Nigeria: The need for Buyout Firms

In the spirit of Gordon Gecko's(played by michael Douglas) speech in the movie: " Wall Street", to stockholders of the "Teldar Paper" Company, in which he famously declared that "greed is good". I began to ponder the relevance of corporate buyout firms and so called "asset strippers" to the proper functioning of corporate enterprise. Corporate raiders like Henry Kravis, Ivan Boesky ( on whom Gordon gecko is loosely based), helped to dismantle the inefficient corporations and conglomerates that held sway in the 80s in america.

The question you may ask is: Why will Corporate raiders be so effective at fixing problems?. Answer: GREED. Greed is in my opinion the greatest motivator in the history of man, corporate raiders usually target an undervalued company and borrow huge sums of money usually by issuing bonds or bank loans to purchase controlling shares. Now, they are incredibly motivated because they have borrowed huge sums of money, hence they must ensure that the acquired businesses generate a cash flow that is reliable enough to service the debt incurred by the Buyout firm.

However, before the buyout industry can become very profitable and entrenched, some factors such as the following must be present:
1.) The most important, availablity of Undervalued Companies.
2.) Access to Cheap capital.
3.) Venture Firms must be competent in not only investing in companies, but also restructuring & Fixing broken companies.

Point 1 is very important, as overvalued equities are not in anyway favourable to Buyout firms. Purchasing controlling shares in an overvalued company would make acquisitions more expensive as well as make it more difficult for Buyout firms to service and ultimately offset the debt incurred in the course of the acquisition process.

Cheap capital is also very important to private equity companies. For an example of the role of leverage in Principal Investing, consider this scenario. Buyout firm X has 100 million naira in capigtal, however it borrows a total of 900 million naira to buy a failing company (Assume this includes interest payments), it then restrucures & sells the company for 1.1 billion naira, which means it has made a profit of 100 million (1.1 billion-(900+100)) naira on the investment. However, this number is a little misleading, because the buyout firm actually made a Return On Invested Capital (ROIC) of 100 percent ( (Profit made)/(Firm's capital)). This is because the company only invested 100 million naira of its own money in the venture and generated 100 million naira in profit.

Also, it would be beneficial if there exists a well developed Bond market in the country, this is important because a Buyout firm cannot depend solely on short term commercial loans. The "Buyout boom" of the 80s in America was fuelled by readily available "junk" bonds (ie bonds that are not investment grade,& are not backed by solid assets), Buyout men like Henry Kravis, Michael Milken etc were able to take over large companies without the help of the established banks.

Finally, private equity funds must also develop capacity in the area of Corporate strategy and restructuring, to enable them add value to the companies that they purchase. Adding value to purchased companies is probably the surest recipe for profitability. As it is my belief that the only reason for the existence of a company is simply: the maximisation of shareholder value. Therefore buyout firms must be adept at finding ways of enhancing the profitability of acquired companies, by taking a more active role in the management of such companies. So it will be important for them to have workers that have both management consulting and Investment Banking experience.

Transcorp: Yet another white elephant Project?

By now the Transnational Corporation of Nigeria (Transcorp) is now an household name in the financial and business sectors of Nigeria. The company which was launched at a banquet by no less a personality as: President Olusegun Obasanjo on July 15, 2005, as as its aim, investment in areas like:Oil & Gas, Information Technology, Power,Agriculture and Free Trade Zone, in effect creating a national champion . Most observers would recognise the company as the new owners of Nicon Noga Hilton (since renamed Transcorp Hilton).

Now, this is my grouse with Transcorp, the company keeps shouting chaebol at me. My first reservation against the company, is the number of bankers on the board of the company. It is my belief that the major cardinal sin that can be committed by a capitalist is the inefficient use of capital. Having a disproportionate number of bankers on the board of a company, may reduce the level of due dilligence that their banks conduct, thereby throwing good money at potentially bad investments. This situation can be potentially disastrous, as is evident in Japan where some banks have been threatened to the point of extinction, because of the exposure to Bad debt incurred by companies, on whose boards their senior bankers sat on. That is why I am slightly uncomfortable with the fact that chief executives or board members of some of Nigeria's biggest banks such as Zenith, First bank,Standard Trust Bank and GTBank, sit on the board of Transcorp.

Furthermore, the need to create a National (Homegrown) business champion which is often cited as the motivation for the establishment of Transcorp is suspect. There already exist quite a number of homegrown industrial champions, that have emerged or are in advanced stages of emerging. Oando is an emerging national champion in the field of energy, the company's petroleum products retail network is steadily improving. It has an Exploration and Production subsidiary that has just been awarded Oil blocks. It has a power generating subsidiary, it is expanding across the West african region, running refineries and distribution outlets.

Another case in point, is the Dangote Group which has proven itself in the area of manufacturing, running perhaps the biggest cement project currently in Sub-Saharan Africa(Obajana). Globacom is another national champion in the area of telecommunications, the speed at which it has rolled out sophisticated services, is unmatched even by the south African backed companies. The question I have for the government is,given the few examples listed above is: why not actively promote these companies in the fields in which they have been showing leadership, rather than try to create an artificial Champion that pretends to be a Jack of all trades?. I think that is food for thought.