RADIO INTERVIEW on 102.7 - CLASSIC BUSINESS DAY

17/10/2006 - Darryl Horney is interviewed by Lindsay (Classic Business Day on 102.7)

Lindsay

We reported last night that private equity world-wide, I think has achieved profits of something £152 billion and if you take the previous 15 years, it puts it all into perspective, because over that period, only £350, £355 billion was made. So really the last year has been absolutely phenomenal for those lucky private equity people. Can it continue? Is it a good thing? Is it a bad thing? On the line now, Darryl Horney, Partner at Spirit Capital. Darryl, good evening.

Darryl Horney

Evening, Lindsay, how are you?

Lindsay

Very good thanks … I mean I am really talking I suppose … globally … is the private equity market as buoyant in South Africa as it is in Europe and in the United States and in the Far East?

Darryl Horney

I would suggest so, I mean if you look at what is happening today … in the news you will see as you reported earlier, Edcon have put out their announcements saying they have been approached by private equity bidders. I mean the press has the last couple of weeks have had the story about Alexander Forbes and how that will be unfolding. But not only that, there is a private market where private equity houses play a large role, so … the returns that they generate here, I would equate to be … similar to those internationally and in some cases, even higher, because of the risks associated with investing in this country.

Lindsay

The type of deal that we are talking about in terms of Alexander Forbes, Business Day has reported that it could be in excess of R9 billion. Edgars is going to be absolutely massive. Shoprite could be a big one as well.

Darryl Horney

Correct.

Lindsay

These aren’t local companies are they? These are foreign raiders?

Darryl Horney

Correct. I think what you might find is that the local private equity houses, the bigger ones being maybe Breyten Ethos and Actiss, will partner with International Balance Sheets, because a transaction the size of Edcon will be R16 billion odd at the current … what last week’s market capital … so it is probably closer to R20 billion now, and even the local private equity funds which struggle to raise enough capital or equity to facilitate those transactions, so I think you will find that they will partner with international funds because of the size of the their balance sheets.

Lindsay

I was just trying to work out quickly, where this leave us? I mean I did give some stats at the beginning of the interview to suggest that the last year has probably been an all time record for private equity. What sort of market conditions lead to this extraordinary activity?

Darryl Horney

Yes I suggest that if valuations of good businesses or good companies are low or are when compared to historic kind of pricing levels are lower than they have been, I think you will probably find that the private equity houses get more aggressive and they are comfortable with risk and they perceive that the current valuation cycle is kind of a downturn and that they can take the upside on the business when it corrects or re-rates itself and when you add that to the leverage component of a transaction, it just compounds the effect of the IR’s to the rate of return that they are looking for.

Lindsay

To ‘dim wits’ like myself Darryl, what does it actually mean? Let’s say somebody comes along and says, right Edgars, we love you, you are selling loads of T-shirts, we love the South African economy, we love the management, we are going to buy you, we are going to take you off the market and then in five years time put you back on the market, is that what happens and that’s where they make their money?

Darryl Horney

That has happened a lot. If you look … if there’s … take for example maybe Edgars does get taken out at say R20 billion, you will find that a large component of that … possibly up to even R10 billion will be serviced in debt, and then the balance in equity, and over the five, six year period which Edcon generates significant cash flows, it will settle or retire the balance of the debt, repay most of the equity loans and you will be sitting with a business that in five years time it is un-geared again and ripe for re-listing and on sale again, and that is when the private equity houses will realise their investment and make their returns.

Lindsay

It is bad for the stock markets though isn’t it, because people are snapping up these companies that are perceived to be undervalued. It is not great for investors because we can't get in there. I was speaking to a stock broker earlier on today and he said, ja (meaning yes), we can do so many things when you are a private company that you can't do when you are on the JSE. That must be quite attractive. Whitey Basson … some … a lot of people have said one of the reasons that Shoprite may go private is because he just doesn’t want to be in the public eye any more.

Darryl Horney

Sure … I think your flexibility or your decision making process is far simpler, far easier. You are right also in saying there is a … there is a bad day for the JSE when stocks such as Edcon or Shoprite and Alexander Forbes are taken off, because you don’t necessarily have exposure to them anymore and Shoprite and Edcon being major retailers in our economy, significant retailers in our economy, it kind of limits the options that you have got to the retail sector, so I would agree with you, it is bad for the JSE, but from the business owner perspective or from a management perspective, flexibility or ease of decision making is certainly assisted and those kind of things will be addressed in the new shareholder agreements with the new shareholders, whoever they may end up being, and it is quite attractive, you are below the radar and you are not in the press as much, so there are a lot of pros and cons for both arguments.

Lindsay

And of course, let’s look to the positive side. It makes it such fun to now pick the next target, because no-one is safe.

Darryl Horney

Correct.

Lindsay

There is nobody safe on the JSE from the so-called corporate radars as a private equity firms. Are there a lot of companies out there that could be targeted in the future?

Darryl Horney

No, there is no doubt, I mean you can't just limit it to private equity transactions. In the press of late there has been rumours of even our greatest stock, our most significant stock, Anglo American being a potential target for Ex Charter and maybe BHP Bouillon or Reo Tinto, so there is no-one who is absolutely safe … I would probably answer that by saying that every asset has a price.

Lindsay

Ja (meaning yes).

Darryl Horney

And the shareholders are prepared to accept it, well someone is prepared to pay.

Lindsay

And at some stage of course, the banks are going to say, look we just haven’t got any more money to lend to you, so the private equity boom will come to an end. Do you see that happening soon?

Darryl Horney

No, I don’t. I think … what you see internationally is that the private equity houses there or that industry is so … so overtraded or has got so much capital available to it, you will probably seeing a little bit more exposure or they are dipping their feet into our waters, evidenced by Actiss and Ethos’ possible partners in Alexander Forbes transaction where they have got international pension funds from Canada assisting them with the equity contributions, so I think the international guys are looking at our markets and seeing that there is significant IR’s available, manage your risks appropriately and I think they are looking at South Africa as an emerging market with less risk than other emerging markets … that we have a highly developed financial system. In discussion with a fund manager, a private equity fund manager last week, he identified South Africa saying it is one of the emerging markets that’s developed enough to make your exit options far more variable than in other emerging markets, for example, in Africa and Kenya or Uganda for example, the financial systems aren’t as developed, whereas here it is, and they are seeing a lot of international funds looking at South Africa as an option now. You know, look at … and if I can expand on that …

Lindsay

We can't actually Darryl, but I will tell you what, we are going to talk about private equity a lot more in the future. Unfortunately we have run out of time now, but thanks for that insight. So we have got Shoprite already on the radar screen, has been for two to three months. Edgars now entering. I wonder if Pick ‘n Pay might be next. I am wondering what Shaun Summers would say about that. He has just walked into the studio. We are going to be speaking to him in a moment about that company’s interim results which were released earlier today. Meanwhile it is quarter to seven. Classic Business Day.

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