There was a flurry of excitement last week. Could private equity be poised to launch its most ambitious foray to date into South Africa, dwarfing other deals in the country with a $12.5bn takeover of iconic miner Gold Fields? Alas it was not to be.
But Merrill Lynch think that South Africa does present an increasingly attractive alternative for buyout groups, encountering growing difficulties in finding targets in Europe and the US and willing to look elsewhere to deploy funds.
South African companies have strong earnings growth, valuations remain sensible and, most significantly, they are under-leveraged, argues the report. While the average net debt/equity ratio in Europe is 45 per cent and in the US is 32 per cent, the figure for South African companies is just 7 per cent.
In any case, they believe that a ‘wolf at the door’, even one that has yet to bare its teeth, could prompt South African execs to take a closer look at their funding structure – before someone else does it for them.
Retailers look the most attractive for the private equity groups, conclude Merrill. After all, South Africa’s largest private equity deal to date was sealed on Monday when shareholders in fashion retailer Edgars Consolidated Stores voted in favour of a R25bn ($3.5bn) buyout by Bain Capital. Elsewhere, Merrill argues, the sector offers stable cash flows, inefficient balance sheets, little incremental capex, and attractive valuations.
More controversially, they also highlight the natural resources sector – where in the past, the perception of cyclicality has limited pe enthusiasm. But with the sector throwing off cash thanks to high commodities prices, this could change, they say.
But for those whose interest was piqued by events of last week- a word of caution. One banker expressed extreme scepticism that a Gold Fields would be the first big South African name to be taken private. The risks are just too great, he said – with operational uncertainties, labour difficulties and a lack of clarity on future legislation weighing heavily on a potential deal.