November 22, 2004
By Kobus Gertenbach
The continuing strength of the rand has created an opportunity to realise substantial returns by establishing a private equity fund that focuses on turnaround situations.
Three or four years ago, a number of new companies sprang up to take advantage of the tremendous weakness of the rand, particularly in the manufacturing sector. They saw an opportunity to make huge profit by manufacturing products for international distribution.
Because their business plans projected substantial margins, many of these companies financed their operations through debt. But now that the rand has strengthened, those margins have disappeared and their ability to service their debt has deteriorated significantly
Often, these companies over-invested in infrastructure. For example, they would buy triple the manufacturing space they required on the basis of hugely optimistic revenue projections. Now, many of them have run out of financial road.
This has created an ideal opportunity for savvy investors to establish a private equity fund that focuses specifically on these potential turnaround situations.
The opportunity exists to buy out the holders of the debt, who normally also have security over most of the assets. You should be able to buy out the holders of the debt at somewhere between 40c and 60c to the rand, and then effectively get the benefit of all the previous shareholders' capital.
Then, with the portion of the debt that you are in effect getting for free, you could buy the assets. The next step would be to apply management focus to the business in order to right the wrongs of the past and pare down the expense structure.
Having done so, you could look forward to a very profitable return on that investment. Such a fund would ideally be established by individuals who either have capital or have access to capital that can be placed at risk, as well as management expertise.
You would need more operational skills than the traditional private equity fund, which is normally heavily staffed with financiers.
You would also need a solid understanding of liquidation law plus traditional corporate finance knowledge. Finally, knowledge of JSE legislation, company and tax law, especially with regard to restructurings, would be critical.
The big opportunity for investors is the fact that these companies have existing products and the ability to manufacture them, existing customers and an established distribution channel, and can be acquired at a discount.
Despite the current strength of the rand, many of these companies still have the ability to return to profitability. Many went into business on the basis of making excessive profits.
With a new injection of capital to pay off their debt and the right management team, it is quite feasible you could produce lower, but still acceptable, profits.
Kobus Gertenbach is an associate at integrated equity and debt company Bravura
Publisher: Business Report
Source: Business Report
