Determinants of exit mode for leveraged buyouts in South Africa

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2015-05-29

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Seetswane, Seetsele

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Abstract

The dramatic growth in South Africa’s private equity and leveraged buyout market in recent years underlines the increased significance of the asset class and its importance in the asset allocation decision. This growth has equally been accompanied by the emergence of write-offs and unrealized investments carried at cost by private equity funds, eroding returns and generated value. This phenomenon mounts pressure on private equity practitioners to formulate and evolve better exit strategies in the face of an unfavourable exit climate compounded by dwindling arbitrage opportunities. This study therefore seeks to explore and establish the determinants of exit mode in the private equity industry thereby driving the evolution of exit strategy formulation and also contributing to the limited understanding of decision making in the industry. The study employs a mixed methods approach or methodological triangulation to provide empirical evidence supported by qualitative findings to achieve the objectives of identifying factors which predict or impact on the choice of exit mode for leveraged buyouts. Using a sample of 46 exited investments in the South African private equity industry, the study used various statistical techniques namely; descriptive analysis, independent samples t-tests, one-way analysis of variance (ANOVA), trinomial logistic regression modelling and robustness tests to identify the explanatory factors of exit mode for leveraged buyouts. The study found empirical evidence that the portfolio company’s operating performance and size (total investment) can significantly distinguish between choice of initial public offering (IPO) and secondary buyout as exit modes. The other determinants or predictors of exit mode; investment holding period and industry concentration were found not to have a significant contribution to the choice of exit mode via the quantitative analysis. Elite interviews were conducted with private equity experts selected through a purposive sampling technique. The findings of the qualitative analysis confirmed and supported the empirical findings pertaining to the predictive abilities firm size and operating performance in the choice of exit mode. Respondents to the study confirmed iii that investment holding period plays a diminished role as a predictor of exit mode owing to timing, macro-economic factors and the experience of the private equity manager all playing a either a direct, a mediating or moderating role in the choice of exit mode. In the South African context, respondents supported the consolidation hypothesis and justified that South African companies’ acquisition strategies are driven by the need to consolidate locally in order to gain access to new markets and improve the parent company’s market share. Therefore, portfolio companies in highly fragmented industries are ideal targets for strategic buyers and as such are likely to be exited via trade sales. This study also revealed that the choice of exit mode has no bearing on the ex-post realized exit multiple. The key findings of this study can be surmised as follows; the portfolio company’s operating performance and size are significant predictors of choice of exit mode. Investee companies in highly fragmented industries are likely to be exited via trade sales to strategic acquirers. Despite these findings, a fund manager’s competitive position to originate superior deal flow as well as negotiate higher exit multiples is greatly enhanced by the manager’s industry experience and his/her professional network in the financial/investor community. Other factors such as the robustness of the mergers and acquisitions markets, pressure from fundraising activities and existence of multiple arbitrage opportunities are also potential key drivers of exit strategy.

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Leveraged buyouts ;Consolidation and merger of corporations -- South Africa.

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