Our sovereign wealth fund, the NZ Superannuation Fund, released a report at the end of last year covering its investment view on the market for expansion capital in New Zealand. Titled “How We Invest: White Paper - NZ Expansion Capital”, the report has some interesting takeaways in terms of the opportunities and wider issues they see for private equity and the capital markets in New Zealand.
The Fund defines “expansion capital” as the provision of capital to small, fast-growing, privately-held companies. These companies have proven products and established business models that require additional capital to accelerate their growth, such as investments in product development, entering new markets, or engaging sales teams. Companies in the expansion stage are generally more mature in their business life cycle than the more frequently discussed venture capital and angel investing stages.
The Fund defines these types of mid-stage companies as having an enterprise value of $5 to $100 million NZ dollars, and revenues of $5 to $50 million. These criteria can cover a wide variety of companies. For example, PushPay was valued at $50 million privately, just before it listed on the NZAX in 2014, or Zeffer Cider, who raised at a post-money valuation of $5.7 million in 2017. The NZ Super Fund estimates there are around five thousand companies in New Zealand that fit these criteria.
Since 2005, the Fund has committed over $450 million to expansion stage capital in the country. Over this time, they’ve generated an internal rate of return of 14.7 percent or a 1.5 times return multiple from these investments. Their comparable public market equivalent metric generated a return of 10.7 percent over the same period. In the white paper, the NZ Super Fund outlines what they see as the three key drivers of long-term opportunities for investors in the NZ expansion capital market:
1. There is significant demand from high growth companies for expansion capital, but not enough deals getting done. Current transaction levels suggest that only 0.3 percent of the five thousand SME’s in New Zealand who could fit the criteria for expansion capital have actually raised private equity funding.
2. There is a constrained supply of capital available for growth companies when looking at the small level of private equity activity and the undercapitalisation of the NZX, in comparison to larger developed markets such as Australia and the United States. Some of this constrained supply may not be due to a lack of funds, but possibly from a lack of platforms or efficient methods for companies and investors to find each other.
3. As well as low levels of capital penetration by big market players, the Fund identified sparse broker / intermediary coverage and insufficient price discovery tools as a cause of mispricing. This can create attractively priced opportunities for investors willing to do their homework. This is resulting in a series of well-funded Australian private equity firms swooping into New Zealand to take up major positions in our country’s fastest growing companies at discount prices because there isn’t enough capital in NZ to invest in their growth.
The woes of New Zealand’s publicly listed equity markets have been well-documented in recent times. If we want to improve our capital markets and economy, then mid-sized, high-growth companies are exactly the types of companies that need funding to grow towards a size where a public listing becomes sensible.
We understand the NZ Super Fund’s mandate is not focused on public good outside its return objectives, but there are definite win-win opportunities to their operation in this space for New Zealand. Expansion stage companies generate increased jobs, growth and exports as they grow. At Snowball Effect, we continue to see promising growth companies that require significant investment to make the most of their market opportunities.
It’s great to see the Fund being proactive about their investments in expansion stage companies, and sharing their views via position papers and research reports. We look forward to more of this transparency and thought leadership from the Fund. New Zealand has the potential to build significant international businesses in many industries and we’re excited to have the wealth of all New Zealanders invested into these dynamic companies.