at the market and make sure you have enough liquidity to have a good exit. The way the dynamics change once you become listed is probably not preferable to most management teams that we operate with.

Typically, our exits are trade players. Over the last 5-10 years a lot of that’s changed to other financial buyers where there is a lot of new black empowerment funds that have been raised, and where there’s more private equity funds that have a lot of international backing. That has created probably the biggest pool of liquidity for most private equity teams over the last few years and I think it’s actually a great opportunity.

We’ve bought into businesses such as Universal in the last couple of years. We did a deal last year called Kevro and again that comes from other private equity players where they were sitting on the board and it was time for a change, time for their funds to exit and to realise their value. With some management teams, the guys are relatively young, still looking to create proper value for themselves going forward. And so that’s where financial buyers are selling from one to the other. It’s a change of dynamic, change of team. Sometimes a change is good for everyone and that was the trend over the last few years and I don’t think that’s going to stop. I think there’s certainly more money being raised with more international funds in private equity. The market is only getting stronger. I think that the secondary bias to other firms is certainly going to continue.

You mentioned international a few times. After the 18th of December and the watershed decision at the ANC Elective Conference has the international community in private equity shown more interest?

Not yet, to be honest, I think there has been lots of talk and I think South Africa is certainly a limited market for them. They’ve always been looking at Africa as a play and South Africa was probably a little secondary. I think they are sometimes looking to get a base in SA just because the corporate governance and expertise is perceived to be better in South Africa. But again that is always for me the base to get into Africa.

With the political change, yes, it’s good for us, it’s good for local businesses, but I think from the international side, we haven’t seen massive flows of activity and I think in the longer term it will happen, but as I say, South Africa’s still a relatively small market for those internationals.

Mike Donaldson is a director at RMB Corvest and this special podcast was brought to you by RMB Corvest.

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