Episode 5 of the Curious Kiwi Capitalist Podcast
13th September 2019
My guest for this show is Ian Frame, retired CEO of Rangatira Investments, a long-term private equity firm.
In this episode we discuss
- what is a private equity firm, what's their fees, investors and strategy
- the difference between classic private equity (PE) firms and long-term PE firms
- what sort of investments they're after and their investment horizon
- stock market crashes, investor cynicism and regulation
- venture capital and angel investing
- and much more..
Ian Frame was the CEO of Rangatira, a long-term private equity company, for 11 years up to his retirement in 2014. Rangitira was one of the earliest private equity firms and Ian was one of a line of extraordinarily talented CEOs who have made it one of the most successful PE investors in NZ.
Originally an engineer, he was one of the first New Zealanders to get an MBA and worked at DFC duing the '70s before joinging Downer in an international role. He worked for investment companies often in a CEO change management role. He has retired in Taranaki but still is involved in angel investing.
Transcript: Long-Term Private Equity with Ian Frame
Bruce: Firstly, what is private equity?
Ian: Well in New Zealand private equity really falls into probably three categories actually. The first there are a number of private equity firms that go and raise capital from from superannuation funds and other large institutional parties and they will invest that money on their behalf. They take a management fee.
And usually they have to pay the funds back within five or seven or ten years. The second category of those that invest similarly that they have their own equity and I'm talking about the Rangatiras, Todd capitals those family funds, and most of them will have maybe up to 200 million of funds to invest and they invest longer term. They don't have to repay the money they can afford to hold on to it and ride out the cycles.
The third category is really in New Zealand there are a large number of family businesses and that includes virtually all of the farming sector that run based on capital provided by the family and the money they have accumulated from those companies over the years.
Bruce: In the case of the first category the what I'd call perhaps erroneously as a classic private equity firm, they would have the limited partners: the superannuation funds, the endowments perhaps, wealthy families and individuals and they would invest that money into a fund and then the private equity firm would get a management fee and a performance fee. What's the management fee and performance fees that they tend to get?
Ian: Well they vary but generally speaking they would take a 2% fee per annum on the funds invested and then they will take a percentage like 20% of the gain over and above a fixed return.
So the fixed return maybe eight percent per annum so they have to achieve that over the life of the investment and then if there's a surplus above that then they'll take that. So that's what's known as a 2 plus 20 arrangement. There have been times when that's been common have been times when that's been under pressure.
Where it's right today, I'm not a hundred percent sure, but it it's probably around that.
Bruce: And that firm will have different funds how long do those funds tend to last?
Ian: Well, they raise them on the basis that they have to be repaid within a certain period of time and that period of time will invariably be longer than five years, but less or at a maximum 10 years.
Bruce: So if they invest in a company in year zero/one they need to sell their company by year 10.
Ian: Yeah and sure and they don't, they raise their money first and then they look to invest those funds. It may take them two or three years to find something to invest in. So often they are having to sell within seven years maximum because it's taken them three years to find that business to invest in.
Bruce: Now, we'll get to some more permanent capital soon rather than the limited life of a of the fund. But while they've raised fund, let's call it fund one and they've deployed all that capital do they then go and raise fun two?
Ian: Oh, yes. Yeah, I mean the successful ones and but it depends on the success of the private equity fund because the more successful they are the easier it is for them to raise more money and often they'll raise that money from the investors that invested in the first fund because they are happy investors and they will put more money in. But yes they will continue that's how they operate they they will probably raise a fund every one or two years.
Maybe maybe longer than that just depending on on how successful they are and what the markets doing.
Bruce: And those investors that are investing into most types of private equity including the classic PE firm, what are they looking? They can invest in bonds and the stock market, why are they investing in this risky private equity thing?
Ian: Well, it depends on the on the investor but the large superannuation funds and institutional funds for example insurance companies, they like to have a portfolio of investment. And so they mark 2% or 5% of their portfolio for higher-risk higher-return and that's where private equity probably isn't the highest risk class return but it is certainly at the more higher risk higher return end of the scale.
Bruce: What's the difference between private equity firms and ong term private equity firms?
Ian: The short term private equity firms get the money from institutions and they invest on their behalf. So they act a bit like a broker in that they are making the decisions but they're not making decisions with their funds.
And so they are investing on behalf of somebody else. The long-term investors private equity investors, like Rangatira are investing their own funds their own equity so they don't have to worry about looking after the investors and they can invest for as long as they like. And Rangatira for example does invest long-term. It has one company I'm aware of that they've been invested in for the best part of 50 years and they always they always co-invest with someone that knows how to run the business. So those long-term funds often will only take a 50% share maximum and the other 50% to be held by those that know how to run the business.
They also when Rangatira invests, it doesn't need to have an exit strategy. It's a key difference between the long term private equity investors and short to medium term ones.
Bruce: Going back to the classic private equity firm when they've reached the end of their fund, what options do they have? They obviously they keep going through a normal m&a process to find other other buyers.
Do they have other options outside of just straight out selling the though the company?
Ian: Yeah, well, basically that's got to sell. Although they are raising further funds. So they may raise a new fund every two or three years. It is a possibility for them to sell that investment may not be mature yet into the next fund but they have to be very careful in doing that.
Usually they would want to bring in some Independent party to audit that process and audit the price but that does happen and generally speaking they set out to have an exit strategy from day one and they will work continuously on that exit strategy through the investment period.
Bruce: When you're looking at the the longer-term private equity companies.
What sort of turnover of investments do they tend to have if it's up to 10 years for a clasic private equity firm and it's more longer term for the Rangatiras of the world, how long on average has longer term?
Ian: Okay, the the long-term private equity firms in New Zealand are generally what I would call in the emerging growth sector. So they invest in businesses that are probably turning over a minimum of say 10 or 12 million dollars per annum that's like a million dollars per month and they look to grow them to fifty hundred million hundred fifty million dollars of turnover.
In some cases they may be able to achieve that in 5 to 10 years in some cases it takes longer. And then they generally speaking do not have to sell so they do not have an exit strategy. They just believe that they keep adding value to the business then sooner or later there will be an exit opportunity for them.
But if they don't have to sell because they've invested their own private equity then they can continue to hold. So they always sell well because they never have to sell at any particular point in time and they can wait until they have added as much value as they possibly can to that business and the market conditions are right. There are a number of interested buyers and they can play the market and usually do very well on exits. The short term private equity firms are forced often to sell at a certain point in time. And so they have to really work hard to make sure that they have got suitable strategic buyers lined up.
And there are cases where they just have to cut their losses and get out because they've got to realize their funds. They haven't had time to achieve what they expected to achieve and they're under pressure to exit at an inconvenient time in the market.
Bruce: During the time that the classic films are holding the investments those investments would be probably distributing dividends. In the case of longer-term private equity firms who are holding those Investments for 20 30 40 years they are taking those dividends. In the case of Rangatira how did they distribute the divdends because Rangatira is actually "Unlisted" so to speak?
Yes. Well Rangatira acts very much as if it is a listed company. Its shares do actually trade on the unlisted platform which, while it's called "Unlisted" it is actually, it is actually a listed platform. And it's just not it's not that doesn't have all the formal compliance requirements of the main Stock Exchange, but they do carry on like a listed company and they do pay dividends. They declared dividends every year and they pay dividends. And traditionally those dividends have been quite good.
See Rangatira itself is about two-thirds owned by charitable trusts and many of those charitable trusts are dependent on the income that comes from Rangatira. So yeah, it's a bit like a superannuation fund that pays a steady or steadily increasing dividend from its shares. Now it will receive income it will receive cash from its investments to be able to pay those dividends. And from time to time, it does sell some of its investments and receives cash from that. So Rangatira, if you have a look at it if its balance sheet is actually at the moment pretty flush with cash. No problem with paying dividends.
I don't suppose it would do an extraordinary dividend payout based off that cash or getting into the internal machinations of the company here or must it invest it in companies.
Ian: Theoretically they probably should but practically when you've got charitable trusts holding two thirds of your shares you really want to provide them with steady income. They don't know how to handle large dollops of additional income.
So there's a bit of a practical issue there with Rangatira itself. But they tend to manage that by paying higher dividends then they may otherwise do but keeping them steady or steadily increasing year on year.
Bruce: What are the companies like Rangatira are in New Zealand? It stands out because it's on the unlisted board and therefore there is public information about it, including the annual report. We don't know much about Todd Capital and there are other family firms that I guess are private equity in structure. Do we know of many others that are other long-term firms.
Ian: No, we when I was running Rangatira we didn't come across too many that were in the same category. Todd Capital was there, K1W1 which is Tindall family company is quite active, but generally speaking there were no others so that we can across in a regular basis. The parties we did come across where the what you call classic PE firms, the ones who get their funds from others and invest on that basis.
Bruce: Going back to when you were first involved in the the whole private equity sector what changes have you seen from your early knowledge of the sector through to when you exited.
Ian: Oh, that's a massive question because it changes, it changes all the time. Every year the markets are different and and every decade Rangatira has basically had a different strategy. And it's been going for 70 probably closer to 80 years now. So it's it's probably in its lifetime had eight different major strategies.
What causes that is that when I first got involved with Rangatira it was about 2004 and it was a good time to acquire companies. We were looking to acquire 50% of what I call by New Zealand standards medium-sized businesses turning over 20, 30 40 million dollars and then growing those to be much larger.
Investing in private equity is not too different from investing in a rental property in the in the suburbs. You got to buy right. You got to develop it right. And you got ultimately set it right. And if you don't do the first one right like buy right you pay too much for it you'll never make money on the second two steps.
So you have to be able to buy private equity at the right price at the moment the private equity market prices being paid what I would call high and that does make it difficult for the long-term players. The short-term players short-term players can be in and out and still make a dollar but you wouldn't want to be caught with an in and out strategy if there's a major downturn in the markets like the global financial crisis and you have to sell.
Bruce: The price of our business is often expressed a lot by multiple, of course multiple of probably EBITDA and if we're at the height of the market right now or back in 2007 back when you were at Rangatira, you are the height of the market back then again 12 years for before what might be the peak now who really knows... a new world I guess every day. What was the multiples that you were being offered at the height of the market versus the bottom of the market.
Ian: Yeah. I got Market to my mind would be, and it depends on the sector that you're in but you know, we're talking about companies may be turning over say 15 or 20 million dollars.
So you're not paying a premium for size and they probably haven't got a strong market presence that there's ability to develop that you could perhaps pick them up at the right times 4 times EBITDA, maybe three-and-a-half to four and a half depending on the sector that they're in. At the peak of the market those figures will be doubled that, seven eight nine times EBITDA and there's not much room for downside in those sorts of prices.
There's plenty of room for downside with there's not much attraction for the investor at those sorts of prices. You've got to work really hard to do a whole lot more than just buy and modify and sell you've got to actually have a major growth strategy to go with it. And that usually involves pulling a number of different companies together.
I mean I saw a company recently that was turning over about 15 million dollars purchased and the acquirers paid a very high multiple and you know in a category that I was talking about and they had the acquirer had a major strategy to use this acquisition as a core for accumulation of a lot of other companies in that sector. So you've got to have major growth strategies if you want to be playing in that in that shorter-term and private equity game. Of course players, the longer-term players can afford to wait, can afford to sit on their money and wait for the right opportunity to come along.
They aren't under the same pressure to go out and invest in the markets at its peak. So they are quite different really in many ways those two categories supplier in the market. Course when they come head-to-head the more aggressive shorter-term players will often win. So the longer term players have to work on other factors such as there maybe a family that doesn't want to commit to an exit strategy. They're just happy to sell half the business and have a long-term growth strategy for the next generation.
Bruce: So we have 3 factors of buying low and selling high, being one and three I guess, and the second factor being growing the profitability size of the company. You talked about one strategy there of a rollup I'd call it. Or having a the first platform company and bolting on an additional perhaps more perhaps same size companies to that to grow it. What other growth strategies are there that you
Ian: look at?
Well if you're if you've got a consumer brand for example, and it's not well known and you can make it famous throughout New Zealand perhaps Australia, may be global.
You can increase your multiple a lot. So if you increasingly EBITDA and you're increasing the multiple because you're actually creating brand value. You can get a double whammy on growth and that's when you really make money in private equity.
Bruce: And one of the shorter-term firms focuses on on export markets that's they want to take New Zealand firms international. So that's I guess that's a core part of their growth strategy.
Ian: We're let's there's also the strategic aspect because a lot of the technology companies are trying to predict lease SAAS companies are trying to develop a strategic value that a large player offshore would want to acquire.
But you have to get to a certain point. I mean trademe was a good example Xero is a good example of as well. They basically made themselves that well known that somebody had to pay a high price to acquire them. Which happened with trademe. Or people were prepared to pay a high price to to acquire them which underpined the share price for Xero.
Bruce: And in the case of Xero especially it had international venture capital underpining its early years.
Ian: Well, they were able to attract that I think once they had got to the point where they had demonstrated their strategic importance. I think that came first. I think Rod Drury saw that there was a market for turning these accounting packages in to a SAAS product and he he stole a march on the other players with that MYOB and QuickBooks. He stole a march on them that then gave him a really good strategic value and it was at that point that the Americans started to invest in it. But he had to prove that strategic value first.
Bruce: Talked before about a size premium and that the mid-market firms didn't have a large size premium, what, in the case of New Zealand, where does company size start to increase the value of the company.
Ian: Depends a bit on sector that you're in but generally speaking I would call anything under 15 million dollars of turnover for a small company in New Zealand, 15 million to a hundred million of turnover maybe a bit less would be medium and anything over that over a hundred million of turnover is a large company by New Zealand standards. So that I think those boundaries because don't forget if you convert New Zealand dollars to US dollars those figures are all smaller again. I don't think in the United States, they would have the same categories, the numbers would be much higher, you know a large company in the US is going to be a lot more than 60 million US dollars of turnover.
What though from a private equity perspective, I find very interesting is whether they treat themselves manage themselves as a small or medium or large size company.
I mean take Gallagher in New Zealand. I don't know what their turnover would be but it would be certainly in the large company category, but they probably still run themselves as a small to medium-sized company.
So that's important I think in New Zealand because if you run as a large corporate in New Zealand, it doesn't it doesn't work that well. New Zealand is not managed on a large corporate basis very well. So you then have to import the Chief Executives from offshore know how to run a large companies and large companies sort of way and and that doesn't work all that well. You pay a massive salaries to them and and you don't necessarily get success. The most successful stories in New Zealand companies in the private equity sector, this is, are companies that think big but operate as if they're a small to medium-sized company.
Bruce: The growth of private equity seems to mirror the decline of the number of listings on the stock market as well. We're seeing this all around the world, especially in the US, but the ability for fast-growing companies to stay in the private sector for much longer than they used to and there's a lot of angst there seems to be with the NZX participants about the lack of IPOs and what they are doing wrong. I'll look at that review that they're doing with a great deal of interest, but I wonder if they're doing anything wrong at all. It's just the market the markets change.
Ian: New Zealanders like to have control of their Investments. It's interesting. You know, we've had some terrible stories in New Zealand in the finance sector large amounts of money have been lost both publicly listed shares and non-bank finance corporations.
Some terrible terrible stories and even through to private investor advice Ponzi schemes and you know terrible stories. So it's not surprising that New Zealanders very cany about where they put their money and and that actually it leads to a lot of people investing in property. So they feel with property they can own property your bank's more comfortable lending to people on property that can take personal guarantees to secure those loans, etc.
So the it does make it difficult for in the private equity market if people are going to invest into it they often prefer to either control the business themselves or know the person that controls it or be involved so they have some direct control themselves. And when they do that, they find that it operates pretty well and they would prefer to keep it privately owned.
Why would they want to go to the market and have other people dictating how they manage and operate. It's just a quick at the New Zealand market.
Bruce: The extent of our residential property investment certainly is a heck of a quirk to have too the amount of money that's been diverted away from the productive sector into selling houses to each other seems to be the to be one of the tragedies of the capital markets.
Ian: Well it is that the capital markets really in New Zealand can only blame themselves or maybe they can blame the politicians being too weak terms of legislating.
The scandals that have occurred in the in the finance sector and in the share market I mean 1987 there were a lot there were a lot of very unsubstantial companies that were trading at very high prices all on hype.
And of course when the crash came they were those companies through exposed to what they were, and the people behind them are exposed to what they were, but how many people went to jail for it? I think there might have been one Alan Hawkins anda lot of the other cowboys came back into the market within the next 10 years and everyone forgot about it.
So we also have had the global financial crisis recently and through that period then non-bank financial sector, 67 finance companies went under, I don't think do it basically any substantial finance companies in New Zealand survive that.
And government finally we can put some legislation and after that which hopefully has solved that problem, but you can't blame the vast majority of New Zealanders feeling nervous about giving their money to somebody else to invest on their behalf.
They would much prefer to invest it themselves and their own name. And the best way to do that is to buy property. So unfortunately because the vast majority of New Zealand private equity is gone into property we have got property prices at probably what is an unsustainable level. I'd like to think it's sustainable, but I'm sure that as soon as interest rates that going back up property prices will come down. And and that's going to create problems of its own. It would be nice if New Zealanders became more confident, no it would be nice if the New Zealand private equity markets became much more reliable and people gain confidence in them and started to invest and productive enterprise.
Bruce: Let's talk about one area that has grown and then that is Angel Investing. I'm not sure how long Angel Investing has actually been around, no doubt it has been around for many years and many decades with a different term used, but it's shown remarkable growth and you've had something to do with this early stage investing as well I think Ian.
Ian: Yes since I left Rangatira five years ago I have been involved in angel investing in New Zealand and that is developing and it's developing well. The reality of what it is though is it's a group of people who get together and they are prepared to perhaps put 5% of their portfolio into higher-risk higher-return investments.
And they get together in angel groups because they can share the knowledge of other people in those groups and they can combine their funds and co-invest with these other people. So Angel Investing is filling a gap in the New Zealand market. It's certainly at a much earlier stage then it's really a stage investing then private equity.
And yeah, that is taking off pretty well
Bruce: Angel Investing has certainly taken off and in the recent budget, we're recording this in July 2019, so the May 19 budget, filled a gap a "funding gap" they called it, or they said they're going to fill a funding gap it in Venture capital. I've heard this a number of times that Angel Investing is reasonably strong certainly compared to how I used to be, private equity is strong. Is that a stage almost in between that a venture capital? Where are we at with venture capital side of things?
Ian: Yeah, venture capital is not strong in New Zealand. It's strong in the United States. It's pretty strong probably very strong actually in Australia, but New Zealand, it just hasn't taken off. And I think it's because there isn't the expertise to undertake it. In many ways it is even more risky than Angel Investing and certainly more risky than private equity investment. The reason for that is simply the amount of money that's required for venture capital.
With the Angel Investing individuals can put up tens of thousands of dollars maybe and and that's not a large amount of money for a lot of people to risk. Whereas once against the Venture capital, the venture companies are looking for millions of dollars and so you need a party that can come in with a few millions of dollars and put into that investment.
And that money isn't easily raised in New Zealand you can get it from institutions, but they're increasingly concerned about the criteria under which that money is invested and the and you can get it from private individuals but also they they recognize that venture capital is probably the riskiest part of the whole cycle. Simply because it's still the companies are still high risks have been invested in but the amount of money required is much higher than for angel investing.
Bruce: And that's the big difference, angel investing is what I would call seed, the very early stages a good idea and a good person who's implementing that idea well enough to get you Angel Investors. The big change in risk as you say as the level of money required to help it achieve its growth objectives. It seems we need to get to the bottom of why we don't have so many Venture capital firms.
I mean Jenny Morel at No 8 Wire seemed to be doing well there and closed out it's fund and she hasn't raised another fund but continues to help out companies through her MoreGo meetings conferences. We've got Stephen Tyndall. We've got Movac in Wellington. We've got Lance Wiggs Punakaiki Fund... I struggle after that.
Ian: I think the reason why we don't have a lot of venture capital funds in New Zealand is because takes a lot of expertise to run and I don't believe that we have that expertise in New Zealand. I think we're very thin on the ground. By the time you go to Australia, there are a number of people there that have gained their experience perhaps offshore and are living in Australia now or they've learned their expertise in Australia. In New Zealand during a handful of people I think that know how to do. And some of those that are in the market doing it probably didn't have the expertise when they started out but have developed it since.
Bruce: Its almost a horse and cart thing I guess you need to either have worked for a venture capital firm or you've developed a grown a company and you've exited the company and now you have capital.
Both those cases you have the experience or knowledge and so you can start a VC firm with confidence. But without a large group of companies, a large group of entrepreneurs who have exited their companies, we don't have a large group of people who can start up VC firms.
Ian: No, and often people that have started their own firms and develop them and successfully sold out.
Often they don't actually have the skills to go and run venture capital activities which cross a much wider market sector. People that have started their own firms often know that industry, know that sector, got lucky with some people they brought on board so they had a great team, and can't repeat it elsewhere.
It's one of the reasons why I have enormous respect for Richard Branson. He's one of the few people that seems to have been able to be successful in one sector and go to another. But venture capital is like an early form of private equity. It's taking its transitioning those companies that are gone beyond seed capital and Angel Investment. It's picking up the ones that have got really good prospects, but then developing them into strong private equity companies. And that takes a complete range of skills, across a complete range of Industry sectors. And when I say a complete range of skills, you've got to have Financial skills. You got to have people skills. You've got to have market knowledge. And you've got to know how to add value you've got to know strategically what adds value. And I in my working career have seen very few people that have been able to do that in the New Zealand market.
Bruce: Let's talk about a bit about you. Before you joined Rangatira, what was your career path? Where did you start and how did you get into private equity?
Ian: I originally graduated in civil engineering. I liked engineering but I found it two dimensional and I wanted to get into management which I saw is three-dimensional. And so I was in the in my mid-twenties, I was in the United Kingdom and I went and did an MBA back before anyone in New Zealand heard of MBAs. And then I came back to New Zealand and and and people were very suspicious of anyone with two degrees. And so I had to work my way back up through. So I got into back into Management in the construction industry and did a lot of large projects around the Pacific and in New Zealand and managed those but I was happy because I was managing rather than doing pure engineering.
An opportunity then came up to join the Development Finance Corporation. And that was back when they were doing a very good job they were set up by Rob Muldoon and the national government to fill the Gap. The Gap being that the banks would not lend any capital or any funds where the capital was at risk.
And it needed some party to come in and step in and and plug that gap. And DFC despite the fact it got criticized a bit for for acting too much like bankers and taking too much security on everything. They did actually fulfill a very needed much-needed service. And a lot of people came out of that did interesting things after that, you know, I was there at the beginning of the 1980s and through the 1980s with the major restructuring that took place after Rogernomics or was part of Rogernomics, a lot of those DFC people were playing very active roles in terms of transitioning the New Zealand economy.
So after that, I got involved in change management and from the mid-80s through to the year 2000 there was an enormous amount of restructuring took place in the New Zealand market and I'm talking about restructuring of businesses because they were largely asset-based and largely cost focused their pricing policies were all Cost Plus.
And they needed to learn how to be market focused. And price on a market basis rather than a cost-plus. So there was a lot of corporate restructuring and took place and I participate in all that. Through to the early 2000s when I went to Rangatira. And it was a dream job really because that was putting all my previous experience together and running a private equity firm.
Part of that restructuring corporate restructuring that I did was done with what was Renouf Corporation and Hellaby Holdings at the time. We would buy into companies that were struggling after or as a result of Rogernomics and we would we would close down what we had to close down. We would realize assets where we had to realize assets but we would pick the best parts of it that had a future and a lot of those companies trading very strongly to this day. So yeah, it was it was a very interesting and very satisfying period because New Zealand needed it. New Zealand would not be the vibrant free market economy that it is today if it hadn't done all that major restructuring from 85 to 2000.
Bruce: Well, we're sitting in your beautiful Taranaki house looking down over rolling farmland towards the sea. After Rangatira you moved up here I think? Is that right if I missed out a section.
Ian: Yeah, it took me a couple of years to get here. But I knew Taranaki was good. I love looking out the window and seeing green productive Farmland.
It does my heart good. A lot of my friends have gone to live in Central Otago where you look out the window and it's barren barren barren
Bruce: Rabbits rabbits rabbits...
Ian: And rabbits running around, I look at and see beautiful green pasture and dairy cows fattening by the day
Bruce: Thank you very much for your time.
Ian: You're welcome
Bruce: Much appreciated very very interesting and I look forward to getting this one out.
Thanks so much.
Yeah great Bruce.