More investors than ever before are allocating money to private equity. LP commitments are at record levels for the industry, but so are purchase price multiples, leaving many to wonder how much longer private equity has before the music stops? At the State of the Union Panel at SuperReturn East yesterday, delegates from some of the US' top private equity firms said they aren't that concerned about the frothiness in private equity.
"We have noticed that it is more expensive to do transactions right now," said Steve Pagliuca, Co-Chairman at Boston-based Bain Capital. "However, our return expectations remain unchanged. The key for us is finding companies that are transformable."
Gaining the edge
What makes a transformative deal? Pagliuca says that companies have to have some type of significant growth story. He cited examples including taking a company global or expanding sales. "We recently did a transaction where we did a merger of equals at the time of the acquisition. We were able to capitalize on the synergies between the two companies at the beginning," he added.
Jonathan Coslet, Chief Investment Officer at TPG Capital agreed with Pagliuca. "At the end of the day it's really hard to change companies," he said. "We have to bend the curve. I would argue that there are maybe a handful of top-tier private equity firms that can really change companies and do it well."
Coslet highlighted TPG's investment in Burger King as another example of a turnaround deal. "When we invested that company, it was a mess," he said. "But we were able to work with the franchisees and get things moving in the right direction. We changed the company significantly, that lead to the sale to 3G. 3G has already changed the company again and for the better. It's all about improvement."
Another way that top private equity firms have been able to gain the advantage and create value in their transactions is by capitalizing on informational asymmetries in the market. Panelists agreed that very often the information available about a given company is lacking. Firms that prevail typically work with industry experts before, during, and after a transaction, so that they can go into a deal well aware of issues in that industry as well as issues in a given company.
"We are constantly looking for unfair fights"
"We are constantly looking for unfair fights," said John Maldonado, managing partner at Advent International. "It's our job to create that uneven playing field so that we get to a twenty percent IRR. To do that you have to be deeply aware of what's going on in an industry and who the players are."
Shifting LP relationships
While competition for deals heats up and GPs start to rely more heavily on industry experts to create value, relationships with investors are also changing the private equity industry. Investors are looking at ways to cut costs and get a bigger piece of the action through co-investments and direct investments. That shift has led to some early blunders, but panelists note that some LPs have been successful by committing to the process.
"With co-investments the exceptions are the ones that do it well," said TPG's Pagliuca. "The LPs that are the best at it are the ones that have been investing with us for years. We are very familiar with them, they are very familiar with us and with the process. They understand that it takes a certain level of responsiveness and expertise. In some cases they can bring their own value to the deal and add capabilities we don't have, but again that's an exception."
GPs are also learning to deal with a more diverse investor base. As public pensions and corporate defined benefit plans have started to retreat, family offices, international investors and sovereign wealth funds have become more interested in the asset class. Panelists say that they welcome the diversity and that it will also add longevity to the private equity industry.
"We are focused on building a diversified LP base," said Advent's Maldonado. "We think there are a variety of funds that will replace DB plans, and we are interested in finding ways to work with new LPs. Ultimately, a more diverse group of investors is good for the industry."