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The Private Equity (PE) industry experienced its worst year ever in 2008 with overall returns on investment down 27.6%. Although performance has picked up in H1 2009, the industry still faces a set of fundamental challenges ahead. There is recent evidence showing PE capital markets units sidestepping investment banks and providing bridge finance and underwriting services themselves.According to FT, the private equity industry is sitting on over US$1 trillion in dry powder (i.e. committed but not yet collected equity capital by investors) but is facing a dearth of investment opportunities. Banks’ continued woes are the main reason the cash remains uninvested. Although many bank shares have seen their share prices rocketing over the past few months, the reality is quite different, especially when it comes to "risk management". Banks are unwilling to provide loan financing for leveraged buyouts (LBOs) they cannot securitize and sell on to hedge funds and other CLO investors.Moreover, as long as banks are not willing to write down their distressed assets, PE funds cannot buy them up cheaply, especially as LBO sponsors prefer to loosen covenants in order to keep companies alive. Meanwhile, the FDICs new rules make investment in destressed banks too onerous. This leaves the secondary funds market where PE firms sell their stakes to each other as an exit strategy.
PE owned companies need to refinance or repay US$400 billion of leveraged loans within the next five years (BIS estimates US$500bn in 2008-2010). On the other hand, the maturity structure of high yield bonds starts to kick in in 2014 as many high yield bonds were refinanced at record low interest rates shortly before the crisis hit. It remains to be seen whether PE partners agree to deploy funds to rescue zombie companies or whether they rather redeem their stake, even at a loss.
PE's core competences include management restructuring and improvement of operative efficiency. These are in high demand during a recession. Investments in U.S. and UK account for about 50% in buyout value. China and India account for only 4% of buyout value and 8% of the number of buyouts. Although many funds want to invest in emerging markets to take advantage of impressive growth rates, corporate challenges in emerging markets differ from those in industrial countries. It will be necessary to develop tailor made management solutions.
Earlier research predicted that 20-40% of the largest 100 LBO firms will go out of business in this cycle. For the remaining firms, limited partners have committed more 'dry powder' than ever before but there is a risk that some limited partners will not be able or willing to make good on their earlier commitment in the aftermath of the crisis. The future PE contribution of financial institutions, of family offices and foundations, and of endowments in particular is likely to shrink whereas pension funds, insurers and sovereign wealth funds/government agencies will grow in significance as limited partners.p/s photos: Aum Patacharapa Chaichua
Malaysian Companies To Watch
The following are significant stakes taken up by some international funds with a decent investing record in Malaysia. I will also rate the attractiveness of their investment out of ten. Bears watching.
Newton Investment Management Ltd is a big UK based fund. The fund has bought 42 million shares, a stake of 8.2% in Bursa Malaysia (the exchange). Its last reported purchase was for 305,000 shares on March 3. The fund's buying could a be a momentum play following the takeover bid by Macquarie for London Stock Exchange last year. That was rebuffed and was topped by Nasdaq by offering nearly a bid nearly 80% higher than Macquarie's a few weeks back. Bursa is making good money despite being so-so managed currently, so the potential for higher returns are good. Readers of this blog know how I feel about Bursa's management - probably ruling myself out for a job offer from Bursa. Good medium term investment by Newton Investment Management Ltd. (Rating 7.5/10)
The Capital Group, one of the largest mutual funds in the US, has been buying shares in IJM Corp Bhd. It last reported buying 403,100 IJM shares last week, which raised its stake to 9.9% in IJM. Capital Group owns many stocks in this country, including a substantial stake in property developer SP Setia Bhd. The move by The Capital Group to load up on construction and property probably has a lot to do with the broad view that these are main beneficiaries of the 9th Malaysia Plan, especially IJM, I think SP Setia's favoured more due to their township in the offering and their clever buildup of strategic landbanks. SP Setia's offering of Setia Pearl Island in Penang is a very much sought after project. (Rating 6.5/10)
Fidelity, billed as the largest mutual fund in the US, has been active in buying Mah Sing shares this year. Firstly, Mah Sing almost has to come back from the dead a few years ago. The company still suffers an image problem in Malaysia among investors. However, kudos to management for really rebranding the company. Its recent launches of Damansara Perdana and Aman Perdana in the Klang Valley were good value and attractive. Even bigger kudos for Fidelity to have the guts to look past reputation and on fundamentals alone. (Rating 8/10)
Pelikan International Corp Bhd has the Arisaig Asean Fund Ltd as a substantial shareholder, which bought Pelikan shares right up to last week. Arisaig Asean Fund, listed on the Irish Stock Exchange, is also a large shareholder of Uchi Technologies Bhd. Now, Uchi is a firm favourite among many analysts for the past few years, and Arisaig would have made a lot of money from their stake in Uchi. I expect similar results from Pelikan, albeit taking a bit longer than Uchi. Pelikan is the result of a LBO. Strange because 95% of revenues come from outside of Malaysia, main factory is in Voehrum, Germany, and the company is now Malaysian owned. The CEO and management is still saddled with a huge debt and is working hard to penetrate markets to payoff the funding. Europe accounts for the bulk of their stationery product market, but has made in-roads into Asia, Latin America and Eastern Europe. The brand is sound, currently trades at low PERs, good yield, more and more long term funds are buying long terms stakes in the company. A deal with Parkson Retail in China brought immediate exposure for Pelikan in 37 outlets in China. (Rating 6/10)
Hedge fund Level Global Investors L.P. bought 10.4 million shares, a stake of 5.2%, in Jobstreet Corp Bhd last month. Global Investors' interest could have been attracted by Jobstreet's mid-teens' PE whereas its counterparts in the US, Australia and China are traded at PEs of over 30 times. A consolidation will come soon in Asia. Better funded job sites such as Monster.com could so easily swallow up the company, or a company like Google would not be averse to latch onto Jobstreet for its market visibility in Asia-Pacific. Still, Jobstreet remains a "only-if" play, i.e. price will shoot up only-if someone buys the company. (Rating 6/10)
Aberdeen Asset Management has bought a 5.92% stake in one of my favoured Imaginative Investing picks, Pos Malaysia. The bulk of the shares was only acquired in the first 2 months this year. Mail and courier revenue are still on an uptrend, we expect courier services to be a major jewel that is still not yet recognised by investors. Once you have wired the hotspots and delivery points, you cost per courier delivery is close to nil but these are premium services you can charge for. No one can match Pos Malaysia's breadth and width in delivery points, others can only replicate a small part of it. You have the platform, now the kicker is Pos Malaysia's 20.3% stake in Transmile Holdings. Transmile now acts like a feeder to international courier and cargo services for Pos, in and out of Malaysia. Since Robert Kuok has taken over Transmile, its performance has been spectacular, thanks to Kuok's way of doing business. Hence both companies I like very much. A brilliant move by Aberdeen's Hugh Young. (Rating 9.5/10)
Used to be, investors would jump in with all they have whenever there was a subscription for new IPOs. Back in the early 90s till the financial implosion in 97, most IPOs were recording opening day gains of at least 30%, and usually a lot more than that. Even during the dreary post financial crisis days, one can still get decent gains on most IPOs. For the past 3 years, Mesdaq IPOs started shakily, but thanks to new listings such as Symphony House (now transferred to the Main Board) and the huge (but sedentary YTL-e), investors got more comfortable with Mesdaq stocks. As long as one can make money, people will come in droves. Sensing an opportunity, syndicates got involved quickly. The authorities basically practiced a hands-off approach as the rise in Mesdaq activity bodes well for future listings and viability of Mesdaq.
This is good for most concerned as entrepreneurs get to cash out (well, some or most of it, if they play it smart). VCs and angel investors got to really cash out big time, thus propelling interest for the VCs to fund more start-ups.
In The Edge Daily, it was reported that: "Most Mesdaq Market initial public offerings (IPOs) in 2005 were disappointing, with more than half or 26 of the 46 listings closing on Dec 30 below their offer prices. Analysts blame the disappointing performance of these Mesdaq counters on unexciting prospects, high valuations and poor market sentiment. ... On a brighter note, analysts say a handful of Mesdaq companies such as mTouche Technology Bhd and Green Packet Bhd appear to have gotten their strategies right and are moving in the right direction. ... ES Ceramics Technology Bhd was the worst performer. Its share price fell 66% to 18.5 sen as of Dec 30 from its offer price of 55 sen. Ygl Convergence Bhd is down 58% to 37.5 sen (IPO price 90 sen); ConnectCounty Holdings Bhd 60% to 13 sen (32 sen); MLabs Systems Bhd 49% to 28 sen (55 sen). EcoFuture Bhd is down 50% to 12.5 sen (25 sen) and Vitrox Corporation Bhd 28% to 43 sen (60 sen). ... However, analysts say there were several companies that bucked the trend, especially those with strong business models and growth strategy. mTouche’s share price surged 460% to RM3.36 (60 sen) while Green Packet’s jumped 270% to RM2.04 (55 sen). TMC Life Sciences Bhd is up 136% to 90 sen (38 sen) and KZen Solutions Bhd 92% to 63.5 sen (33 sen). "
The authorities have threathened to tighten listing requirements for Mesdaq companies. Since Nov 29 last year, companies now must provide a profit forecast while non-technology-based but high-growth firms must have an audited operating revenue for at least three years. My view is that the authorities should take a hands-off approach (as much as possible) as over-regulation will impede the natural forces critical for the well-being of a "good capital market". Tightening listing requirements is good as it was a too easy to list before - but we should be careful from here on as we don't want to make it so hard to list. Bearing in mind these are "growth stocks", the risks associated with them would be much higher and investors have to understand and live with it.
What the authorities should do, is to tighten where/when the owners/promoters get to sell their shares. As these are growth companies, one is listing to secure capital to fund their growth - it is not a cashing out exercise. That being the case, the owners/promoters must show as much committment to the company as the investors are willing to bear the high risk of buying their company shares. Even the current rules are too loose for owners/promoters. We first need to tighten rules that allow owners/promoters to sell their shares. We need to discourage them from a quick turnaround. I would recommend something like:
a) owners/promoters must collectively hold at least 50% of the company's outstanding shares for 4 years
b) after the first 4 years, the minimum ownership level will be lowered to 40% for another 4 years
c) owner/promoter cannot sell a single share until 12 months after its IPO, even then they can only sell no more than 5% of outstanding shares each year
That would solve part of the problem of dumping. The danger here is that if we enforce lock-ups of a large amount of shares, it will make it easier for syndicates to play havoc with them, without the need for approval/consent from owners/promoters. However, this is not the kind of problem faced by Mesdaq listings, but rather the grave under-performance of new IPOs. Let's face the facts, for every Mesdaq IPO, only a very small amount gets to the hands of the public. The bulk has been placed out to institutions, high net worth individuals or fund managers. The fact that most of them still went below their IPO price soon after tells us that even "astute financial minds" do not consider the growth prospects of most these companies to be up to scratch. If they do, they would be holding on to these shares.
So why do we have a problem with most new IPO listings. For one, it is the over-aggressiveness of merchant bankers to score new deals that the "viability" and "growth prospects" are being glossed over. I am a firm believer in free market forces, i.e. when a merchant banker brings an issue to the market, the risks transfers to the buyer of the shares. It is up to the buyer to assess the inherent risks and attractiveness of the counter. Too much hand-holding by the merchant banker,... well, you might as well ask the merchant bank to buy the shares themselves and sell it to you when the price goes up! However, we must have a stronger link and effect on merchant banks to their IPOs, so that investors know their reputation is on the line. We need the media to focus more on performances of the Mesdaq firms and the merchant banks that took them public. If there is more accountability, eventually the merchant bankers will tighten up on themselves on the listability of a firm, whether they can get long term institutional shareholders to hold the shares instead of "trading outfits", and whether they can sell the growth prospects/concepts for the stock - plus they will make more of an effort to educate and inform the public on the prospects and make-up of each company. Below are the bankers involved in the under-performers and out-performers cited in the article in The Edge Daily. You draw your own conclusions, but its pretty clear to me. Just go ahead and list the Mesdaq IPOs and their sponsors for the past 2 years and see how they have been performing.
Under-performers
YGL Convergence - K&N Kenanga
ES Ceramics - AmMerchant Bank
Connect County -AmMerchant Bank
MLabs Systems - Alliance Merchant Bank
EcoFuture - Affin Merchant Bank
Vitrox - Hwang DBS
Out-Performers
mTouche - Public Merchant Bank
KZen Solutions - Public Merchant Bank
Green Packet - OSK Merchant Bank
TMC Life Sciences - AmMerchant Bank
