ADVERSITY is invariably accompanied by opportunity. I suggest, with a considerable measure of confidence, that Black October has opened the door to a huge prospective private equity boom.
I suggest, too, that the door opening to mezzanine funds is especially wide and extraordinarily welcoming.
The global meltdown, necessitating an almost trillion-dollar rescue package — and counting — has set the scene; one that pretty much coincided with the issue of former president Thabo Mbeki being forced out of office by his own party.
These are events that confront us in SA with an unusually high level of uncertainty, not unnaturally prompting one to ask what the future holds for our nation. Several
basic questions need to be asked and satisfactorily answered:
n Is democracy alive in SA? I believe it is. What transpired over these past few weeks was a highly encouraging demonstration of a thoroughgoing democratic state at work. That a judge felt confident enough to pronounce against the Presidency is manifest testimony of vibrant democracy. While I decline to comment on the merits of his pronouncement, it suffices that he unequivocally expressed an opinion that did not favour the executive.
n How did the Presidency react to the pronouncement? With great restraint. It was a reaction that ensured the sanctity of the constitution and the judiciary — yet again underlining an important criterion of a democratic state.
- Is there political instability in SA? No. We are a young democracy, certain aspects of which will be tested over time. Yes, there are elements that provoke discomfort but I have no doubt that in the near to medium to long term good sense will prevail.
- What of macroeconomic stability and populism? Back in 1994, many of us returning from exile with long-held beliefs thought we would end up with a command economy. For most of the cadres, once in charge and faced with the issue of balancing scarce resources, good sense has and always will prevail. The macroeconomic policies followed to date have been and will remain critical in dealing with poverty and restitution.
Yet while the domestic climate might be clement, our prosperity is obviously threatened by the global meltdown. Not for nothing is the fallout from the subprime lending cris is creating turmoil in global credit markets. It is squeezing liquidity, crystallising losses and stripping billions from the value of equities. It is hurting banks and crippling corporations.
The climate change is generating painful consequences:
- It is widening interest margins and increasing the cost of capital;
- It is making it difficult, even impossible, to refinance existing debt;
- It is eroding both the capacity and the willingness of banks to participate in many transactions;
- It is seeing finance professionals struggle with unfamiliar market conditions;
- It is causing refinancing risk to become a major concern in assessing the viability and value of companies; and
- The credit crunch has all but shut the markets’ gates to large lines of credit.
In the face of this depressing scenario, private equity in SA is open for business and looking for deals.
The fact of the matter is that R15,3bn was raised by South African private equity funds in the past year, with as much as R31,7bn remaining uninvested.
As asset values come off in the face of head winds in the markets, we are likely to see an acceleration in the number of mid-market deals; transactions that are private equity’s bread and butter, though with continuing issues in the funding markets, private equity firms will need to seek more complex debt and equity structures to fund the growth of their investments.
It is this note of caution that highlights the unique opportunities that are starting to present themselves to firms involved in mezzanine funding. Indeed, at no point in the past three decades has mezzanine funding been poised to play so pivotal a role in the mergers and acquisition market.
Mezzanine debt will be required to supplement more traditional senior and subordinated debt. Mezzanine debt enables financiers to increase their leverage, while providing investors with additional equity featuring some debt characteristics.
Junior debt providers are putting themselves out of the game by increasing spreads to unaffordable levels.
Mezzanine financiers have more leeway to structure deals in which they believe, because their equity participation provides access to better risk-adjusted returns while putting less strain on the target’s cash flow.
Mezzanine structures provide a significant tactical advantage to players who understand it and are able to deploy it optimally.
In short, the medium-term opportunities for mezzanine funds are phenomenal.
Mogase is the chairman of Vantage Capital, a Johannesburg-based company specialising in mezzanine funding.
