behind closed doors - in association with MARSH
Around the table
> Advent International
> August Equity
> Baird Capital Partners
> CBPE Capital
> Graphite Capital Partners
> HIG Capital
> Inflexion Private Equity
> NBGI Private Equity
> Oliver Wyman
> Real Deals
> Risk Capital Partners
> RJD Partners
On the eve of Angela Merkel’s victory in the crunch euro bailout vote – and just three days before the Greek finance ministry admitted it would not be hitting deficit targets any time soon, piling pressure on Germany to reapply the sticking plaster and sending stock markets haywire once again – a group of private equity investors gathered in a London restaurant for a dinner hosted by Real Deals and Marsh, a global insurance broker and risk adviser, to discuss how the spiralling European debt crisis is affecting their day-to-day business of doing deals.
After a dramatic spike in investment – and confidence – in the first half of the year, it soon became clear that macro volatility has put a spoke in private equity’s wheels since the summer.
Transactions at the top end have almost ground to a halt as high-yield bond markets slam shut and underwriting stalls. Further down the spectrum, the macro blow has been less debilitating. Leverage is not as central to the investment thesis and “lifestyle-led” deals have kept activity ticking over.
“People still need to retire and there are numerous other family dynamics and life events that create opportunities,” said one participant. “But that doesn’t make it any easier. Volatility is playing a huge role in distorting vendor expectations and getting deals over the line is as difficult as ever.”
Indeed, while cash-out deals appear to be in the ascendancy for those comfortable with minority investment, in the absence of an over-riding driver, persuading vendors that now is a good time to sell outright can be hard work.
“Processes are taking longer. Diligence is tougher to get comfortable with. Where there’s a will there’s a way,” said one mid-market investor at the table. “What we are seeing, though, is a lack of will. Hitting the ‘go’ button is the biggest challenge.”
Ironically, though, the private equity investors themselves believe that now is a great time to sell, largely because of the wall of money coming out of their own industry, combined with genuine competition from trade – although many believe this is now beginning to tail off.
“For good businesses, prices are as high as they have ever been,” said one.
Establishing value against not only a volatile macroeconomic backdrop, but also intense competition, is key to successful investment in this market.
“If you are not willing to take a view, even in a period of extreme volatility, on intrinsic value through the cycle – the fundamental quality of a business – you might as well pack up and go home. That is what we are paid to do,” said one guest. “We’re not traders. What we do is all about intrinsic growth.”
“It is harder to attribute value in a volatile market. The crystal ball is harder to see into, but you still have to take a view,” agreed another. “You don’t want to outsource your valuations to credit committees at the banks. You have to back your own ability to grow the business – to be a better owner than the incumbent.”
Of course, the true cost of getting caught up in a buyer frenzy and being pulled away from that intrinsic value can be found in private equity portfolios all around us. Exponent’s bed retailer Dreams was cited as a prime example.
“Operationally, that’s a decent business,” said one. “But they paid 11.5x for it. They have grown profitability but it will still be a terrible deal because they paid so much for it. They won’t be able to sell it for more than 7x or 8x.”
In reality, most sectors have valuation norms that you can gravitate towards, regardless of where you are in the cycle, the guests said. Building products, for example, is around 4x. Other sectors may be 6x or 7x.
“We are not working in hedge funds. We are private equity investors,” one explained. We look to build value over three to five years. Macro volatility is less important for valuations than it is for sentiment and market growth. We can change management, systems or strategy, but we can’t change the market.”
The proprietary deal
The truth, however, is that it has not only been at the apex of the market that gob-smacking prices have been paid. At the end of 2010 and beginning of 2011, some pretty hair-raising valuations were achieved, particularly in retail and in major auctions.
Which is why many private equity firms like to wax lyrical over that holy grail of buyout investing – the proprietary transaction. But at our gathering, guests were divided over the ultimate benefit of the off-market deal. On the one hand, it is possible to argue that transaction certainty is increased when a firm is a sole suitor. However, private equity houses chasing these deals are often confronted by non-serious or vacillating sellers – and never more so than in a market such as this. Indeed, processes will often be long-winded as vendors will not be prepared for sale.
“The amount of time it takes to get there is extraordinary. It takes you six months to see if this is actually a business you want to seriously look at,” said one participant. “Their systems aren’t very good; you don’t know what their margins are; there is no particular view on the market. You have to build all that stuff. It is a big commitment in terms of resource. We have a lot of lively debates internally as to whether it is worth it.”
The advantage, however, is that the buyer can work alongside the target company as it prepares for the next stage in its evolution, helping to shape strategy and getting unparalleled access to the inner workings of the business.
It is clear, though, that proprietary deals are not always cheaper than their auctioned counterparts – indeed, proprietary deals rarely remain truly proprietary. At some stage the market will be tested to keep you honest – in the words of one guest.