HONG KONG (Reuters) - Affinity Equity Partners, one of Asia’s largest and most successful private equity firms, has taken a hit to its reputation and seen some credit lines pulled over two failed investments.
Affinity sold a majority stake in Jaya Holdings JAYA.SI for S$202.6 million to a Deutsche Bank-led (DBKGn.DE) consortium in February, after struggling for a year to offload the troubled Singaporean shipping firm. It had bought the stake in 2006 for around S$586 million ($476 million at current exchange rates).
A month later, Affinity-backed Colorado Group surrendered control of its business to lenders owed around $400 million, as the Australian clothing and footwear retailer failed to cope with a weak sector and folded under the weight of heavy debts.
Affinity had bought Colorado in 2006 for A$430 million ($460 million).
Any private equity fund is bound to have a bad deal or two.
In Affinity’s case, three companies in the portfolio of its Affinity Asia Pacific Fund II, L.P. struggled. Before Jaya and Colorado, lenders had taken control of the third company, First Engineering of Singapore, in 2009.
However, Jaya and Colorado have seized headlines in recent months as Affinity was making early preparations for its next fund.
Colorado’s problems sparked scathing Australia media reports. Sources quoted by The Courier-Mail dismissed Affinity as “accountants trying to play the retail game” after buying the respected company in 2006.
And because fund restrictions meant Affinity couldn’t inject more money into Jaya or Colorado, sources at two international banks said they were no longer allowed to issue loans for the firm’s deals.
“We’re an old fashioned bank. When we lend money, we like to get it back,” said one source from a bank that cannot lend to Affinity. “It’s not a case of the credit. We can’t lend to that firm.”
Affinity, based in Hong Kong, declined to comment for this article. The Asia Pacific Fund II raised $700 million in 2004.
The firm, one of the few major buyout groups that focuses solely on Asia, has enjoyed huge profits since it was founded by former top UBS bankers K.Y. Tang and David Lai in 2002.
An investment in 2005 in Korean consumer electronics retailer Hi-Mart Co is among the most profitable private equity deals ever in Asia. An initial investment of $200 million returned around $2.1 billion.
Affinity’s investments in Australian packaging and pallet-maker Loscam, and Korea’s skincare company FaceShop and auto-parts firm Mando, returned between four and five times what the firm paid in, a source with direct knowledge of the matter and who did not want to be identified, said.
Colorado and Jaya weren’t the only problems in Fund II.Affinity also lost its stake in First Engineering, a Singapore precision engineer serving the computer and auto industries, when bank lenders took control through a debt for equity swap in 2009.
Institutional investors, who allocate tens or hundreds of millions of dollars to private equity, understand the risks of leveraged buyouts.
The losses in some parts of the portfolio do make it a “high loss rate fund,” said an existing investor. The source declined to be identified due to the sensitivity of the matter.
Still, the failures at Jaya and Colorado were flagged to Affinity’s investors well in advance, this source said. And the losses were more than offset by gains elsewhere in the fund.
“The writeoff of Colorado was not a surprise to us. We had it written down to zero for 18 months. It wasn’t a shock, but an unfolding drama,” he said.
Institutional investors are more concerned about the overall performance of a fund, and are usually able to overlook some failures so long as the final fund returns are high. These types of investors, known as limited partners (LPs), have so far been well rewarded by Affinity.
The gross internal rate of return (IRR), or annual growth rate before taxes and other costs, of Affinity’s Fund I was around 25 percent, a source with direct knowledge said.
The gross IRR for Fund II was 40 percent, the source says, thanks to the success of the Loscam, FaceShop, Mando and Hi-Mart deals.
The source with direct knowledge said Affinity recognizes areas where it went wrong, and one of those was in taking on too much debt.
And in the case of Colorado, Affinity took on a “turnaround” for the first time, which is when an investor aims to revive a company that is close to collapse.
“I think this is Affinity clearly taking on too big of a challenge, in terms of the risk and the work they would have to do to turn this company around,” said the LP source.
Affinity declined to inject more money into either Jaya or Colorado, because Fund II was already fully invested, said the source with direct knowledge of the matter.
Though rare, private equity firms can raise a separate pot of money for a company in need of cash. It can also try to get approval from investors in its next fund to put cash into a company from the previous one. However, such requests are usually rejected if the new fund has new investors.
That Affinity was unable to put more cash into the struggling companies led to tensions with banks that backed the buyouts with loans, and had to eat big losses when the companies couldn’t repay the loans.
But while some banks stopped making loans to back Affinity deals because of those losses, others continued.
When Affinity acquired New Zealand poultry producer Tegel Foods Ltd in December 2010, Singapore’s UOB (UOBH.SI) and food and agriculture specialist Rabobank joined the buyout loan — both banks that had previously lost money on loans to Affinity.
“We did note that it is Affinity, and Colorado has not been a good experience, but at the end of the day we still think it is a good opportunity from the debt side,” said a source at Rabobank RABO.UL.
UOB sources said Affinity remained a core client for the bank, and they were comfortable that Tegel was a strong asset.
“A deal’s a deal,” said a leveraged finance banker from another bank that works with Affinity.
Affinity re-examined its approach after the press caning it took over Colorado, said the LP source.
“It did cause a lot of soul searching and they took it to heart,” said the LP. “There are still issues and questions to monitor. But at this point there hasn’t been a catastrophic loss in confidence.”
Editing by Michael Flaherty, Lincoln Feast and Neil Fullick