Last week's announcement by Bank Hapoalim (LSE: BKHD; TASE: POLI) of its massive, strategic entry into private equity funds, will intensify this instrument's's popularity Israel, even though it designed for institutions and for private investors with at least $500,000 available for investment. The bank plans to set up new funds with local and foreign investors, who will join the six existing funds managed by its subsidiary Poalim Capital Markets - Investment Bank Ltd., and then invest in existing global funds. In all, the move will amount to $1 billion, a quarter of which the bank will contribute from its own resources.
It's not as if there weren't any private equity funds in Israel two weeks ago. Several dozen such funds, most of them Israeli, currently operate here, managing in excess of NIS 13 billion in assets, not all of which, obviously, is available for investment in Israel. Worldwide, such funds are viewed as one of the engines driving growth in the financial and non-financial markets, since the company mergers, acquisitions, and turnarounds they lead inject new capital into markets, boosting the rate of company growth.
According to unofficial figures published recently, private equity fund activity increased to 35% of total merger and acquisition (M&A) activity in the first half of 2007, from 22% in 2006 as a whole. M&A deals for the first six months of the year totaled $1.17 trillion, a record figure for a single half, of which a substantial portion is attributed to private equity funds.
According to figures released by Private Equity International, from the beginning of 2002 through April 2007, the 50 largest global funds financed deals worth a total of $1.2 trillion. During this period, they raised $551 billion, a quarter of the initial and secondary offerings. Including leverage, their buying power amounts to $2.76 trillion.
Choosing from all this wealth
Bank Hapoalim's move provides an informative glimpse at the way the private equity industry functions, and the tools that investors use when selecting the right fund to invest in. For eighteen months now, Poalim Capital Markets president and CEO Nir Brunstein has been working on this program, together with the team he set especially for this purpose, headed by Ami Samuels and Oren Monhite Yahav, both graduates of Yale University.
Monhite Yahav is leading the foreign fund selection process, a role that has earned him the title "Mr. No" from his boss. "Oren meets 300 private equity fund representatives a year," explains Brunstein. "Only 20 of these reach the stage where he carries out a due diligence review and ultimately, only 10 of these are considered worthy of investing in."
Globes: How do you screen the funds?
Monhite Yahav "We invest, first and foremost, in people, not funds. I'd rather invest in people who know how to make good investments and generate value and profit for me. The comprehensive assessments are designed to weed out those managers who could give us hassle. I also look for investors who know what it is to make a loss on investment, people whose ability to recover times of crisis I can examine."
Are all the figures disclosed? This is not an exceptionally transparent industry
"The funds show us their wares, because they know that they won't get us to invest in them otherwise," adds Monhite Yahav. He gets most of the information from a private fund's prospectus. "After reading hundreds of these you too would know which data you need to get hold of."
Due diligence examinations of funds are extensive, covering many issues, and are accompanied by a concluding report 200-300 pages long for investors, who then have to decide whether or not the investment in the fund in question would be worthwhile. The report addresses a number of issues and criteria, from the personality of portfolio managers, through to the number of secretaries on the payroll (an efficient and non-wasteful organization is supposed to have a reasonable proportion of secretaries to managers. R.B.). To this end, Monhite Yahav spends two days visiting the headquarters of each fund, in order to "strip away the managers' fancy presentations, and get them off balance," he says.
How much weight do personal contacts and acquaintances have here?
"Personal acquaintances contribute a lot," says Monhite Yahav. Some funds, however, like Poalim Capital Markets, can afford the luxury of interviewing potential investors. Monhite Yahav says that there are 30-50 large and well known entities, out of the 1,000-plus funds, which have built themselves a reputation big enough to enable them to choose their partners, when setting up a new fund. "Supposing KKR (one the world's largest private equity funds, R.B.) starts a new fund. If you weren't a partner in their previous funds, you've no chance of joining the new one. It's a totally different world," says Brunstein.
Fund management philosophy
Monhite Yahav looks at the remuneration conditions of the fund's manager, who usually is a partner in the investment and also gets a bonus for achieving a return higher than that stipulated in the fund's prospectus. "I'm a bit wary of investing in contented managers, whose level of remuneration is relatively low, unless it's someone whose hunger for success outweighs everything else," he says.
"The money for investment is called by the funds during the investment period, which ranges from three to five years," explains Samuels, who is responsible, among other things, for setting up funds in Israel. "They usually prefer to receive the money just before the investment in the portfolio company is made, so that any sums lying in the fund without use will not be counted in computing the fund manager's returns. After a year and a half, the fund is closed to further investments, and in effect, there are no exit points after that stage. The penalty investors pay is the lack of liquidity of the investment, but the compensation comes in the form an extremely high rate of return." According to the Listed Private Equity Index, the average return is 16% and the top one quarter of the funds yield a return of 25%.
"We're currently in talks with a number of entities, and we have 30-40 prospectuses on the table," says Brunstein. "Ultimately, we'll invest in between five to seven funds this year, half of them in Israel, and we'll be dominant partners in them." The goal is to reach 15 funds within three years. These will specialize in different fields. Poalim Capital Markets has not disclosed any details about the planned funds, although it is considering setting up an alternative energy fund, with the assistance of two former Goldman Sachs managers.
Private equity funds are an exclusive club for wealthy financiers, and the minimum sum required for entry to an investment is usually $500,000. Poalim Capital Markets will offer investment opportunities to investment institutions and Bank Hapoalim's platinum customers. As for the development of products that would give access to less wealthy investors, such as a fund of private equity funds, Brunstein says it is "an interesting thought for the future," but probably not relevant for the time being.
If the conditions for joining a private equity investment remind you of hedge funds, it would be no surprise. Both are long-term tools instruments for the very rich. Brunstein does not consider hedge funds as a rival product, but rather, a complementary one in the overall portfolio, especially suitable for institutional customers. "The biggest difference of all between the two is in the level of risk exposure. While both industries use leverage, and both fall under the category of alternative investments, hedge funds use various strategies (arbitrage, long/short etc.), while private equity funds stick largely to investment in companies," he says.
Private equity funds raise capital from investors and then invest it in companies, usually ones that are not publicly-owned. The goal of the investment is to develop new products and technologies, expand company production capacity, and assist it in making acquisitions or strengthening its balance sheet. The funds aim through these moves to upgrade companies in order to achieve a higher sale price in the future.
Published by Globes [online], Israel business news - www.globes.co.il - on August 5, 2007
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