Private equity (PE) is back in the headlines again with the sale of Griffin’s Foods by Pacific Equity Partners and the sharemarket listing of Scales Corporation yesterday and Metro Performance Glass next week.

What is PE? Why does it have a mixed reputation in New Zealand? Do private equity IPOs underperform other new sharemarket listings?

In simple terms, PE is the acquisition or privatisation of a company by a specialist PE firm.

One of the key characteristics of these purchases is that they are usually funded by a high proportion of debt, mostly borrowed by the acquired company.

The primary aim of PE investors is to improve the performance of the acquired company and exit with a large profit, mainly through a trade sale or IPO.

There are a number of private equity firms in New Zealand, including Direct Capital, Knox Investment Partners, Maui Capital, Pencarrow Private Equity, Pioneer Capital and Waterman Capital. The sector took a battering during the global financial crisis but has recovered in recent years.

According to the New Zealand Private Equity and Venture Capital Monitor there was $401.5 million of new PE investments in 2013 compared with $84.6 million the previous year.

The increase in activity is encouraging but is well short of the $1141.4 million invested in 2007 and $1133.3 million the previous year.

PE has a mixed reputation in New Zealand because of a number of controversial transactions, particularly the purchase of New Zealand Rail from the Government.

A Fay, Richwhite consortium acquired New Zealand Rail for $328 million in 1993 and changed the company’s name to Tranz Rail. The deal was a typical private equity transaction with $223 million, or 68 per cent, of the purchase price funded by debt and the remaining $105 million by equity.

The $223 million was borrowed by Tranz Rail to partly fund the purchase of itself by the Fay, Richwhite consortium.

Subsequently, Tranz Rail made a $100 million capital repayment to shareholders. This reduced the capital contribution of the consortium investors to just $16 million (additional equity had been contributed by management between September 1993 and the share buy-back).

In 1996 Tranz Rail issued new shares through an IPO at $6.19 each with most of the funds used to repay the debt raised to fund the 1993 purchase and the subsequent $100 million capital repayment to shareholders.

The rest is history. Tranz Rail was a complete disaster as an NZX listed company and is one of the main reasons many New Zealanders are totally opposed to Government privatisations.

Feltex was another listed PE disaster.

Griffin’s Foods, which was established in Nelson in 1864, produces a large number of high-profile food brands.

Nabisco bought Griffin’s in 1962 and sold it to Danone in 1990. The Sydney-based Pacific Equity Partners (PEP) bought Griffin’s from Danone for $385 million in 2006.

Immediately following the PEP acquisition, Griffin’s balance sheet was restructured with the value of intangible assets, mainly brands, increased by $200 million and the company acquired $130 million of additional debt.

We can assume that the PE firm contributed around $255 million of equity to the Griffin’s purchase — rather than $385 million — because the $130 million loan was probably used to partly fund the PEP acquisition.

In addition, there was a capital repayment of $193 million in August 2013. Thus, it appears that PEP had a net equity investment of approximately $60 million in Griffin’s compared with the sale price of $700 million announced this week.

PE can deliver fantastic returns for investors but the New Zealand tax-payer has been a loser. This is because Griffin’s tax payments were well below normal levels due to the huge amount of interest payment deductions. In addition, the sale of the company by PEP is probably not subject to any New Zealand capital gains tax.

In light of this, it is not surprising that Australian PE firms love New Zealand.

Three years ago, the receivers of Allan Hubbard’s South Canterbury Finance sold 80 per cent of Scales Corporation to Auckland based Direct Capital for $44 million. This valued Scales at $55 million.

Unlike Griffin’s there has been no increase in intangible assets and Scales debt has fallen since a majority stake was bought by PE interests.

Scales is valued at $343 million at the IPO price of $1.60, giving the Direct Capital consortium an extremely healthy profit on its three- year investment.

Scales shares started trading on the NZX at $1.61 a share yesterday morning.

Metro Performance Glass, which will list on the NZX and ASX next Wednesday, is one of the more fascinating PE investments.

Catalyst Investment Managers bought Metro Glass from Aucklanders Andrew Smith, John Bedogni and Cameron Gregory for $366.2 million in 2006. This was a huge price, particularly in light of the looming global financial crisis.

Nearly $317 million of goodwill was created by Metro Glass following the acquisition and the company borrowed $290 million, mainly to finance the acquisition of itself by Catalyst.

Metro Glass drowned in a sea of debt and recorded a loss of $201 million for the March 2011 year. A liquidator was appointed to the company in March 2012.

The liquidator reported that as at February 28, 2012, the company had consolidated assets of $131.1 million, liabilities of $275.7 million and a net deficit of $144.6 million.

The Metro Glass prospectus is short on detail as far as the liquidation process is concerned but it makes the following comments: “The breach of covenants by the group [in 2012] led to the recapitalisation of Metro Glass business pursuant to which Crescent Capital Partners took ownership and control of the operating subsidiaries of the Metro Glass Group”.

Thus, Catalyst and the original lenders suffered huge losses as the recapitalised company did not assume any of the pre-liquidation borrowings.

The newly recapitalised company had $100 million of equity and $80 million of debt at inception in 2012.

The Metro Glass offer will raise $244 million at $1.70 a share with $230 million of this going to the Crescent Capital consortium. Consortium members will retain 41.4 million shares worth $70.4 million at the $1.70 a share offer price.

Thus, the Crescent Capital consortium will have trebled its $100 million equity investment in just over two years.

The past performance of PE companies gives little indication how they will perform once listed but a number of observations can be made about New Zealand and Australian IPOs in the past 12 months. These include:

• There have been over 30 Australasian IPOs, with seven of these in New Zealand. The average unweighted capital return of all these companies has been 7 per cent, 8 per cent for NZX IPOs and 7 per cent for ASX new listings

• Half of the Australasian IPOs have been either PE or venture capital originated. These PE floats have had an average unweighted return of 7 per cent since listing, the same as the overall average

• The two New Zealand PE/venture capital IPOs that listed before yesterday — Z Energy and ikeGPS — provide a small sample but have had capital returns of plus 10 per cent and minus 8 per cent respectively since listing.

In addition, the Hirepool listing, which was PE-originated, was abandoned. Australian PE floats have had an average market return of 7 per cent since listing.

The overall performance of IPOs over the past twelve months has been disappointing, with the notable exception in New Zealand of Meridian Energy and Genesis Energy.

Investors will be hoping that Scales Corporation and Metro Performance Glass have positive market returns over the next few weeks as this is badly needed to re-ignite interest in New Zealand’s flagging IPO market.


Brian Gaynor

Portfolio Manager

Disclosure of interest: Milford Asset Management holds shares in Scales Corporation, Metro Performance Glass, Meridian Energy, Genesis Energy and Z Energy on behalf of clients.