Challenges in the eyes of the investor

After the spectacular failures of private equity houses to buy Coles and Qantas last year, the private equity sector has been viewed with suspicion by investors.

ING Investment Management director of private equity Richard Hughes accepts the sector has lost a lot of its profile during the past 12 months.

“The credit crunch in private equity markets has affected the sector in both the cost of money and reducing investment opportunities,” he said.

“Everybody is talking about loan covenants, but every transaction has three to five-year terms for its loans and 75 per cent are at fixed rates.

“If somebody has an $80 million term debt, $60 million of it will be fixed.”

Hughes said the nature of private equity investments meant debt was negotiated on a long-term basis unlike the short-term debt of some publicly listed companies.

“Most private equity invests on a five year cycle,” he said.

“And the relationships between Australian established private equity managers and the banks is very good.”

Australian private equity managers also work with the Australian Venture Capital Association (AVCAL) guidelines on asset valuation.

Hughes said the guidelines are designed to smooth valuations.

“In the first year, the investment managers are not allowed to re-value the asset,” he said.

“After 12 months the guidelines will allow part re-valuation to apply, with a discount of up to 30 per cent.”

Hughes said research undertaken by ING revealed that private equity managers were being realistic with their valuations of assets.

“We did some analysis at the end of last year of almost 100 private equity investments and the premium of realised value over previous quarter valuations was 39 per cent,” he said.

“Private equity is a more conservative segment.”

However, past performance is no guarantee of future outcomes and what will happen to the global economy in the next 12 months is a concern to private equity managers.

“The real question will be what will happen in a real economy and that is what most managers are concerned about,” Hughes said.

“If the global economy goes slow, how will it impact and what will be squeezed if there are high levels of gearing in an investment?”

One comforting factor is most private equity investments have gearing levels of about 50 per cent.

“Private equity is not highly geared, the average gearing is 52 per cent,” he said.

“Most private companies would have a higher level of debt, but you have got to keep an eye on the real world.”

Hughes said if the asset was in discretionary spending there could be some distress.

“But if it is a good business, it will quickly re-surface,” he said.

“There will be businesses that go into these times that will come out better.”

Hughes said private equity is a long-term asset class and any changes to the sector will take time to turnaround.

“The key to picking a private equity investment is the quality of the manager and that they have a good portfolio of investments,” he said.

“It is also important that the manager understands the AVCAL guidelines and acts within the requirements.”