Uncertainty Reigns In Private Equity by Bailey McCann, Private Equity Strategies – Opalesque
Listed private equity mega-firms like Carlyle, KKR, and Apollo have all been in the news recently for engaging in share buybacks. The practice is common for public companies that want to improve their share price by reducing the number of available shares. Buybacks can come in handy if share prices take a tumble, or a company finds itself in a lull, but the case for buybacks with listed private equity firms is a bit trickier.
Private equity GPs make a name for themselves on their ability to buy companies and create value in the form of earnings growth. So what does it say when guys who are in the earnings growth business have to prop up their own share price? Ostensibly, private equity firms should also use the cash they have on hand to invest in companies, and their own funds. If you look at all of these factors together, the optics of share buybacks for public private equity are a little dicey.
Yet it is equally bad to be in Carlyle’s position, for example. Carlyle’s share price hit a historic low already this year and doesn’t look like it will rebound to previous highs on its own anytime soon. KKR has also taken a beating with share prices dropping approximately 50 percent over the past 12 months.
Sluggish M&A may be to blame. According to new data from Dealogic, leveraged buyout firms like Carlyle and KKR only did 116 deals in January, one of the lowest volume months in ten years. Exits are also down to start the year. Despite only a small interest rate rise at the end of last year, and stimulus efforts from global central banks, the credit markets are tightening up, and traditional private equity is starting to feel the heat.
Many GPs are now merely hoping to match last year’s deal flow, but that may be difficult if investors are struggling to put financing packages together that are essential to get deals done. According to data in the 2016 Preqin Global Private Equity and Venture Capital Report, GPs say that in addition to difficult financing, it will also be challenging to find deals to do at all. North American firms are particularly concerned with valuations, which have been steadily creeping up over the past two years. Some 56 percent of respondents in Preqin’s survey of GPs cited pricing as their most important challenge for 2016.
Data in the report shows that there is some $435 billion in dry powder waiting to be deployed after 2015’s stellar fundraising year. But, data from accounting and advisory firm BDO shows just how conservative GPs plan to be in the year ahead – 95 percent of the firm’s surveyed in BDO’s study say they plan to do five deals or less in 2016. That may explain why some of the largest firms feel as though they have cash on hand to do share buybacks, especially if they can’t find any place else to put the money.
That raises the question, though, what lies ahead for private equity at least in the near term? With a whole slate of new funds all dressed up and with nowhere to go, investors in listed private equity may have to put up with buybacks – at least in the US. Elsewhere, the BDO survey suggests that European fund managers are taking a more opportunistic view. They expect more cross-border transactions than their US counterparts and aren’t as concerned about valuations. But, those European GPs will have to contend with local economic weakness of their own.
There is no doubt that uncertainty reigns in private equity at the moment. For investors in the asset class, 2016 may prove to be a renewed opportunity for a close look at manager skill as well as true value creation both in the firm and portfolio companies.
Dealmaker Q&A: Cyrus Investment Management Goes For Fund 2
UK-based Cyrus Investment Management has launched its second fund focused on investing in precision engineering firms in the UK. The firm focuses in on specialist engineering turnarounds and has steadily been building a track record of finding solid companies for its first vehicle.
Fund 2 will employ the same strategy as the debut fund – identifying undercapitalized and undervalued precision engineering businesses in the UK that are suitable candidates for “growth investment.” Cyrus’ growth strategy includes a range of options from injecting new capital, to replacing management, products or markets in an effort to improve the profitability of these companies.
“Traditional private equity doesn’t hit this part of the market, there is a strong opportunity set here to build these companies and expand their footprint globally,” explains Peter Schwabach, Managing Partner of CIM in an interview. He adds that the average holding period for one of these turnaround companies is a minimum of three years. Once they are ready for exit, the firm is looking to trade buyers, rather than secondary sponsors to sell to.
Precision engineering is an industry with high barriers to entry, and a significant consumer base. The aerospace, defense and security industries all rely on precision engineering companies for their parts and a solid majority of those companies are based in the UK.
“Businesses in this industry have high barriers to entry because of the sheer number of certifications you have to have to be able to provide services to defense and aerospace. That gives companies with these certifications a significant advantage,” Schwabach says.
The UK is a world center of excellence for this type of work and has some 1,500 companies making up the industry. The majority of those companies are small to medium-sized enterprises with values in the range of one to five million pounds. Historically, these companies have underperformed their larger counterparts within the country as a result of undercapitalization and an on-going inability to access capital.
Individually these companies are attractive as potential investments as they retain significant unencumbered assets: machinery, stock, skilled engineering work forces, proprietary industrial designs and accreditations as well as embedded accredited relationships within the global industrial companies they service. Strategically aggregated under single management and sold as a single business they offer the potential for investors to make a significant return on their investment.
“The businesses we are targeting with this fund are on the high-value end of the engineering market. In some cases, margins can be as high as 40 percent,” Schwabach says.
The goal for selling them will be to merge small companies into more sustainable – and more profitable – larger entities that can compete on the global stage. According to Schwabach, by doing that jobs will be saved, as will an industry core to the British economy.
Regs Watch: Brief Updates on Changes in Regulation for Private Equity
As journalists like me and lawyers have written ad nauseum, new and ever more regulations are in the pipeline for private equity and alternatives as a whole. Here we will hit on some of the cases of note and provide links to new guidance over the past month.
CVC lawsuit brings private equity’s gender imbalance back in the spotlight
A sexual discrimination lawsuit against CVC Capital Partners has brought fresh public scrutiny to issues of gender in the private equity industry. Read more at eFinancial-News.
New Year: New Regulatory Developments Affecting Managers Of Hedge Funds, Private Equity Funds And Other Private Funds
Attorneys at Proskauer have done a round-up of all of the new regulations implemented for private funds managers throughout 2015. It was a busy year to say the least! Rules will impact private equity, hedge funds, and real estate. Read the full roundup here.
The Cayman Islands Financial Services – Regulatory Framework
Cayman has made changes to several of its financial regulations in an effort to catch the eye of European regulators as they make decisions on the future of passporting for offshore funds. Read about the new developments here.
Disruption Causes Seismic Shift For Private Equity
A new EY report looks at the impact that regulatory and compliance changes have had on the private equity industry.
Private equity: Extension of MiFID II application date
The European Commission has proposed a one year extension to the application date of the MiFID II legislative package. This will likely be a significant benefit to GPs which have been struggling with implementation and ensuring compliance. Read more about what the extension might mean here.
SEC Provides Warning on “Accredited” Investors:
Even though the US Congress has expanded the defintion of what makes an individual an accredited investor, the SEC says it will be paying close attention to who funds admit as subscribers.
LPs want PE managers to improve the level of reporting transparency
It’s a constant refrain, but investors still aren’t pleased with the level of transparency they receive from GPs. Read more about new demands on managers.
AMAC Tightens Regulation On Private Investment Fund Sector
AMAC, China’s self-regulatory body is cracking down on private fund managers and is imposing a stiffer regulatory regime. Read more about it here.
Taking the Guesswork Out of Private Equity Fees
ILPA has released a set of new templates for investors aimed at putting clarity around private equity fees. Will managers take note? Read more here.
TPG nears $10 billion private equity fundraising close
Reuters is reporting that TPG is nearing a close on its latest mega-billion dollar fund. The fund has been in market for two years and signals a bit of a comeback for TPG as a firm, and leveraged buyout private equity as a strategy. The new fund will rely on TPG’s core buyout strategy, and will be part of its flagship funds line.
TPG has had to make the case to investors that it is still a strong firm, after raising a $19 billion fund in 2008 and making several bad bets. Since then, the firm has had several exits and appears to be back on top.
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