Private Equity KeyTrends
June 18, 2013
A concise fortnightly distillation of key private equity news, with links to noteworthy PE articles and studies, edited by Palico – The Online Marketplace for Private Equity LPs, GPs and Advisers
“POTENTIALLY SEISMIC NEWS FOR THE PE MARKET” – that’s what Fortune’s Dan Primack calls cancelled debt refinancings for Madison Dearborn-owned Yankee Candle and Asurion. He observes that the possibility of rising interest rates – what apparently scotched these two deals – isn’t just “a Madison Dearborn issue. It’s an industry issue. It’s possible that Big Ben [Bernanke, chairman of the U.S. Federal Reserve] won’t announce tapering of the Fed’s” quantitative easing program at a press conference scheduled for 2:30pm EST, Wednesday, or in the near-term, “but the debt markets seem to think he will.” Primack warns that private equity “has been propped up by artificially low interest rates,” while Jim O’Neil, Bloomberg View columnist and former chairman of Goldman Sachs Asset Management, tells investors to brace for “turbulence, especially for assets that have moved far above reasonable valuations.” Yet there are signs that last year’s high PE purchase prices are moderating. The S&P Capital IQ figures in the Q1 report from limited partner market leader CalPERS show average prices fell to 8.4x EBITDA in Q1 2013 – the ten-year PE average – from 8.7x in 2012.
PE FIRMS ARE HOLDING ON TO THEIR INVESTMENTS LONGER THAN EVER. That is the conclusion of a pair of studies: PitchBook’s 2Q 2013 PE Company Inventory Report, which covers the U.S., and Ernst & Young’s Myths and Challenges European PE exits report. The U.S. report shows that the average hold time for a portfolio company in the U.S. now stands at 5.4 years, up from just 3.5 years in 2007. The Ernst & Young sample shows a record hold period of 4.7 years for PE-backed companies exited in Europe last year. It notes that at 2012’s annual rate of 61 European PE exits, it will take 13 years to clear portfolios. Meanwhile, the European Private Equity and Venture Capital Association’s “Quarterly Activity Indicator” shows that PE divestment pace rose in Europe in Q1 2013, while investments and fundraising declined.
“LPs TURN TO THE SECONDARY MARKET TO KILL PROBLEM PORTFOLIOS,” writes Pension & Investment’s Arleen Jacobius. “Investors are starting to see the emergence of end-of-life solutions” for an estimated “1,200 private equity zombie funds worldwide with total unrealized assets of about $117 billion.” Zombie’s are pre-2006 funds that still hold assets, run by GPs who collect management fees, but with little prospect of raising follow-on funds. “Investors are banding together on the secondary market to send zombies to the grave. Close to one-third of LPs surveyed by Preqin sold interests on the secondary market in order to exit poor performing funds,” notes Jacobius. “Deals include buying the holdings of investors that want out and creating a new fund, with the same holdings, for investors that want to let it ride.” Global fund adviser “Triago estimates that there are more than 2,000 companies that remain in PE funds from the 2000 to 2005 vintage years” in Europe and North America alone.
GROHE, THE FIRM THAT SPARKED THE INFAMOUS “LOCUSTS” QUOTE, joins a significant number of private equity-backed “German companies that have announced an intention to list in recent weeks, including Deutsche Annington, the property group and Kion, the fork lift truckmaker,” reports the Financial Times. Grohe, Europe’s largest bathroom fittings maker, is contemplating an initial public offering that would value it “at nearly E4 billion,” 2.6 times the price paid by TPG and Credit Suisse to acquire it in 2004. The “debt-funded purchase triggered a now infamous claim” by Franz Müntefering, the then head of Germany’s ruling Social Democratic party, “that PE companies were no better than ‘locusts.’ But in Grohe’s case the politicians who viewed PE groups as asset-strippers were proved wrong. Following a restructuring, Grohe navigated the financial crisis without cutting jobs and has since greatly increased its product range and rate of innovation.”
HERE’S AN ELOQUENT EXPLANATION OF PE COMPLEXITY & APPEAL. In this Q&A with Institutional Investor magazine, Eric Upin, chief investment officer of leading U.S. asset manager Makena Capital Management, dissects the difficulties of tracking fragmenting investment choices and explains why private equity is attractive across economic cycles.
THE GROWING POWER AND ATTRACTION OF PE CREDIT STRATEGIES clearly comes through in this 6,800-word profile of Blackstone Group’s GSO Capital by Institutional Investor magazine’s Julie Segal. The private funds lending operation, purchased by Blackstone in 2008 for $1 billion, has seen its assets grow “fivefold” under its parent to $58 billion. “Bennett Goodman, the 56-year-old ‘G’ in GSO,” tells Segal, “banks want to syndicate risk. We, on the other hand, want to own risk.” Brian O’Neil, chief investment officer of the $9 billion-in-assets Robert Wood Johnson Foundation, one of GSO’s first investors, observes: “GSO and others like it, with their ability to make commitments, have more market power than ever.’” Indeed, GSO “is preparing to be a buyer when rates rise and long-only mutual fund managers have to sell bonds to meet investor redemptions.” Concludes Segal: “The new power brokers in the financial industry are investors like GSO.”
SELLING PE FUNDS TO RETAIL INVESTORS IS GAINING MORE STEAM. Bloomberg reports that Blackstone Group “is planning a mutual fund-type offering” for later this year “as the world’s biggest alternative asset manager joins firms from Carlyle Group to KKR & Co. in efforts to attract individual investors.”
PE’s USE-IT-OR-LOSE-IT CHALLENGE IS BIGGER THAN YOU MIGHT THINK. Tax consultancy Rothstein Kass polled 215 private equity general partners this year for their latest Private Equity Outlook report and found that almost a quarter of the GPs might face an “invest-it-or-return-it situation” this year “as they near the end of their contractual periods with investors with cash still on the books.” Another surprising finding: “nearly half of those polled will offer deal-by-deal structures to attract new capital.”
FOR A BROAD VIEW OF LIMITED PARTNER ATTITUDES, check out Coller Capital’s Global Private Equity Barometer. The latest installment of the biannual survey polled a diverse global group of 140 LPs. Among key findings: overall target allocations to private equity are rising, but one in three LPs are slowing the rate of new commitments to PE, due to the record volume of unrealized investments in general partner portfolios, while one in ten are offloading PE fund interests on the secondary market. The survey also found that a third of LPs plan to increase their target allocation to PE credit strategies over the next year, with just one in seven decreasing their allocation. Over half of the LPs surveyed have PE interests in China and India, with many singling out Indonesia and Malaysia as emerging markets where they will significantly boost investments over the next three years.
“DO PRIVATE EQUITY FUNDS GAME RETURNS?” That’s the title of the latest study attempting to gauge the fairness of PE fund valuations. Steven Kaplan of the University of Chicago, and co-authors from the University of North Carolina at Chapel Hill, Gregory Brown and Oleg Gredil, find that managers do artificially inflate values, but that “little manipulation of net asset values goes unnoticed by institutional investors. Some GPs of poorly performing funds appear to game returns in a last ditch effort to raise a follow-on fund.” But “they are unsuccessful in so far as those firms are ultimately unable to raise a new fund.” In contrast, the researchers “find evidence of conservatism among the GPs of the best performing funds.”