“Turning over a New Leaf - Canada Surges in M&A Activity”

After two years in which deal making was down, Canadian buyout and private equity investments were on the rise again in 2010 and now are positioned for a strong 2011. Estimates suggest that close to $5 billion was invested in Canada by its private equity players in 2010, which signaled the first rise for the asset class since 2007. The charge was led by deals like the Canada Pension Plan Investment Board's C$900 million purchase of a 10 percent stake in the 407 toll highway near Toronto. According to data from Canada’s Venture Capital & Private Equity Association, in 2010 there were 130 buyout and other private equity deals closed in Canada, which is up 7% from 2009. Disclosed deal values totaled $5 billion, which was a 21% increase on the previous year. Canadian private equity has snapped back to form in 2010, which puts it in line with private equity developments in North America and around the world last year. But what have the signals from Q1 2011 shown for the rest of the year?

All indications have shown that 2011 will be a strong year for private equity globally, and Canada’s private equity firms will be in the midst of the fray. "Private equity has been on the upswing around the world in 2010," said Gregory Smith, president of the Canadian Venture Capital & Private Equity Association. "And Canadian firms are fully participating in this rising activity. We are convinced that there are significant prospects for future growth." The sentiment that this year could be a great year for private equity seems to be shared by players who say now could be the best time to invest and take advantage of recession-adjusted pricing for high quality assets. Assets, which in an improving economy, would only rise in price as comfort and awareness return to markets. In fact, one could suggest that with the rise in Canadian private equity exits in 2010 (there were 72 exits, as opposed to the 35 exits in 2009), there is a growing desire and readiness to participate in new ventures as private equity and buyout firms realize on investments made in earlier stages of their portfolios. There is also consensus amongst Canada’s private equity community about the relative “return to normal” of credit markets, making for considerable liquidity in the system. Capital is available, with fundraising already exceeding the total amount raised in 2010. So if the capital and confidence are in line for Canada’s buyout players, the only question is, “Where do we go next?”

For starters, one can expect Canadian buyout and PE investors to continue playing a pivotal role in global markets. In 2010 which saw domestic investments at $5 Billion, Canadian investors contributed to international transactions valued at close to $30 billion. Canadian investors have been strong players in international private equity markets, leveraging new opportunities abroad as the global economic environment continues to stabilize.  And while a considerable amount of the domestic deal activity focused on smaller transactions, there is an expectation that investors will be on the lookout for the elusive “megadeal,” which was absent from the list of deals closed in Canada during 2010. There is a sense that there will be a deviation from last year when billion-dollar-plus deals were non-existent, and the Canadian market focused on investments in mid-market businesses located in a handful of industry sectors such as industrial products, oil & gas, and real estate. It will be interesting to see if this strategy is adopted employed again this year, or if investors will pursue opportunities in media, technology, and travel – all seen as great target areas in the coming year.

“Hitting the BRIC Wall - Indonesia’s Fight for Inclusion Amongst the Emerging Market Leaders”

                At a recent investors’ conference held by Royal Bank of Scotland Plc, participants voted for Turkey and not Indonesia to be the next country to join the BRIC group of emerging-markets economies, which includes Brazil, Russia, India and China. 35% of respondents favored Turkey, with 23% favoring Indonesia and 16% choosing Mexico, according to a summary of the results from RBS late February. With economic growth among the strongest in Southeast Asia and brightening future prospects for the resource-rich country, economists are determining whether it should be the next country added to the BRIC grouping of global powerhouses-to-be. But uncertainty still remains amongst the analysts of the world. “Should Indonesia be included in the BRIC grouping, or not?”

With 240 million people, Indonesia is the fourth most populous country in the world. It is also the biggest Muslim nation, with a youthful democracy that followed the decades of post-colonial dictatorships under Presidents Sukarno and Suharto that ended in the late 1990s. It is an understatement to say that Indonesia “is doing well” – its economic growth is hit 6% last year after gross domestic product (GDP) rose to 6.2%. There are few who deny that Indonesia will repeat the feat this year, with estimates of year end GDP growth as high as 6.6%. The Jakarta Composite Index, Asia's second-best performing stock exchange after Japan, hit a record high mid 2010 following the appointment of Darmin Nasution as Bank Indonesia's new head, ending a period of uncertainty regarding the country’s central bank. Foreign direct investment (a significant indicator of investor confidence) has continuously grown for the Southeast Asian nation reaching $13 trillion for 2010, a 22% increase on the previous year. And when the 2008 global recession hit, Indonesia weathered the storm with relatively little difficulty due to abundant natural resources, a growing middle class, low levels of government and household debt, and of course, a $690 billion dollar economy (Southeast Asia’s largest). Perhaps this is why Indonesia moved a step closer to investment grade last month when Moody's upgraded its sovereign debt rating to Ba1, putting it ahead of BRIC rival Turkey who is at a Ba2 rating. When Jim O’Neill, global economist for Goldman Sachs produced the BRIC acronym in 2001, he projected that the combined economic size of the four countries would be bigger than all G-7 countries except the United States by 2050 (The other G-7 countries being Japan, Germany, the United Kingdom, France, Italy and Canada). This grouping of countries would be the fastest growing and strongest of the economies outside of the G-7: the leaders of the emerging markets. By this criterion, it would seem that Indonesia is an obvious candidate for this grouping, but there are concerns amongst the economists and analysts who are watching closely.

While a Standard Chartered Bank report released around the same time as the RBS poll results pointed to Indonesia’s political stability and strong economic fundamentals as reasons to invest in the country, it also noted investor concerns. “The lack of trans-Java and trans-Sumatra highways, inadequate power supply and insufficient seaport facilities in the world’s biggest archipelago, has become the biggest impediment to foreign direct investment,” the report said, also noting that these problems limited the nation’s growth to an average 5.1 percent over the last 9 years. Another concern shared amongst investors is perhaps the biggest: Corruption. Indonesia is known for a culture of bribery and kickbacks that has pervaded everyday life - politics, bureaucracy, the legal system, and business. Indonesia’s years of democracy have seen a crackdown on this illegal activity, but new cases involving kickbacks, bribery, and extortion are still frequent and common. In fact, at one point the campaigners Transparency International had given Indonesia the title of “Most Corrupt Place in the World.” Indonesia no longer enjoys this proud distinction (Somalia was the 2010 “winner”), but according to Transparency International, Indonesia still has much work to do, even if it has made progress.

Still, other analysts suggest that Indonesia should be included in the BRIC grouping ahead of Turkey and even Russia, an existing member. Although a nation of 70 million, Turkey and Indonesia share several similarities. Both are moderate Muslim majority nations. Both escaped the global economic downturn. Both are oil and gas producers, although neither is self-sufficient. A big difference is that Turkey is expecting 4.5 percent growth this year, while Indonesia is looking at growth of over 6%. And a senior institutional investor noted recently, “Where else do global investors put their money in Asia after China and India? There aren’t many alternatives. Indonesia’s very attractive.” And for a good number of money managers and economists, the excitement over Russia’s inclusion since the early 2000s has all but died. Economists have cited Russia’s policymaking in the Kremlin, demographic atrophy, endemic corruption, and its heavy and almost singular reliance on its natural resources as reasons why it can’t be trusted as more than a “one trick pony.” And while Indonesia has successfully made strides in its struggle with corruption, Russia seems unable (or unwilling) to do likewise and actually rated below Indonesia in several global corruption assessments. Richard Shaw, Managing Principal of QVM Group, a South Glastonbury, CT investment advisory firm put it best - "Russia is just not a good place to put your money."  

If those voting participants at the RBS investors’ conference were truly deciding, then it would be Turkey and not Indonesia to be the next in joining (or Russia staying in) the BRIC group of emerging market leaders. However, it is Indonesia that will prove most worthy of the BRIC distinction in the coming years, whether it receives the distinction or not.

“Brand Recognition – The Private Equity Dash for Retailers in Q1 2011”

The First Quarter of 2011 saw a wave of private equity firms either showing interest in retailers or participating in a string of retailer acquisitions. Leonard Green & Partners left the checkout aisle with Jo-Ann Stores in tow, paying $1.6 Billion for the transaction. Later the firm would be seen in a consortium deal for J. Crew Group, partnering with TPG Capital to put up a $3 Billion offer.  Recently, there has been a lot of buzz around LGP’s due diligence into BJ’s – giving rise to speculation that the deal could be worth $60-$80 per share if a deal were to take place. In the high fashion world, Castanea Partners has been making acquisitions – securing both Donald J. Pliner and Astor & Black Custom Clothiers in the span of two weeks. In the midst of this action Privalia, an online fashion retailer with strong positions in Europe and Mexico, acquired Germany’s Dress For Less with support from private equity firms General Atlantic, Highland Capital Partners, Index Ventures, and Insight Venture Partners in a deal that could be worth as much as $280 Million. It’s clear that investors have placed their bets on the retail market, and more importantly the all-important consumer…but how secure is that bet?

 Fairly secure in the eyes of those who believe in the power of brand. “Brand,” as one private equity veteran stated, “is enough to get customers – and new customers – in a down economy.” If one were to follow this logic to its inevitable end, this would mean that certain “brands” would be able to not only attract new customers in a slower economic climate but also “rebound” once economic conditions improved. Basically, retailers such as Jo-Ann Stores and J.Crew would retain a good amount of their cache, and once economic conditions return to profitable levels, an investor could sell their holdings for a reasonable profit. In the case of investments like Dress For Less or Astor & Black, investors can take advantage of the benefits of stylish, forward thinking symbols and clear market share leaders in their respective niches. These retailers and investments have brand recognition, which translates into brand loyalty, which for investors translates into a modicum of certainty and stability but more importantly, potential for growth.  In a recent press release concerning their acquisition of Donald J. Pliner, a premier designer and marketer of luxury footwear, Castanea’s Brian J. Knez, Managing Partner said, “Donald J Pliner is a terrific investment opportunity for us…this new partnership provides the Company with the resources to accelerate its growth and enhance the prominence of the brand.”

All indicators would suggest that investors should follow suit with all due haste, but there are concerns that do arise when looking at the surge in retailer buy-outs, especially when considering the acquisition of BJs  or even Big Lots Inc. and Family Dollar Inc., who have also been flirting with the idea of participating in a buyout.  Both Big Lots and Family Dollar are known as low end discount retailers who operate under tight margins. And one wonders whether or not they can retain their customer base in the face of further economic stability.  One would think even interested, offer-toting parties feel this way. Perhaps this was the reasoning behind PE firm Trian Group’s offer to Family Dollar. As of this writing, the board at Family Dollar had turned down the offer from Trian, citing that at $55-$60 per share the offer seriously undervalued the company. For now, Family Dollar seems to be off the shelves.  However, Big Lots is still in play, after a strong fourth quarter of sales and earnings. Looking at the buyout possibilities, Big Lots has upside – operating strength and valuation multiples are in Big Lots‘ (or an acquirer of Big Lots) favor. But if brand strength and recognition are the key ingredients in recent retailer buyout recipes, it would seem that retailers such as American Eagle Outfitters, Inc. (who demonstrate stronger brand loyalty and roughly equivalent valuations) would be the better and safer play.

“Diamonds in the Rough – Missed Opportunity in the Race to Get to China?”

Even before Marco Polo wrote Il Milone, China and exotic locales seemingly on the edge of the world have beguiled investors and entrepreneurs alike, with promises of riches, wealth, and success beyond measure. For a select few, the successful return of a caravan or the safe docking of an inbound spice ship brought incredible returns to stakeholders. A captain fortunate enough to be on that sole surviving vessel would have a bountiful estate that would last him 3 lifetimes, with more than enough left over to pay tribute to the Crown. However, for many others this trek would often end in violent confrontations with local inhabitants, lost ships resting peacefully at the bottom of the ocean, and mutiny. It would not be until several centuries later that those same entrepreneurs in search of a shortcut to the treasures of the fabled “East Indies” would discover a “New World,” The Americas. How would the history of the world have been different if these risk-takers had taken advantage of the opportunity that was right in front of them sooner? Did those businessmen of yesterday miss opportunity in their haste to reach the Far East? Are our modern day equivalents doing the same thing with markets such as Africa?

Recent news of The Carlyle Group opening offices in Lagos and Johannesburg in anticipation of investments in a fast growing sub-Saharan African market has investors asking the question. The vote of confidence from one of the world’s leading buyout firms highlights the growing success story of the African continent.  In the sub-Saharan region, the years of 2002-2008 have seen substantial growth, fueled by a strong flow of commodities, political stability, and maturing capital markets. And this growth and success was by no means confined to the sub-Saharan region – by 2008 the entire African continent had a GDP of 1.6 trillion dollars, which made it equal to the GDP of Russia or Brazil. In 2020, that same GDP is projected to have almost doubled – 2.6 trillion dollars.

"Africa is in a take-off phase, with foreign direct investment (FDI) increasing from 15 billion dollars to 80 billion dollars in eight years. And the per capita GDP of the top performing economies - Algeria, Botswana, South Africa, Libya, Mauritius, Morocco and Tunisia - exceed that of BRIC (Brazil, Russia, India and China), the traditional emerging countries," stated Nozipho January-Bardill, group executive for corporate affairs at Mobile Telecoms Network (MTN), a South African company that has invested in 21 countries, both in Africa and in the Middle East. In addressing a gathering of executives at the 4^th Annual Swiss-African Business Exchange, January-Bardill pointed out that Africa’s recent success is very much the international business community’s most understated coming of age story. “Africa is the last frontier of growth. In the past, investment opportunities were mainly in oil, diamonds and property. But today resources are diversifying, with 60 percent of growth coming from non-traditional sectors, such as retail, manufacturing, financial services, telecoms, real estate and tourism."

However, China is still seen as private equity’s new frontier. The Beijing Private Equity Association has grown to more than 100 members. Similar organizations in Shanghai and Tianjin have over 100 members between them, and are growing. The expectation is that China is on its way to becoming one of the world’s top private equity centers, despite geopolitical tensions that permeate discussions between Beijing and The West. There is also the often mentioned tale of PE firms looking to enter the Chinese markets having to work harder than any other market they participate in. At a recent conference, a VP of a PE firm building a presence in China stated, “We have to have five times the number of people on a deal than we do if it were done here.” The imagery of a spice galleon fleet comes to mind…