International investors may close funding taps to SA private equity funds

The downgrade of South Africa’s sovereign credit rating to junk could make it difficult for local private equity funds to raise capital from international investors through traditional means in the short term, but the uncertain political and economic climate could spur alternative initiatives to raise capital.

It may also offer opportunities to buy attractive investee companies from anxious sellers and for consolidation within specific industries.

Speaking at the release of the Southern African Venture Capital and Private Equity Association’s Case Study Compendium, Anthonie de Beer, partner at Ethos Private Equity, said during times of turmoil pools of capital shifted in the short term.

While private equity funds might still receive capital from the Far East, North American investors would probably not rush into South Africa on a long-term basis at the moment, he added.

South Africa had not presented the best investment thesis to a lot of investors for some years, added Polo Leteka, co-founder and CEO of IDF Capital. On a recent fundraising trip many American and European investors said Nigeria had much more exciting growth prospects than South Africa.

“I do think that we’ve already starting seeing a lot of investors sort of questioning whether South Africa makes sense.”

Richard Rose, head of investments for the Vumela Enterprise Development Fund at Edge Growth, said foreign investors were very aware of exchange rate movements. A stable currency made it much easier to sell the private equity investment story.

“With the volatility we’ve seen it makes it much more difficult to have that conversation.”

The rand has weakened from levels of around R12.74 to the dollar since it emerged that president Jacob Zuma ordered former Finance Minister Pravin Gordhan to return from an investor road show late in March. It was trading at R13.82 to the greenback late on Tuesday, after S&P Global Ratings and Fitch downgraded South Africa’s sovereign rating in the wake of the cabinet reshuffle in which Gordhan was axed.

But while the current uncertain environment could make it challenging for firms to raise money abroad in the traditional sense, it could pave the way for alternative funding initiatives.

Pieter Erasmus, partner at Rockwood Private Equity, said given current pressures, one could expect to see some “out of the box thinking” around new initiatives to raise capital – whether through listed vehicles or alternative structures.

De Beer echoed this sentiment and said firms were increasingly raising money through alternative mechanisms like listed vehicles, which he expected to continue.

Leteka said a new kind of investor looking for different types of investment opportunities was emerging – particularly in the impact investing space.

“We’ve already certainly started seeing that shift even before the events of a few weeks ago. Perhaps that is going to be much more evident in the coming month or so.”

Private equity fund managers typically raise funds from third parties (for example pension funds) to launch a closed investment fund with a particular investment mandate and a long (generally ten-year) lifespan. The capital raised is used to buy stakes in a handful of businesses referred to as portfolio or investee companies, which the firm believes would offer an attractive return by the time of exit. Firms often assist with the introduction of governance structures, employment equity initiatives, skills programmes and job creation plans in their investee companies.

While the economic environment will likely be difficult in the months to come, making it tough for especially smaller-size investee or portfolio companies that may not be able to absorb shocks in the same way as bigger businesses, turmoil often offers opportunities to dispose of non-core assets, to replace long-term debt with equity or to consolidate within specific industries.

De Beer said their business had been through incredibly turbulent political and economic periods, but has made some of its best returns during these times.

“I think you’ll be surprised how many great opportunities either sits in buying from people that panic or consolidating areas and spaces where others are running away from.”

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