November 23, 2017
– Why High PE Purchase Prices Don’t Matter (All That Much)
– Calpers will Review ‘Bigger, Fewer’ PE Investment Approach
– It’s Getting Harder to Rely on Top Quartile Persistence
– PE Doesn’t Like U.S. Tax Reform, But That May Change
– Five Private Equity Predictions from Carlyle’s David Rubenstein
– PE KeyTrends Quick Question Results
WHY HIGH PE PURCHASE PRICES DON’T MATTER (All THAT MUCH). This is the theme pursued by Anthony Tutrone, Neuberger Berman’s global head of alternatives, in an intriguing guest column in Private Equity International. One reason Tutrone says Neuberger Berman is upgrading “its view on private equity relative to many other asset classes,” despite historically high acquisition prices, is sound capital structures. The cash flow of the typical PE portfolio company is 2.4 times greater than its interest payments and loan terms are more flexible than a decade ago due to the rise of covenant-lite debt. Furthermore, at a time when stock prices for publicly quoted companies are typically higher than purchase prices for private companies, Tutrone notes that there is more potential for PE managers to generate value due to their activist approach to improving operations through strategic reorientation, acquisitions, or investment in markets and products.
CALPERS WILL REVIEW ‘BIGGER, FEWER’ PE INVESTMENT APPROACH. WSJ Pro reports that Calpers is evaluating whether a strategy announced more than two years ago to cut the number of private equity fund managers it works with to 30 from 100 is working. According to Calpers adviser Meketa, there is no clear evidence that the giant public pension fund has benefitted from fee discounts as a result of investing more money with fewer managers. Moreover, Mekata observes that Calpers’ reliance on a restricted list of 30 managers may make it difficult for Calpers to reach its target of investing $4 billion annually in private equity. Yet new doubts about Calpers’ strategy are unlikely to have much of an impact on the broad trend of PE managers cutting back on the number of fund managers they invest with, given generally positive reviews of the practice and seemingly related improvements in performance.
IT’S GETTING HARDER TO RELY ON TOP-QUARTILE PERSISTENCE. Axios columnist Dan Primack reports on soon-to-be-released research from MIT economist Antoinette Schoar that shows that in recent years only 12 percent of top-performing private equity managers have had back-to-back top-quartile funds, versus 28 percent prior to 2004 and 31 percent prior to 1999. This helps explain a variety of current trends, including the expansion of limited partner staffs, the increasing willingness of LPs to invest in first-time funds, and the growing popularity of investing in less crowded speciality niches within private equity. Put simply, less reliable top-quartile persistence puts a greater premium on LP fund selection skill and resources.
PRIVATE EQUITY DOESN’T LIKE U.S. TAX REFORM, BUT THAT MAY CHANGE. The Wall Street Journal points out that while a number of U.S. tax reform proposals are stirring opposition from PE, bills in the House of Representatives and the Senate still have a long way to go before becoming law. Already, the House bill “is more positive for the industry than a previous plan” and there is hope of more concessions. One objection from PE is that the House bill “would limit business’ ability to deduct interest from their taxes with a cap of 30 percent of earnings before interest, taxes, depreciation and amortization.” But that cap is offset by tax reform’s priority: reducing corporate rates to 20 percent from 35 percent. With a few tweaks – say replacing a portion of leveraged debt with preferred equity – current tax reform proposals could actually already be positive for PE.
HERE ARE FIVE PRIVATE EQUITY PREDICTIONS from Carlyle Group co-founder David Rubenstein, made in a speech at last week’s SuperInvestor conference in Amsterdam, and reported by WSJ Pro: 1) Sovereign wealth funds and large non-U.S. national pension funds will replace U.S. public pension plans as the biggest source of private equity capital; 2) The U.S. will cease to dominate the supply of capital to private equity, as PE investment is spread more evenly between developed and emerging economies; 3) Over the next 10 years investment in private credit will become as big as investment in traditional private equity; 4) Larger PE firms will increase their market share of fundraising due to their greater resources for sourcing capital; 5) Extra-long-term private equity funds with investment periods of 10 to 15 years, as opposed to the current norm of 5 years, will become commonplace.