A PREDICTED “BONANZA” OF PE-BACKED DEALS “FAILS TO MATERIALIZE,” proclaims the Financial Times. Despite “abundant credit, buoyant stock markets and mounting cash piles in buyout funds,” private equity purchases of portfolio companies dropped 11 percent to $82 billion in the first three months of 2014 versus the same period last year. “Ironically, by rushing to take advantage of high valuations on the stock markets to list companies and return cash to investors, the private equity industry has deprived itself of of deal flow” from secondary buyouts – transactions where one PE firm buys an asset from another PE firm. Also companies not owned by PE are choosing to list on the stock market, or re-finance at near-record low rates, rather than accept relatively low offers from private equity firms. Corporate groups – whose coffers are bulging – may have to significantly increase the acquisition of peers to kick-start the kind of restructuring and spin-off activity that could lead to more attractive pricing and greater deal volume for private equity purchasers.
CalPERS WANTS TO FURTHER CUT ITS PE TARGET ALLOCATION TO 10 PERCENT of its investment portfolio, with “staff very cautious about attempting to deploy too much capital,” notes an agenda item to be submitted for approval at the public pension fund’s May 19 investment committee meeting. CalPERS sliced its PE target to 12 percent from 14 percent in February, after the impact of record private equity cash distributions and soaring stock markets sharply reduced its exposure to the asset class. PE is “where conditions are of the greatest concern to staff,” states the document, pointing out that commitments would have to rise to $10.5 billion annually, from an anticipated $6 billion, to hit the 12 percent target by 2016. The typical PE purchase price multiple is at a near-record 9.5 times corporate cash flow versus a “long-term average” of 8.1 times, according to CalPERS. Undrawn committed capital is close to an all-time high and current conditions continue to encourage unusually large volumes of PE sales and cash distributions.
“THE SECRET TO SUCCESSFUL PE INVESTING IS SPECIALIZATION,” contends a Forbes column written by Palico founder Antoine Drean. Buyout “fund managers had some $400 billion in unspent capital at the end of 2013 or 2.8 times the value of the deals they successfully concluded last year. That huge supply of capital explains why buyout managers are increasingly focusing on particular sectors and geographies where they have strong track records, real expertise and hence few serious competitors. It also explains why a growing number of private equity managers are developing expertise in less traditional areas where there clearly isn’t enough capital to satisfy demand. Some of the better known categories where capital supply is short of demand include non-core or distressed debt, energy, real estate, mining and shipping.” To achieve the “promise of double-digit returns, fund managers and investors alike need to look beyond plain vanilla buyout investing,” concludes Drean.
THE U.S. SECURITIES AND EXCHANGE COMMISSION TURNS ITS ATTENTION TO PE. Reuters reveals the regulator “has put together a dedicated group to examine private equity and hedge funds,” run by former Amundi PE executive Igor Rozenblit and former Stark Investments hedge fund partner Marc Wyatt. “Ensuring transparency” will be a “top SEC priority.” More alarmingly, Bloomberg writes that an SEC review of PE, which began after the 2010 Dodd-Frank law required regulatory oversight for the asset class, has found that “more than half” of some 400 examined PE firms “have charged unjustified fees and expenses without notifying investors.” Barry Barbash, a senior PE lawyer at Willkie Farrr and Gallagher in Washington D.C. tells Bloomberg: “A lot of practices, in the eyes of the SEC, raise conflicts. The SEC wants those conflicts aired out and wants certain practices ultimately changed.” A peHUB article notes that the SEC is also looking at PE co-investments, but says that “a hard line governing co-investing” is “unlikely.” The biggest impact of the new SEC attention is likely to be greater PE transparency, not a wave of lawsuits.
HERE’S ANOTHER POSITIVE SIGN FOR EMERGING MARKETS PE. Using the occasion of its first investment in the Middle East – the purchase of a controlling stake in Dubai-based aviation software solutions company Mercator – respected PE pioneer Warburg Pincus says it’s ramping up emerging markets investing from its $37 billion in assets under management. “We are looking beyond the core euro-zone markets into the rapidly growing emerging markets around Europe for investment opportunities,” Joseph Schull head of Warburg Pincus in Europe tells Bloomberg. He adds: “Africa is the next big frontier in PE and we are spending an increasing amount of time investigating opportunities in that region.” The article cites a range of recent private equity acquisitions in both the Gulf and Africa and notes generally that capital is flowing “back into emerging markets.”
“A PRIVATE EQUITY TITAN WITH A NARROW FOCUS” BEATS THE COMPETITION “Vista Equity Partners, a firm with $8 billion under management,” has compiled an unrivaled record buying, improving and then selling enterprise software businesses, reports The New York Times DealBook. Vista’s speciality has delivered investors “a staggering 31 percent average annual rate of return” since its founding in 2000 by chairman and chief executive Robert F. Smith, a former Goldman Sachs investment banker and “one of the few black private equity titans.” According to Smith, both specialization and a lack of preconceived notions when hiring are key to success. Using a personality test developed by IBM and refined by Smith “that gauges technical and social skills” as well as “interest in the arts and humanities,” Vista assembles a decidedly unusual workforce” at the fund group and at its portfolio companies. One top salesman at a portfolio company used to be a roofer while a colleague is a former pizza deliveryman. “Many of these workers are less expensive than their better-credentialed peers” and they are “often more driven to succeed.”