Deal making Down Under

After an opening address by Chief Economist, Austrasia at HSBC Bank, Paul Bloxham, Philip Bilden, MD at HarbourVest, opened the first day of the 8th Annual AVCJ Australia and New Zealand Private Equity and Venture Forum 2011 by answering the question that every delegate was here to answer: "Why Australia?"

In response, Bilden talked about the "remarkably robust" economy, with which private investing is linked; about Australia as a place where allocations are "well treated"; as well as the transparency, rule of law and management teams that apply best in class treasury and fiduciary practices.

With the positive of course, come the challenges, which include the general shift within the asset class from "developed to developing" countries, with Australia currently getting a smaller share as fundraising in China and India rises significantly. With "China and India showing exits, this is giving Australia a run for its money," Bilden continued.

Fellow panellist Simon Moore, Head of Carlyle for Australia, explained, "Australia is as a place where you can invest large amounts of money safely. From a regulatory perspective - and in terms of the management back home - it's almost seen as a 51st state."

There is no question that one of Australia's stand-out points is its combination of developed, Western regulatory and legal infrastructure, coupled with an economy that is more robust and varied than most in the rest of the developed world, particularly post-GFC. But this must be rationalized with reality. Part of that reality is that Australia is beginning to rely on its position post-GFC versus the strengths of its market in any cycle.

Peter Wiggs, managing partner with Archer Capital, attacked the issue with his typically candid perspective. "Would you rather put money to work in Australia, or the US... no... the EU... eh... or New Zealand... probably not."

Hurdles and market rationale

One LP who has attended the AVCJ event for years noted, "Last year [in 2010] it felt like everyone in Australia was on happy pills. This year everyone's come down, and we're not sure whether tomorrow we'll feel okay or we'll all have a hangover." In short, in spite of the strong points, there are issues in Australian private equity that need to be addressed.

One of those of course is taxation, another the much-discussed changing perspectives of the superannuation funds - historically a major proponent of the domestic industry and today quite sceptical - and a third, questions around Australian GPs' competitiveness in terms of returns when compared to managers in emerging markets like China and India.

Many of the LPs - from QIC to Telstra Super - claim to have global benchmarks. The Achilles' heel to that argument is of course the risk factors inherent to a place like China versus those of Australia. When asked how much stability counts for, Robert Talevski of Telstra Super explained that the "risk adjusted" returns the group is looking for make up for the lack of stability in some markets. That said, be believes that "it's a tough sell to invest in private equity. Trustees are asking, and performance is tough as well."

In response to that logic, David Jones, MD CHAMP Private Equity said, "There needs to be a focus on returns - not cost - with domestic LPs... We're never going to be as cheap as an index fund." The value private equity returns, assuming LPs are investing in top quartile managers and have the patience to wait for returns, can significantly outpace other asset classes, as Jones pointed out. "One of our LPs has seen global returns over 10 years materially ahead of other asset classes."

Still, all agree that getting back to basics and producing solid returns is going to be the main priority for private equity managers, in order to be able to prove to LPs - both domestic and abroad - that they are competitive on a global scale.

But with fees "the first 30 minutes of a discussion with a super[annuation fund]" as one delegate pointed out, "the bar is set pretty high right now and it's hard to climb back from there in a meeting."

Australian funds are increasingly needing to move into the international sphere for fundraising, and as Archer's Wiggs advised, "If you don't have international LPs, get them." This comment segues into another issue, which is that generally the fundraising environment is difficult. GPs are having to devote more time and effort to it, and re-evaluate how they maintain relationships with their LPs.

The Asia connection

It came as no surprise that many of the discussions about investment decisions, Australia's selling points, as well as the future of the industry revolved around the growth of Asia. Many on both sides of the industry believe that China's continued growth - and demand for both mining and natural resources related goods, as well as demand for more developed skill, knowledge and expertise from Australia - would be the biggest determinant for the next 12 months' performance in PE.

"I can't see any negative regarding Asia's growth for Australian private equity," said Wiggs. "Nobody is weighing China growth versus Australia buyout, so China is not a constraint. And, for me, the closer the money moves to me is good. With so many firms setting up [in Greater China], it is much easier to engage with US and European LPs - much easier than going to New York or to London."

Interestingly, while the rise of Asia is impacting Australia positively, it does not necessarily factor into investment decisions by fund managers. "It is part of the consideration," said Simon Pillar, Co-Founder and MD at Pacific Equity Partners. "If it has potential for Asia, that is not a ‘slam dunk' for us; it's an option ticket." Operational risks in other markets that are developing are something Pillar says the firm is not necessarily equipped to handle. "It's a consideration, though."

This was echoed in a panel on value creation in the middle market, when Craig Cartner, partner with Archer Capital explained, "We haven't backed a company because of the idea that we would go off-shore. We're conscious of this, but it is not the sole driver."

Peter Hasko, MD for Wolselley Private Equity explained that one of their portfolio companies has half of its business outside of Australia, but that in this case "the expertise and understanding of those markets is key." Wolselley relies on the management team of the company to take care of this aspect of the business, while the firm's responsibility is to direct the business on a more fundamental level.

Value creation

Whether it is about Asia's growth, operational changes or expansion and networks, private equity is charged with adding value to companies - value that goes beyond financial structuring.

Anthony de Nicola, MD for Welsh Carson Anderson & Stowe, operates just in healthcare and business services. He explains, "What we bring is expertise beyond [the portfolio company's] size."

In the mid-market space in Australia - below A$300 million in enterprise value - Peter Dowding, Co-Founder and MD at Propel, explains that "given the size of our investments, you are working very closely with management teams, looking to migrate to more professional management levels through hands-on involvement."

Anthony Kerwick, MD for PEP, explained that one of the most valuable things that private equity can provide is "capital to release them from constraints. [Add-on] capital is a great source of generating returns, and it comes at a lower risk than new investments." Fund managers should also bring energy, motivation and clear KPIs which management teams can then run with.

CEOs at the conference who had experience with private equity investors were forthcoming with praise for the work these groups have done - a significant vote of confidence for the Australian private equity community. On the plus side, David Kirk, Executive Chariman of Hoyts Group; Tim Reed, CEO of MYOB; and Arvid Petersen, Chairman of Study Group agreed that relinquishing the requirements of public companies in terms of reporting and clearing was a great positive.

Petersen also mentioned that "having hand-on directors that are not political, and come with a very clear focus... gives the entire management team a log of good energy."

At some point, the reality that a company owned by private equity is always for sale can be difficult. Reed said that "at a certain point, making sure the company is ready to sell is more restrictive," but that negative is superseded by the value creation that comes with dedicated, professional and quick-moving private equity partners, with one goal in mind: "growth of the equity invested."

Opportunities: abundant and varied

Particularly among true mid-market firms and distressed players, there was no shortage of sunshine and light when talking about opportunities. In addition to the Asia connection, Wolselley's Hasko explains that there are simply more smaller businesses than larger groups. And, "the mid-market has about 20% lower valuations than the top of the market," which allows much more room for the firm to create value.

Finding these opportunities means having a top down approach, in which the firm understands the sector. "It's important to have an idea of industry themes so you can filter opportunities very early based on that criteria," Archer's Cartner said.

Equally, distressed players believe that their deal flow is ripe with potential. In part this is due to the vast range of distressed opportunities, which includes trade buyers, private equity sellers, specialized situations and secondary debt trading. "The opportunity set is reasonably broad," explained Chester Moynihan, MD with Allegro Private Equity. "Debt for control is increasing, and this year buying out of administration and receivership is also driving deals." But all opportunities are not the result of the GFC.

Robert Petty, MD at Clearwater Capital told the audience, "Pick your year and I can show you a crisis where things went awry." That could mean anything from the global financial crisis to a more localized event that affected corporate borrowing, but Petty explained that these inefficiencies led to a continued deal flow for the firm and investors like him.

On this topic, the resident lawyer on the panel - Ian Wallace of Allens Arthur Robinson - insolvency reform is unlikely, which means directors of stressed companies will continue to be subject to onerous restrictions, making the restructuring process difficult. In this vein, he points to private equity and special situations' groups value for companies. The Alinta deal he is currently working on involves TPG, several traders and a number of other funds. "There are multiple schemes of arrangement" which will be voted on this month. These include: debt for equity, the injection of new business (through networks of prospective creditors), new management and the "hopeful success" for a company with "real operational assets of value."

LPs remain stoic

Given the expressed commitment to value creation, the deal flow in Australia and the transparent and regulated environment, domestic LPs remain unconvinced that they need more than about six (maximum) Australian GPs in a portfolio which allocates 5% to the asset class globally.

In discussing performance, moderator John Brakey, a Director with KKR, started the discussion on benchmarks. "What are we comparing it to?" he asked. "In general we are looking at the ASX 300, which is one-third resources and another quarter banks." The point was that private equity has little ability to access these sectors directly (through buyouts) and thus must be categorized differently.

Michael Lukin, MD and Global Head for Macquarie's PE asset management group, was perhaps the most scathing about fees, and in particular fund-of-funds. "I think they're over in Australia," he said. "People want to be closer to the investments." Suzanne Tavill, Head of Alternatives for AMP Capital Investors, echoed this, explaining that AMP re-evaluated its private equity strategy and in "kicking out" fund-of-funds in the program, dropped fees by one- to two-thirds.

The exception to this, Brakey noted was f-o-fs' applicability in Asia, where investors do not know the market as well, nor do they necessarily know how to navigate these disparate markets.

There is no doubt that the fee discussion was on everyone's mind, and not just on the LP panel, which closed the Sydney conference. The shared sentiment remained that, at the end of the day, until after-fee returns are proven, domestic LPs may continue to be a force to be reckoned with - particularly when fundraising. All is not lost though. While local groups are looking at weaning off the notion of being overweight local firms and while fees are top of mind, this is one phase in a much longer private equity cycle with its ebbs, flows, ups and downs.

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• Topics
• Australasia
• LPs
• GPs
• Investments
• Philip M. Bilden
• John Brakey
• Craig Cartner
• Peter Hasko
• David F. Jones
• Anthony Kerwick
• Simon C. Moore
• Robert Petty
• Simon Pillar
• Peter Wiggs
• Archer Capital
• The Carlyle Group
• CHAMP Ventures
• Clearwater Capital Partners
• HarbourVest Partners
• KKR
• Pacific Equity Partners
• Wolseley Partners