AVCJ at 25: Nick Bloy of Navis Capital Partners

When Lehman Brothers collapsed within days of Navis Capital Partners launching its sixth Asia fund in September 2008, there was a sense of déjà vu, but not despair. After all, the GP had been here before: it raised its debut vehicle during the Asian financial crisis.

"We thought we should absolutely continue with the fundraise because it was potentially an unusually good vintage," recalls Nick Bloy, co-managing partner at Navis. "Our sense that it was good to have cash overwhelmed our sense of ‘Gosh, how many of our investors will be able to re-up because of what's going on in the world.' We were much more excited about the former and therefore less concerned about the latter."

The importance of having cash to deploy when others would find it hard to come by was emphasized repeatedly to LPs that were pushing for a delay. In many cases, the hesitancy was driven by the fact that institutions weren't in a position to commit. Their asset allocations had been thrown completely off balance by atrophying public markets and investment committees were unwilling to budge until there was sufficient portfolio transparency to decide when - and if - they had space for private equity.

In addition, allocation models based on pre-Lehman criteria had to be comprehensively revised. Portfolio company exits by funds would be delayed by months if not years, which meant distributions wouldn't be made to LPs as scheduled.

One point upon which Navis did compromise was fund size. The initial target was $1.75 billion, significantly larger than the previous fund, but suddenly this figure appeared neither realistic nor necessary. LPs won the day by arguing that, in a post-Lehman world of depressed valuations, $1.75 billion was too much of a step up in terms of company size and complexity. The target was revised down to $1.25 billion and the fund ended up closing $1.16 billion in August 2010.

Repackaging exercise

"Partly out of necessity and partly out of choice, we did reconstruct the LP base," adds Bloy. "It was painful but one of the biggest benefits was the fund-of-funds representation went from 35% to 11%. Although there are some very good fund-of-funds at the end of the day they are intermediating and putting a drag on returns. What we want are long-term relationships with pension plans and sovereign wealth funds."

LPs with limited exposure to private equity or relatively new alternatives programs were an obvious target - those already fully allocated to the asset class were scaling back their involvement due to the aforementioned risk concerns - but Navis still had to make a convincing pitch.

At its heart was the private equity firm's existing portfolio, which had performed strongly in spite of the macroeconomic headwinds. Bloy says there were two reasons for this. First, Navis focuses exclusively on control transactions. It is therefore much easier to take swift action in the event of a crisis, through cost cutting and cash management, compared to a minority investor who might have little influence over strategy.

Second, acquisition finance is used sparingly. Looking across all Navis' portfolios, on average each deal comprises 85% equity and 15% debt, and most of that debt is on companies' balance sheets at the time of acquisition. Many leveraged buyouts executed in Asia in the boom years of 2006-2007, featured debt portions of at least 50%, and rising as high as 75%.

"A feature of Navis historically has been to put in place the strongest possible capital structure," says Bloy. "We had no covenant breaches post-Lehman and we didn't have to go cap-in-hand to the banks because we didn't need to put new equity into companies. However, our ‘over-equalization' approach isn't so much about managing the downside of a volatile global environment as making sure portfolio companies can make aggressive moves in Asia's emerging markets when a black swan event emerges - as they periodically but unpredictably do on a geographic, industry or company level."

A strong balance sheet also allows a portfolio company to take advantage of weak markets by acquiring a distressed competitor, building a new factory while others aren't in a position to expand capacity, or extending high levels of credit to customers in the knowledge that competitors can't follow suit. In this way, Navis' approach amounts to a bet that the drag on potential returns by using a small amount of debt will be offset by the likelihood of volatility hitting emerging markets at some point during the holding period.

Bloy admits that the strategy wouldn't work in a stable, mature environment where putting in the maximum amount of debt would be the best course of action, but in Asia that notion is turned on its head.

A king is crowned

The outstanding example of a Navis-backed company capitalizing on the post-Lehman chaos is King's Safetywear (KSW), which was exited to Honeywell International for an enterprise valuation of $338 million last November. The private equity firm secured an IRR of 63% and a 4x money multiple on an investment of $74 million made in late 2008.

KSW's value ramped up largely thanks to the relocation of production facilities to lower-cost jurisdictions as well as two follow-on acquisitions. The most significant of these was Oliver, the largest industrial shoe brand in Australia, bought for a low multiple in early 2010. It meant KSW, which already claimed a 50% share of the industrial safety footwear market in Singapore, Malaysia and Indonesia, could consolidate its position in Asia Pacific and improve its global distribution platform.

"It was a huge boost to the overall return profile," says Bloy. "Overall, between the global financial crisis and now, I would estimate that about three quarters of our portfolio companies have made some form of follow-on acquisition or investment. In other cases, we have put in money to build new plants, so it's organic rather than inorganic growth."

He adds that there is also a far greater willingness among entrepreneurs to work with private equity. The asset class is better understood compared to just five years ago and at present there is a disillusionment with public markets, which makes companies open to alternative sources of funding. Entrepreneurs need only look at orphan companies languishing on stock exchanges with no liquidity and owners that are unable to sell down their holdings to understand that expansion capital followed by a swift IPO isn't necessarily the best option.

Even so, the expected rapid deployment of Navis Asia Fund VI in a climate of depressed global financial crisis conditions has failed to come to fruition. Entry multiples were lower for a couple of deals but the portfolio average is on par or higher than for previous vehicles. Rather than experience a protracted U-shape, valuations for strong companies in Asia have followed a V-trajectory, which makes it harder to find economically viable deals.

This ran in complete contrast to the investment environment for Navis' first fund during the Asian financial crisis and the reason for the disparity is that Asia was far less damaged post-Lehman than it was by its own economic calamities a decade earlier. The real fallout was taking place in Europe and the US; no Asian conglomerates went to the wall because their domestic currencies had collapsed and they had US dollar-denominated liabilities.

"Distress wasn't really felt at the corporate level in Asia," says Bloy. "Even though public market valuations were down, entrepreneurs didn't think they had to accept those multiples; they just decided to wait another six months to one year. That's why it took us longer to deploy than expected. Three years since the first close in June 2009 we are about 50% drawn and we would normally expect to be more like 75-80% drawn."

Exits have been more prolific, with six companies sold in 2012 to trade or financial buyers. The same factors contributing to Navis' robust portfolio performance - control transactions, well-managed balance sheets and countercyclical expansion - make companies attractive targets for strategic investors.

"We are former management consultants so we are very focused on the competitive position of a company when we buy it," Bloy says. "Trade buyers only want the number one, two or three in an industry or they might as well do a green field investment and outcompete the more marginal companies," Bloy says.

He admits feeling a hint of schadenfreude when the IPO environment turned, leaving private equity firms that entered minority transactions at high multiples in expectation of even higher public market valuations without a viable exit channel. Navis' 23 exits since inception have all been via trade or secondary sales.

The burden of compliance

While LPs look favorably on managers with a track record of returning money to investors, another characteristic of the post-Lehman world is that institutional players have become much harder to please. Navis may have bucked a trend by securing fund commitments at a time when few were forthcoming, but the price is higher levels of compliance and disclosure.

Gone are the days when a private equity firm could get away with the statutory minimum of quarterly portfolio reports and out-of-the-blue draw-down notices. Now Navis feels obliged to communicate with LPs more frequently. The firm routinely issues memos several weeks ahead of a draw-down that include a description of the target company and the industry in which it operates, an explanation of the deal structure, and a justification of the underlying investment rationale.

"When Asia wasn't so important LPs deployed money to the region and expected to get it back in a few years; apart from a few milestones, there wasn't too much interest," Bloy says. "Fast forward to the present and institutional investors mark their portfolios to market much more rigorously. Interim movements in portfolio value have become much more important, whether it's basic compliance or assessing potential secondary market valuations. Those kinds of metrics have become the standard."

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• Topics
• Buyouts
• Southeast Asia
• People
• Navis Management
• Nicholas Bloy
• Southeast Asia
• buyout