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The transformation of private equity - what's here to stay?

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Earlier this year, the number of private equity funds reached an all-time high. As investors look for higher returns, there is growing demand for this asset class.

But private equity has changed significantly in recent years. Co-investments and direct investments, as well as secondaries, have become increasingly popular ways of investing into private equity.

These trends, along with the emergence of megafunds, big data and how private equity can continue to add value were just some of the topics up for discussion at SuperInvestor 2018.

The rise of co-investment and secondaries

The rapid increase of co-investments and direct investments has been one of the dominant themes of private equity in recent years, and it was a trend that was here to stay.

“Co-invest is a strong, viable and permanent source of deal flow, and a key component of our private equity portfolio,” stated Allen MacDonell, Managing Director at Teacher Retirement System of Texas.

Michael Woolhouse Managing Director, Head of Secondaries at CPPIB held the same view: “Tactically we’re consistently putting out capital in co-invest. It’s our most valuable business, whether passive or active with joint governance. At the small end it’s a volume game, we harvest the no fee, and at the bigger end it’s a security selection game alongside our partners.”

Companies are staying private longer...That’s thanks to increased capital solutions, and the fact that founders are reluctant to rush into the public markets.

Once seen as an option only in time of urgent liquidity needs, the secondaries market has evolved to become a mainstay of the private market, with many now using it as a portfolio management tool. For the members of the panel, the evolution of the secondaries market was a welcome innovation.

Ruulke Bagijn, Managing Director, Head of Primary Investments at AlpInvest Partners, said that the evolution of secondaries was good news: “There is much more fund restructuring taking place where secondary buyers are taking assets out of funds. That’s a very welcome development. If you look back 10 years ago you had a lot more zombie funds that lingered on and became a drag.”

Companies are staying private longer, she added. “The average time between founding and listing used to be around three to four years, it’s now more like eight to eleven. That’s thanks to increased capital solutions, and the fact that founders are reluctant to rush into the public markets,” added Ruulke.

The increased demand for private capital had led to a whole host of new players in the market, which in turn could lead to a new type of conglomerate that hosts a whole pool of capital. But Ruulke was unconvinced as to whether this was a good thing.

Private equity is getting BIG

Twenty or so years ago the largest private equity fund was around $3 billion. Today, it’s more like $25bn, and that trend is only going to continue, according to the panel.

“The megafunds will increase even further, these are now companies that have value in themselves,” said Michael.

But he admitted that, previously, these large houses were often viewed with trepidation: “Our thinking has evolved a lot, it’s a lot more mainstream,” said Michael. “In the early days we liked single product firms, because it was hard to see what the benefits were to us of them raising another platform fund and another team, creating complexity in the organisation. But we see the benefits of franchise stability and that actually does benefit the money that we might have with them in one fund and platform.”

The disruption to many sectors wrought by digitalisation and technology has recently been a key investment focus for many in the private equity industry, but have they been able to take advantage of digital tools in their own business models?

A couple of members of the panel were in the early stages of testing big data solutions to help them with their investment decisions, which they felt could lead to a better dialogue between GPs and LPs.

Allen said that they were currently beta testing a software platform that would allow them to analyse aggregate portfolio trends. “It will help us have frank discussions with GPs as well as a better understanding of how our portfolio is being impacted by exogenous events,” he explained.

Building that kind of data platform was not easy, but was very valuable, added Michael. “How we capture the best information and use it effectively is one of our top agenda items as we build competitive advantage through better data.”

Value add in the digital age

The concluding remarks of the transformation in private equity session segued nicely into the first of the afternoon’s session on value add.

This panel agreed that leverage was no longer a key contributor to value creation. Nowadays, they said, value add was largely down to operational improvements and multiple arbitrage. The majority were focussed on EBITDA growth, though mostly through acquisition rather than the more expensive buy and build. And to generate that growth, they use both external expertise and in-house talent.

Selim Loukil, Head of Portfolio Support Group, Europe at Advent International said that, as deals had become more complex, it had become increasingly necessary to build a network of operational advisers – in HR, finance, sales, and procurement. “It’s the combination of sector expertise, change agents and a functional lens that creates value,” he explained.

Ten years ago, it was about finding the right CEO and leaving them to figure it out. Today, we increasingly work with our CEO to build a strong management team around them. 

Frédéric Stevenin, Chief Investment Officer & General Manager at PAI Partners emphasised the importance of investing in talent: “You have to ask do I have the right people to execute, and do I have the right team to sell the story for the next five years? It’s critical in our industry to make sure we have the talent,” he said.

Whether that talent was in-house or outsourced was a moot point, thought the majority of the panel, it all depended on the needs of that particular company. That said, Selim noted that the HR function in particular was increasingly being brought in-house. This was largely down to the fact that companies were becoming more services than asset-based.

“Ten years ago, it was about finding the right CEO and leaving them to figure it out. Today, we increasingly work with our CEO to build a strong management team around them. You ask what effectiveness you need and then consider if you have the capacity in-house or whether you need to outsource it,” he explained.

The same rules applied to whether you were talking about finance, procurement, or data science, agreed the panel.

Frédéric added that in-house or outsourcing, what mattered the most was “having proper alignment within ourselves and the management team, with the same views and objectives and a document to reflect that”.

There was the risk that too many cooks could spoil the broth, but Selim argued that this could be avoided by explaining to management teams upfront who does what: “It’s a divide and conquer approach, and it’s a lot about how you build trust in the first few weeks.”

Keeping up in the digital age

Every industry faces the threat of disruption – whether manufacturing from 3D printing or retail from ecommerce. How did this affect investment decisions?

“Disruption is only one theme among many,” said Robert Ramsauer, Senior Managing Director at Blackstone. “Private equity’s job, which is to identify robust companies, and leaders and innovators in their respective fields, hasn’t changed. Let’s not forget that even the disrupter can be disrupted,” he added.

“And let’s not also forget, added Frédéric, “that some of the things we haven’t focussed on in recent years, like fx, are now going to be at the forefront of what we are doing and volatility is something we have to take into account going forwards.”

But Selim concluded on an optimistic note, saying that when it came to value creation, the digital revolution could only strengthen private equity investments: “We can unlock even more value by applying digital tools to companies.”

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