Inside African Phoenix’s R1.2bn private equity gamble

Private equity has at times conjured up feelings of trepidation in investment circles because of its bad reputation.

Historically, private equity models were led by corporate raiders who acquired businesses, restructured them by introducing high levels of debt and dramatically reduced costs by cutting jobs. While investee businesses were saddled with crippling debt, private equity investors were pocketing controversial profits and consulting fees.

South Africa has its own disastrous private equity models.

Edcon, South Africa’s largest clothing retailer, laboured under a crippling R25-billion debt load, embarked on mass retrenchments and battled to pay its suppliers since private equity firm Bain Capital bought it in 2007 for R25-billion.

Edcon is the struggling owner of Edgars, Jet, and CNA that has lost market share to its retail peers and recently received a more than R2-billion bailout from investors.

After pumping debt into Edcon to mount the many failed turnaround initiatives, Bain sold the retailer in 2016, leaving it in financial distress. But Bain managed to suck out about R664-million in “consulting fees” over its eight-year Edcon investment.

There is a wide acceptance that the high leverage, short-term investment and profit-taking private equity model is unsustainable. Investors are falling back to private equity models that create sustainable value by partnering with the management of investee businesses for the long term and supporting their growth strategy. Debt will still be used, but not at gargantuan levels.

This is the investment philosophy that has been embraced by a private equity fund established by African Phoenix Investments (API). API is the company that emerged when African Bank Investment Limited came out of business rescue after its underlying banking business, African Bank, was placed under curatorship by the SA Reserve Bank in 2014 due to soured loans.

“We are not trying to make a return in three or five years. We want to be a long-term investor in investee companies and take an active role in their businesses,” said Siya Nhlumayo, the former API CEO who leads the new private equity fund along with Shafiek Rawoot, the former API financial director.

The private equity fund is part of API’s strategy of shifting from being a financial services firm to an investment holding company after it separated from African Bank and recently sold its long-term insurance business, Stangen, to King Price for R140-million.

API will provide seed capital to the private equity fund to invest in unlisted businesses in sectors including telecommunications, education and healthcare.

API has set aside R1.2-billion for the private equity fund to invest in eight to 10 deals over the next three years in tranches of about R500-million. Nhlumayo said the private equity fund has at least two deals under due diligence.

Share buybacks

Before embarking on any investment strategy for the private equity fund, API was distracted by a legacy issue involving African Bank Investment Limited (Abil) shareholders.

To shift its strategy to an investment holding firm, API had to repurchase and cancel all the 13.5 million preference shares issued by Abil in the 10 or so years before its collapse. These shares are common in the banking environment; they get fixed dividends and usually don’t have voting rights.

API valued the preference shares at R37.50, a value which it said was in line with what the preference shares had been trading at — or in other words, the market price.

Some preference shareholders rejected the valuation determined by API because they believed that the shares were valued at R100. However, about 76.75% of preference shareholders voted in support of the buyback at API’s annual general meeting in March.

API still has about 9.6% of dissenting shareholders who didn’t approve the valuation of shares and have approached the court to determine fair value of the shares. API is not budging on its R37.50 offer.

About the motivation of dissenting preference shareholders, API’s Rawoot said:

“Some preference shareholders weren’t even African Bank shareholders from 10 years ago. They bought shares in the market at fair value (at about R37.50) post-Abil coming out of rescue and curatorship.

“When they bought those shares, they were clear on what the company can and cannot pay, they were clear on the new direction of the company. The bulk of the shares were purchased after we issued a notice to say we are repurchasing shares at R37.50. It was opportunistic (to reject the fair value offer).” BM