FXBEACON: TENNIS | SAILING | FX | PRIVATE EQUITY
Seven years ago, my wife took the liberty of signing me up for a tennis team without my knowledge. She thought I needed a hobby to balance the demanding world of finance, which absorbed most of my time. After getting past some growing pains, I fell in love with the sport. Then, last year I embarked on another non-finance venture by taking up sailing. Along the way, I discovered striking similarities between the two sports, and the realms of foreign exchange (FX), and private equity. I encourage readers to pursue a hobby, despite what feels like having limited time. I promise it will increase the longevity of your career.
Tennis is a sport where athleticism does not always produce a win. Similarly, in Private Equity (PE) you can win with the right turnaround strategy even when a company is in an unfavorable industry or has had poor past performance. Let’s face it, buying low usually requires the asset to be out of favor! Like the leverage a tennis racket provides to a player, PE firms typically require the appropriate amount of debt to provide the right economics to its investors.
Sailing requires you to act quickly when the wind changes direction or risk an accidental jibe. Likewise, private equity firms must act quickly when a buying opportunity presents itself. Speed and accuracy are also necessary when it’s time to make capital calls and obtain financing for an acquisition. Timely delivery of funds is essential when the asset seller is in a different country that is not in the same time zone. These time zone differences can impact asset divestures where numerous investors are expecting prompt delivery of funds despite limited wire cut-off times.
It’s important for private equity firms dealing with international transactions to establish a relationship with a foreign exchange (FX) provider that can set up multiple FX and virtual bank accounts quickly for legal entities that often have just been established for a specific acquisition or divesture. Moreover, having a partner that is accessible 24 hours a day to deal with currency conversions and timely funding should be a requirement.
From a currency risk management perspective, private equity firms manage four different types of risk:
· Net investment risk, entails the equity portion of a collective portfolio of companies that have a different functional currency than the reporting currency of the fund. This exposure is longer term in nature and is measured in years.
· Portfolio company transactional risk, is company specific currency risk – revenue, expenses, CAPEX in a foreign currency. This exposure is medium term measured in months.
· Acquisition/Divesture risk, is addressed once the due diligence has been completed and a Letter of Intent (LOI) is issued. Hedging allows one to fix the purchase or sale price in the funds reporting currency and is imperative when making investor capital calls. This exposure is measured in weeks.
· Divesture valuation risk, pertains to a portfolio company that has currency risk that can materially impact EBITA. Once managing partners look to exit their investment, they will want to quantify this risk and factor in the expected multiple. If foreign currency can impact EBITA by $3MM over a 12-month period and the expected multiple is 10x, then one’s risk is $30MM, which can be hedged through various strategies.
Choosing an FX partner that has experience working with the unique needs of private equity, including the ability to underwrite FX credit risk at the fund and portfolio company level is paramount. Liquidity is a high priority for portfolio companies, which are often financed through an ABL facility, making FX credit on an unsecured basis the only option.
Unforeseen weather or a torn ACL are two risk factors in sailing and tennis. Fortunately, with proper preparation these risks can be mitigated. Similarly, to decreasing FX risk through hedging or reducing long term capital risk by owning companies in various industries and regions. There is going to be inherent risk in your professional career and the activities you pursue outside of work, but please don’t let that stop you from living! Get out there, avoid those unforced errors and don’t forget to duck when you hear, “Jibe ho!”