PE Key Trends Blog

Private Equity KeyTrends #17 – September 24, 2013

Sep 25, 2013 11:09:49 AM

Tags: keytrends, newsletter, Palico, PE KeyTrends, private equity, V2

With this issue, Private Equity KeyTrends poses readers one thought-provoking question per item, linked via click to a return Palico email. Next week, we’ll publish a selection of answers to each question. If you want to be identified, tell us, otherwise answers will be anonymous. We’ll also include brief summaries of overall reader reactions. Let Palico and your peers know your opinion!


“BUYOUT GROUPS HAVE REFINANCED A RECORD AMOUNT OF DEBT” this year, reports the Financial Times. In the U.S., buyout firms “have renegotiated more than $110 billion of their companies’ existing debt,” up 25 percent from all of 2012. “In Europe, refinancing volumes have soared 60 percent to nearly €10 billion, the biggest amount since 2007.” Meanwhile, another FT story points out that “many of the putative victims” - almost all of them private equity-owned companies - of the $100 billion “wall of debt” that was supposed to “mature about now” have avoided it thanks to years of cheap debt tied to the U.S. Federal Reserve’s program of quantitative easing. “At the start of this month, the peak year for maturities had moved back to 2019.”


What’s your opinion? Could a higher cost of funding than today’s historically low interest rates lead to a decline in asset prices and higher deal volumes?

“SUPERCHARGED GROWTH IS CHANGING THE RISK-REWARD DYNAMIC” IN VC, claims a peHUB story. “The current generation of high-achieving startups is setting new records” by “acquiring users at an unprecedented clip” and by “seeing valuations rise faster and higher than ever before.” That’s “doling out enormous return multiples” for gifted early-stage venture capitalists. Another “trend helping early-stage VCs is the lower capital requirements for internet and software startups.” Areas that “can churn out multiple monster returns” for well-chosen portfolios include “consumer internet, cloud computing and enterprise software.” Reflecting similar optimism, Reuters writes that “Twitter may kick-start a consumer-tech IPO train.” After a “messy initial public offering” from Facebook “more than a year ago, the buzz in technology investment has mostly surrounded companies serving businesses rather than consumers – a situation Twitter’s imminent debut could help reverse.”


What’s your opinion? Are we on the cusp of a golden age for venture capital investing?

PSST, EVERYONE, CHINA’s MAINLAND IPO MARKET MAY OPEN SOON! That’s the gist of a South China Morning Post story that says the relaunch of China’s main initial public offering market is “expected in the very near term, an expectation that has been reinforced by recent media reports from the mainland that regulators were ready to announce a detailed plan to reform stock offer procedures.” The result of the 11-month shutdown of the mainland IPO market by regulators: “many private equity firms have seen internal rates of return plummet from more than 30 percent to single digits.” An active pipeline of mainland IPOs could help improve those returns. In a Private Equity International article, Joseph Bae, managing partner in Asia at KKR & Co., says the “dislocated environment” in China and in other emerging markets makes it a particularly good time to invest in PE. Company “valuations are at the lowest we’ve seen in the past 5 to 7 years,” he notes.


What’s your opinion? Is now the time to invest in emerging markets, particularly in China?

THE WORLD’S LARGEST SWF IS PRESSURED TO INVEST IN PE, but how should it proceed? The Financial Times reports that Norway’s center-right conservatives, “the dominant party after this month’s election, are in favor of letting” the country’s $760 billion Government Pension Fund Global, the world’s largest sovereign wealth fund, “invest in private equity and infrastructure,” but that there is no consensus on how that should be done. Amidst many ideas, the FT highlights the intriguing proposals of Re-Define, which has compiled an 84-page report on the fund’s future. Re-Define’s bottom line: Norway’s SWF, which has 94 percent of its assets overwhelmingly in developed market stocks and bonds, can lower risk and increase return via illiquid emerging markets investments like private equity. The fund follows “a conservative strategy on the surface, but when you boil it down, it is a concentrated bet on the future of OECD countries,” Re-Define director, Sony Kapoor, tells the FT. He adds: “The profitability in fast-growing emerging markets does not come from investing in public markets. By that stage the gains have gone. It comes from private markets.”


What’s your opinion? How much of a portfolio should be invested in emerging markets and should it largely be via illiquid investments like private equity funds?

FOR SWFs, WORKING WITH EXTERNAL GPs “IS AN OPTION, NOT A NECESSITY and the balance of power has shifted unmistakably,” writes Institutional Investor magazine’s Loch Adamson in a piece that examines the growing penchant sovereign wealth funds show for relatively low-cost PE exposure via co-investment, direct stakes in general partner firms and investing directly in companies. “I see this trend toward direct investing as a continuous, long-term development,” Martin Halusa, CEO of London-based PE firm Apax Partners, tells Adamson. According to Halusa, “in the earliest stages of the post-crisis co-investment trend, some of the most autonomous SWFs were seeking to deploy 80 percent of their PE allocations in co-investments and 20 percent in direct investments. ‘Now some are running a 50-50 split and some are even 80-20 the other way around.’ ” Adamson implies that the best way for external managers to capture the growing amount of SWF capital going to PE maybe to seek investment at the management company level, where SWFs can provide seed money for permanent capital vehicles in exchange for carry.


What’s your opinion? Is there a limit to how much large sovereign wealth funds and pension funds can invest on their own before their returns start to suffer and regress to the mean?

PE FIRMS ARE “VYING FOR A SLICE OF SPAIN’S €1.5 TRILLION LENDING MARKET,” with KKR & Co. and Apollo Global Management leading the charge, as Spanish banks abandon customers they “deem too risky a bet,” writes Bloomberg. PE firms have raised record sums for distressed credit strategies in Europe and Spain looks like the most promising market for putting that money to work. “Record defaults” and Spain’s “26 percent jobless rate make” Spanish banks “reluctant to lend.” Moreover, “the Bank of Spain has tightened rules on how banks treat €208 billion of refinanced or restructured loans, creating opportunities for private equity. The changes mean it’s ‘more expensive for banks to keep lending to sub-optimal or sub-performing businesses,’ Mubashir Mukadam, London–based head of European special situations at KKR, tells Bloomberg. Yet the high rates attached to direct loans from PE firms, typically “8 percent to 15 percent,” may keep demand for those loans subdued. “ ‘The returns being sought are high, and there aren’t many companies that can bear these costs,’ ” says Alberto Garcia Elias, a managing director at March Capital Markets in Madrid.


What’s your opinion? Can PE successfully put to work the large sums of money chasing direct lending opportunities in Spain and Europe?

“BURDENSOME, COSTLY, INEFFICIENT AND INFLEXIBLE” - that’s how “two key Republicans” in the U.S. House of Representatives describe Securities and Exchange Commission examinations of private equity managers, according to a Reuters story that quotes their letter to SEC Chair Mary Jo White. “House Financial Services Committee Chairman Jeb Hensarling and New Jersey Republican Scott Garrett, who chairs the capital markets subcommittee,” added that “subjecting” private equity managers “to the examination process does not appreciably further the goals of investor protection or financial stability.” Prior to the 2010 passage of the Dodd-Frank Wall Street reform law the SEC did not have the authority to regulate PE funds. Notes peHUB’s Chris Witkowsky, SEC “registration comes with the very real possibility of facing an SEC examination which, if you believe some GPs’ descriptions, is not much more pleasant than your average root canal.” Regardless of one’s opinion, Witkowsky concludes, both the SEC and managers “have made significant investments in this new system of oversight, and SEC registration has become a way of life in the industry. It may be too late to go back.”


What’s your opinion? Out of the various new private equity regulatory regimes in the world, is there one that should be singled out for logic and good sense?

HERE’S WHAT IT TAKES TO PAST MUSTER WITH A TOUGH LP. In this 9-minute Privcap video, Peter Von Lehe “managing director at Neuberger Berman explains the firm’s process for evaluating GP track records and how to survive in a ‘Darwinian’ fundraising market.” Lehe also explains why “in some cases” he’s open to investing with general partners who strip out deals from their track records.


What’s your opinion? If you are a limited partner, is there a litmus test that you value over others when it comes to vetting general partner track records?