This article first appeared in Personal Wealth, The Edge Malaysia Weekly on February 26, 2018 - March 4, 2018

Bank Negara Malaysia raised the overnight policy rate (OPR) to 3.25% last month, resulting in higher bank lending rates. This may be good news for local private equity (PE) players as business owners and entrepreneurs may turn to alternative sources of funding.

COPE Private Equity managing director Datuk Azam Azman, for one, thinks good investment prospects are bound to show up in the local market, and that businesses that cater for the mass market will be attractive prospects for PE investments. “Sectors that fulfil large consumer needs such as energy, healthcare, education, food production and peripheries, like medical devices and engineering maintenance services, will continue to dominate growth,” he says.

He adds that key to these companies’ success will be ensuring consistent revenue growth while managing efficient cost management protocols.

Nonetheless, Azam believes that potential portfolio companies in the consumer sector will face increased pressure to maintain brand loyalty as consumers now have access to a wider variety of options, thanks to disruptive technologies. “We cannot ignore the threat and need to embrace these [disruptive technologies] in our investment portfolios,” he says.

Meanwhile, industries that are overly reliant on old technology and labour-intensive production as well as those that suffer from cyclical business headwinds, such as property development and building materials, are to be avoided, says Azam. “We do not invest in property and construction-related companies as this is a capital-intensive sector with long gestation periods and relatively thin profit margins.

“Commodity companies, on the other hand, are inherently dependant on exogenous factors such as global economic cycles, over which our team has little control. Where possible, we would like to be in control of our own destiny.

“As for start-ups, they are essentially experiments on new business models. Thus, these high-risk investments should be left to those with specialised knowledge such as venture capital firms.”

Azam says COPE prefers companies in the food and beverage (F&B), education, healthcare and energy sectors. “We typically look at those with normalised profit after tax of more than RM10 million.”

The firm’s recent investments include a 2016 entry into MBG Fruits, one of the country’s largest fruit retailers, which has a significant presence in shopping malls, public transport hubs and hospitals. Last year, the firm invested in My-Sutera Holdings Sdn Bhd, a uniform manufacturer, distributor and owner of the “Canggih” brand of school uniforms.

COPE’s investing approach has worked out well so far. “As at the fourth quarter of last year, the COPE-KPF Opportunities 1 — our 2006 evergreen fund — achieved an internal rate of return (IRR) of 13.9%, with a realised money multiple of 1.7. COPE Opportunities 2 — a 2012 fund — achieved an IRR of 52.4%, with a realised money multiple of 3.5. Both funds have more than returned the initial funding commitment as well as preferred returns to investors,” says Azam.

Last month, the firm made a successful exit from Serba Dinamik Holdings Bhd after a four-year investment period with the integrated and specialised engineering services company. It had invested RM35 million in a subsidiary of the company in June 2013 via its two funds.

After helping the subsidiary internationalise its operations, Serba was able to grow its revenue by 4.9 times and net profit by 5.3 times. As at September last year, Serba’s revenue and profit after tax stood at RM1.9 billion and RM227 million respectively.

A whopping 71% of Serba’s revenue came from its international operations, up from 45% in 2013. At the point of exit, COPE had generated an IRR of 79.2% and a money multiple of 8.9 on the capital invested.

Although business is on the rise at COPE, senior vice-president of investments Badrul Hisham Jaafar admits that the PE sector is not without its own challenges. “One of the trends we have noticed is large institutional investors consolidating PE investment mandates into a few mega funds, with fund sizes exceeding US$1 billion to US$2 billion. At the end of the day, it takes a lot of resources for institutional investors to select, approve and monitor investments in PE funds, so we understand the move,” he says.

“As a relatively small and homegrown PE firm, COPE has no choice but to grow in size and geographical reach if we are to thrive in the long term. To this end, we have invested in proprietary IT systems over the last few years as well as gained access to private company databases with the help of one of our institutional investors — Ekuiti Nasional Bhd (Ekuinas). We have also worked with external consultants to benchmark our team against global standards.”

Azam says the firm is also considering the possibility of setting up an office abroad, although he admits that the move is still some way off in the future.

Exiting investments

According to Azam, COPE’s expertise lies in helping portfolio companies “institutionalise”. This is done by implementing top-notch corporate governance procedures, investing in IT systems, securing intellectual property (IP) rights for portfolio company prototypes and technologies, implementing operational key performance indicators (KPIs) and developing incentive schemes for second liners in the portfolio companies.

“As a local PE firm, we are heavily invested in the domestic economy. However, if economic growth barely ticks above 5%, how are we supposed to make returns for our investors?

“So, we look at the revenue sources of our portfolio companies: how much comes from home and how much is derived from overseas markets? Looking at the current economic environment, for example, we discuss with the business owners then chart a road map to increase revenue from their overseas markets.”

Once COPE and its portfolio company have agreed to the overarching business objective, the team looks at the company’s fundamentals. “We go through its balance sheets, financial statements and may, for instance, discover that most of its revenue comes from just one source — ad hoc engineering projects. This will be a problem for us as the company does not have any other revenue streams to fall back on. Then, we would consider new business streams that it can capitalise on without straying too far from its core competencies,” says Badrul.

With all the money, time and effort poured into supercharging the portfolio companies, Azam naturally has high expectations. According to him, the firm expects a standard return of 20% over a three to five-year period. “But really, if we can, we want to double our investment by the end of the timeline,” he says.  

Revamping the portfolio company’s business objectives and processes is just one part of the equation, however. COPE also makes it a point to institute employee share option schemes at its portfolio companies. This way, if a portfolio company is listed, deserving staffers are suitably incentivised to ensure the company’s continued success.

But bringing the best business sense and strategic know-how counts for very little if the founders are not willing to commit to what is often a very radical change. “Having a PE firm investing in your business is like getting into a marriage. Having the right chemistry is important as we are then able to minimise ‘marriage issues’ between us and the founders,” says Azam.

He adds that portfolio company founders need to be leaders or “near leaders” in their respective fields. They must also display a range of technical competencies.

“The founders need to have a strong grasp of the technology, distribution channels and branding. Also, they need to have that relentlessness that often characterise the best entrepreneurs of the day,” says Azam.

“We want people who are capable, credible and open to new ideas.”

Although COPE is a relatively new entity, the firm traces its roots back to 2005, when it was established as CMS Opus Private Equity. It changed its name last month to be more in line with the names of its various funds, as well as to distinguish itself from its sister company, Opus Asset Management, which specialises in fixed-income investments.

COPE is one of the few shariah-compliant private equity fund managers in the region.

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