As the magnitude of the economic turmoil becomes graver, analysts are increasingly looking at the role of financial intermediaries to fill the vacuum, and private equity as an alternative investment class has a big role to play.
Experts believe this particular asset class has the ability to go beyond financial engineering and produce sustainable and fundamental improvement in business.
According to Rami Bazzi, Senior Executive Officer, Injazat Capital Limited, private equity is "smart money" and this implies bringing in expertise in addition to capital – a combination, which is very vital now.
"In today's difficult times every sector is being impacted and everybody is in need of professional help plus capital. Private equity firms play an important role here. They give the investee companies a clear direction and structure on restructuring and repositioning themselves to face new challenges," he says.
"In the traditional financial system, banks normally give a loan depending on the credit ability of a company. They really don't care about the company they have loaned money to till the time the debtor has enough cash flow to pay. However, a good financial position/credit ability of a company does not ensure that it is in a good financial position," he told Emirates Business.
In comparison to the traditional financial institutions (banks and insurance companies), alternative investment asset classes such as private equity play a much different role.
"Private equity, on the other hand, becomes a shareholder rather than just a lender. The PE firm will not pay a company if it is not performing well. This is a good time to go back to basics and in such a situation PE firms and their expertise become all the more important. Questions such as whom to bring on board, who to partner with etc are vital. It's not about financial skills, there is more to that," he says.
The success of PE results from the culture of private equity, says Bazzi. "It's all about improving shareholder value. If you are able to improve shareholder value you have succeeded – this means getting better results for the companies, achieving operation excellence and expanding business. If investors don't see any advantage then why would they go through this procedure?"
Alaa El Din Rady, co-founder and MD of Enmaa Financial Services, an Egypt-based financial services and consulting firm, sees PE firms provide funding to fill the gap created by the lack/squeeze of debt financing and helping companies to merge/consolidate to survive the current crisis.
However, he believes, private equity plays both the roles – one just of financial engineering and the other of going beyond and producing sustainable improvement in business. "Even though most PE funds claim to produce sustainable improvement in business, we see both models in real life," he says.
"The first type of PE funds act mainly as financial investors relying on financial engineering to make their money. They invest in companies, have no value added to their growth or operations whatsoever; they only have an eye/controls over company financials until they exit to make their profits."
"The second type of PE funds invest in companies where they can add value in their strategy, growth, operations, etc. For example, they invest in a small local company with potential to grow, help them restructure their company, set their strategy, recruit, grow locally, open new markets for growth, help them make acquisitions or mergers related to their sector until they exit," he told this paper. However, in both the cases PE funds have an important role to play, he says.
According to Rady, the seller/company should do their homework with due diligence on the available PE funds and pick their match based on their needs.
"If they only need money to survive or grow, they can pick the first type of PE funds. If they need value added in terms of restructuring, strategy, operations, regional growth then they can pick the second type of PE funds," he says. According to Rady, "You [the company] have to investigate prior transactions the PE funds conducted and what value they added by looking at real life results and interviewing owners/managers of those portfolio companies," he says.
There are some questions that need to be asked before picking up a PE firm, says Rady.
"You have to look at other portfolio companies currently under the PE fund ownership. Are there any synergies you can benefit from? You have to look at the internal structure and human resources of the PE fund, do they have enough resources/associates to focus on the different portfolio companies? What are the capabilities and prior experience of those associates? Does the PE fund resources/capabilities match your needs (restructuring, strategy and growth plans).
"Does the PE fund have the keys to the doors you would like to open? For example, how can they help you if you want to expand in the GCC markets."
Moreover, PE has a good impact on employment and labour productivity, which again is very important these days.
"If money and expertise are going into new areas, new companies or even existing companies, the outcome has to be good. This also results in employment opportunities. The profits of a PE firm are related to the performance and growth of a portfolio company," says Bazzi. Rady, on the other hand, believes it depends on whether the PE fund is the first type or second type (the differentiation stated above).
"If it is the first type of PE funds, the impact is little since the PE fund employs directly a few number of people and outsources work to a few others (lawyers, consultants, auditors etc).
"If it is the second type of PE funds, the impact can be huge, by growing the company locally and regionally, recruiting people, and providing employment. Citadel Capital started by employing 3,000 people in ASEC several years ago when they acquired it, and now they are employing over 20,000 people across the region through their portfolio companies," says Rady.
On management practices, most agree that private equity owned firms are on average the best-managed ownership group. According to World Economic Forum working paper, titled Globalisation of Alternative Investments, private equity owned firms are significantly better managed across a wide range of management practices than government, family and privately owned firms.
The high average levels of management practices in private equity firms are due to the lack of any "tail" of very badly managed firms under their ownership (that is, very few private equity firms are really badly managed). While government and family owned firms as well as firms owned by private individuals have substantial "tails" of badly managed firms, those owned by private equity appear to be consistently well managed.
Private equity owned firms have strong people management practices in that they adopt merit-based hiring, firing, pay and promotions practices. Relative to other firms, they are even better at target management practices, in that private equity owned firms tend to have tough evaluation metrics, which are integrated across the short and long run, are well understood by the employees and linked to firm performance.
Private equity owned firms are better still at operational management practices. Operational management practices include the adoption of modern lean manufacturing practices, using continuous improvements and a comprehensive performance documentation process.
This suggests private equity ownership is associated with broad-based improvements across a wide range of management practices, says the report.
Experts agree that this is mostly the case but there are loopholes at times. "This is what one would expect. If you bring in capital and expertise then you would naturally expect better-managed companies. But this is not always the case and it depends a lot on fund managers and there are different drives that are used to improve performances," says Bazzi.
"They usually introduce better corporate governance practices to the portfolio companies, but comes with it a lack of flexibility in decision making," adds Rady.
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