 Hey guys, it's MJ the student's act tree and This is going to be a new little series called. Let's talk finance and it's going to be for students who are studying subject CA1 ST5 SA5 and also SA6 as well as anybody else who is interested in the topic of finance and what we're basically going to be doing is going through a question and Discussing the answer That's it. It's going to be very simple And yeah, I hope I hope you guys enjoy it if it gets a lot of views. I'll make a few more But yeah, let's get into it So this is question one from a fellowship exam and it says that you are the fund manager of a private equity fund Based in South Africa that invests in countries in the rest of Africa You are considering a proposal from a small engineering firm based in a neighboring country The firm wishes to expand its operations in a frontier African country that is on infrastructure spending drive The firm proposes that the expansion be financed through a rights issue and that your fund invests Now I'm not going to do part one because that's just book work And I'm not going to do part two because we're not going to have enough time I mean sorry part three because we're not going to have enough time But let's let's do part two which is discuss the factors that you would take into account in considering the proposal And bear in mind is worth 20 marks, which means you're probably going to have to write down 40 yes 40 Different points or 40 ideas so Let's get to it because I think we could all come up with 10 quite easily But to come up with 40 is a bit of the challenge Anyway, let's just focus in on what this question is talking about I mean the keywords that jump out to me are private equity small engineering firm And infrastructure spending so those are the three things I want to focus on as well as bearing in mind that it is African so Let's just get some mental images before we begin Um We're looking at private equity private equity is when people invest in companies that are not necessarily on the stock market um They're normally used to start a company up, but that is not their only purpose they can come in at various stages of the business and Basically, like I said, it's any investment in a company that isn't listed on the stock exchange So in this case, we're going to be seeing that this company is already established. They're small But they're going to be needing some extra capital to finance some new ventures We are based in Africa, which is the best continent in the world and We're going to be looking at some of the unique challenges and opportunities that are in this great continent And remember that the final theme or the whole thing here is on infrastructure spending. It's a small engineering company So let's get into it And I think the the important part to start with these type of questions is to realize that Investments is all about risk and reward I am willing to risk my money by investing in these various projects because I expect a reward If I wasn't going to get a reward, I wasn't going to do it And how can I expect a reward if I'm not prepared to take a risk? So the two go hand in hand So let's look at it. We've got you. We've got a private equity company They're they're out there to to seek a reward We've got um an engineering um firm that you know needs some cash in order to to develop And this deal is going down in Africa Now, let's say we are going to consider purchasing this Um, we need to ask ourselves. Well, what price is required because It could be great but too expensive and then it's not worth it or it could be quite lousy But at a very good price, it might be worth the risk So in order to evaluate the risk and the reward the first thing we need to do is consider the valuation And I know this is where it gets a little bit boring because you know, we have to go to our accounting ratios We need to look at what is the expected growth, you know, how much Money do they want? How much are they going to give us? We also want to look at just the balance sheet strengths, you know, what are the the future earnings What is their gear ratio? How much debt do they have? What is their dividend policy? Are they even giving out dividends? What is their liquidity situation? How are they going to use this additional capital, you know, whether all the project details And how does this compare to the rest of the industry? So With regards to valuation, you can see there's a lot of stuff you can go down But remember we need to discuss 40 points and we don't want to just focus too much on the valuation There is a lot to talk about. So yes, we can maybe get in some nice five marks here Or two and a half but Let's let's move on. So but the very important is to value this whole investment Um, we also want to consider who are our co-investors. I mean who else Is going into this project? I mean, are there some big names behind it? You know, which would make it more attractive or our competitor private equity funds also going into it And we want to match their position, you know, what are who well, who are our co-investors, you know What experience do they have? What knowledge do they bring and what is their reputation and how is that going to influence our decision? We also need to consider the time frames. I mean looking at this project You kind of feel it's a bit of a long-term deal I mean, you're not listed on the stock market, which means you need to consider what are your exit strategies Um Like an investment like this is not going to be that marketable. I mean, you're not going to have a whole line of buyers Offering you every day for you know, your shares in this company So you need to consider the time frames. It is going to be quite long term Which means if liquidity is an issue Um, you look at what are the dividend expectations, you know, how long are you expecting to be in this project? How long until a dividends start coming out? How much do you expect those to be and for how long? So very important to draw your timeline and Yeah, just figure out when things are going to happen What you also want to do is you want to get to know this engineering firm a little bit better You know, you want to maybe meet with the guys say, hey, what is your business plan? You know, what what are they considering? Does their future growth depend on this expansion? Like is this project their, you know, their final thing? Like if this fails does their whole business go out? Um, you want to look at their track record, you know, what are the previous goals that they've set themselves and have they reached those? Um, you also want to consider who the current management team is, you know, their quality guys Have they got good experience and knowledge and degrees and all that type of stuff And then you also want to look at their order book. I mean, who is paying these guys? Um, you know, is it the government? Is it local municipalities? And are they very dependent on one or two clients? So if one government says, hey, hang on We don't want to build these new roads Will that destroy the firm because that is something you need to consider um The order book is very important with companies like this It would be better if it was diversified and you had lots of small clients rather than a few big ones Where if one left it could, you know, damage the entire business um You also want to look at external factors. I mean, how competitive is the the market there? What are the local economic prospects? I mean, if it's an African country that is growing rapidly Then, you know, a lot of spending will be done on infrastructure. So That's a good sign. You want to look at what are the available skills in the market? I mean, is this a country where there are a whole bunch of young engineers a whole bunch of, you know, master builders so that it's going to be easy to grow your workforce? Um, you're going to be looking at, you know, the country's rules and regulations How easy is it to do business in this country? Uh, you also want to look at the infrastructure I mean, what already is in place? Do they have railway and airports to get materials in and out? Um, do they have good telecoms and internet to, you know, just facilitate with communication? And what is your exposure to the government because remember your infrastructure? There is going to be a big government influence So you want to know what are the government's plans and I guess also what are some big private companies plans? With regards to spending and what is the expectations? Regarding that, I mean, you could also maybe talk about commodity prices How steel's at like, you know, quite low at the moment and that's quite good for infrastructure And oil's low so that's also good. So you could also talk about commodity prices as well Um, coming back to the engineering firm, you want to look at their government and structure? I mean, are these guys conforming to the king three, um, standards? Um, is their accounting correct? You know, like are they doing it properly? Are they getting audited by a respectable firm, you know, so that the books are clean? They haven't been cooked and what you also want to look at is when you make your investment Is there a potential for you to be on the board or maybe have a board representative? You know, just to give your views and make sure, you know, everybody's views are aligned And also just to keep an eye on what what's actually happening Um, then of course, there's a lot to be said about risk I mean, you can score lots of marks by always talking about risk I mean, there's the political risk in Africa, you know, where's the current regime? I mean, is it an evil dictator? What are the rules and laws that he's imposed? Um, are their property rights? I mean, some countries they just take away Your land or they take away your business off you built into it Um, so you want to make sure that that's not going to happen And you also want to see are there like supportive policies that will, you know, Maybe provide a bit of an opportunity, you know, governments might be encouraging infrastructure Spending and give some subsidies or something like that Um, regulation always remains a risk. Um, you know, what are the current constraints it has on you? Like can you only, you know, bring in so many foreign workers? Do you have to hire so many locals? What are those type of things? And what are the potential future changes that could happen in the regulations? Um, there's also the exchange rate and that's on both countries. So the South African rent and whatever currency this country uses Both of them can be hit hard. Um, both of them can be devalued Or both of them can interact with each other in a different way So consider the exchange rate risk on both sides A lot of people just focus on one side of the exchange rate But it is a, you know, a coin does have two sides Um, you also can look at operational risk, you know, what happens if You know, it's a small engineering firm and the main boss gets malaria and quits or does or something like that So lots of key individuals What happens if there's fraud? What happens if there's governance failure? You know, all this type of stuff then of course there is liquidity risk Um, you locked in on this in the long run. Like we said, there's not, you know, it's not a very marketable asset Um, try not to repeat yourself though because you're only going to get remember We mentioned that a little bit earlier on and you're only going to get points for saying something once So best to move on to like another topic Another big thing to talk about is the ethical social and whole governance system Um, you know, how is corruption affecting business? What are the labor practices? You know, are the conditions safer workers? Um, are there any international sanctions on this country? You know, is the dictator got bringing in some issues? Um, this type of business that you're doing this infrastructure is it seen as positive or negative? I mean, if you're building a school that's considered positive if you're building like an oil well in a rain forest that's considered negative And also a big thing to consider with regards to this is What is the community's participation? You know, um, are you helping? The the locals is this uplifting the community? That's that's very important. It's very important. It's not always about the money It's about the softer things as well Although talking about the money, um, this investment is going to incur Probably quite a few costs. I mean, there's the initial negotiations Um, there's all the oversight that you're going to have required. You're gonna need a board member there um That's going to involve traveling costs and you know, it's it's going to get expensive So bear that in mind take that into consideration when determining whether or not to buy this So it's going to involve a little bit of a hassle, but hey, you're a private equity manager. This is your day job Speaking of private equity, uh, managers, let's finally discuss their issues and then we're going to conclude so Other issues that private equity guys are going to have to consider. What are the tax agreements of both countries? Um, does this deal fit with your mandate? I mean private equity has a whole bunch of investors themselves And you want to make sure that this is not breaching any of your restrictions or limits that you've put in like Maybe you're not supposed to go into this country or Maybe you've specifically said you're not going to go into these type of industries Or this is an amount that it's just too much for your firm to take on now and Again, you don't want to invest a lot into this country on this project And then that causes concentration exposure in that said country in that industry You want to look to make sure that this um Improves diversification and does not negate it if it's too large Um, also you want to look at the capital requirements. Like I said, if they're requiring a lot of capital And it's like 90 percent of your private equity fund That's going to be disastrous for your diversification because all your eggs are in one basket But if this is very small like just a drop in the ocean Is really worth all the effort of doing the research and sending board representatives and all that type of stuff So the size of your private equity fund is very important Also, what is this going to do to your liquidity constraints? Is this going to use up, you know, your lost bit of cash flow? Um, how is this going to change your position? And then finally you want to also consider like I said your your shareholders your clients You know, what are their expectations? You know, they've invested in you because they want to be exposed to Africa They want access to these type of investments and they kind of do have, you know, a high risk appetite Um, all depends on what your your positioning is. So do consider this and Yeah, think about that But that's all I kind of came up with. I mean, I basically went through the memo and maybe added one or two of my own points Let me know in the comment section below if there's any other factors that you would consider before you invested in an engineering firm in Africa, you know, doing infrastructure spending So, yeah, let me know in the comment section below and I hope you like this video if it was a nice way of doing it I'll do some more if this gets like, you know, five views and five thumb downs Then I'll take the message and I'll probably make other videos But I kind of like this idea Let me know if you want to see more financial videos where we take an exam question and we talk about it like we did now Thanks for watching guys. Cheers