Greek Complexity

McKinsey on success in PE

Read a recent article in The McKinsey Quarterly examining the drivers of success in private equity. Although the article starts out examining why certain PE firms do better than others, the study actually identified the drivers of success in specific deals.

The sample is relatively small (11 "leading" PE firms and 60 deals) but the results aren't that far away from what one would normally expect, so I expect increasing the sample size wouldn't make that big a difference.

One thing that would be interesting to know is whether these deals all took place during roughly the same period. Has performance been different for deals that took place before 2000 and deals that took place after 2000? (I presume exits have happened only recently.)

One interesting tidbit:

The main source of value in nearly two-thirds of the deals in our sample was company outperformance. Market or sector increases accounted for the rest. Outperformance, which generated a risk-adjusted return twice that of market or sector growth, was the least variable source of value.

The article ends with:

These research findings pinpoint the practices that distinguish great deals from good ones. The five steps are, in the main, uncontroversial. They are applied inconsistently, however, and their implementation seems to depend on the individual partner's beliefs and skills. A standard active-ownership process that applies and develops best practices is the next step for the private equity industry.

An interesting point. So the (relatively) young PE industry will begin moving towards benchmarked practices and a level of maturity comparable to other more established industries. I wonder how this will play out in Asia.

• Will best practices quickly make their way into Asian PE given that the industry is very young here and has few bad habits to shed?
• Or are there too few experienced PE investors here who can transfer best practices into their Asian operations? McKinsey's article makes the point that it is not firm-wide best practices that lead to above average deals, it is good practices followed by individual partners within a firm.
• Or another reason people might not bother with instituting good active-ownership strategies within their firms could be if their target markets start heating up, and partners spend more time chasing new deals than managing their existing portfolio. But I don't see this happening.

Link: The McKinsey Quarterly: Why some private equity firms do better than others

Venture capital in Singapore

Jimmy Hsu of TIF Ventures has written an introduction to Singapore's VC scene. Snippets:

Over the last few years, we have increasingly seen companies targeting new markets such as China and India, although the United States does remain the ultimate primary market for most startups. We've also seen an increasing role for top-tier fund managers to help their portfolio expand into these new markets. In the next few years, VCs will want to invest in companies based abroad that have synergistic and value-adding characteristics or have first-mover advantage. VCs will start to have a broader geographic view and invest more globally.

We have already started to see an upturn in the VC industry, both in terms of fund managers raising funds and the dollar amounts into investments made. This has followed the improvement in the local public markets, which in turn have trailed the U.S. public markets. Thus, there is a lag effect but clear signs of improvement. We think convergence technologies, digital TV, media and the biotechnology/healthcare sectors will be ripe for investment over the next few years.

To raise capital in the near future, entrepreneurs will need to balance their presentations and business plans toward financial investors instead of merely focusing on the innovation and technology. Meanwhile, local VCs will need to form meaningful syndicates with overseas firms that can help them move beyond the local markets.

Link: Archive - Buzz of the Week - News - VC Experts

Dissecting the VC deal

Read an old-ish post on A VC about how to value a company. The post doesn't really go into specifics of how to value a company but I came across a comment that I found really interesting as a financial engineering student:

I think it is much better to think of a venture capital deal as a loan plus an option.

To understand how he came up with this (I don't want to simply copy-paste his whole post here), please read what he says.

Link: A VC: Valuation

When competitors are acquired...

Interesting comments from BeyondVC and A VC about how to react when one's competitor is acquired.

A VC:

Stand Up and Cheer. Loudly.

BeyondVC:

Usually when a competitor is bought at a huge price the first reaction is why it wasn't me.  The second reaction usually becomes fear as you begin to worry about what your competitor's product will do in terms of market share with a huge sales force and partner channel, strong brand name, and global infrastructure to support the customer growth.

But, he says:

First of all, the majority of acquisitions fail.  Secondly, your competitor will be inwardly focused and quite distracted for the first 6 months trying to integrate with the parent company.  Finally, depending on how the acquisition was completed, employees will begin to leave as soon as they get the bulk of their money off of (sic) the table.

Last year, for example, one of my companies was able to build an incredible sales team overnight [when a competitor was acquired], saving us six months of hiring and giving us an opportunity to hit the market harder and faster.

Must discuss this with my M&A classmates!

Links: When competitors are acquired..., Stand Up and Cheer

Whence leadership? Whence power?

I have been fortunate over the past couple of years to have met a fair number of quite senior people, whom one could describe as powerful and wealthy industry leaders. I also know people that I am certain will be the leaders of tomorrow based on their current track record.

In my naivete, and having met these people up close and personal, I expected to see some special distinguishing mark that set them apart from others. I almost expected them to be physically bigger than everyone else, or at the very least to have some personality trait that set them apart from others. I had the same feeling when I watched my first live India-vs-WI cricket match at Wankhede Stadium in Bombay.

Instead, I came away with the feeling that these were "just" people. No common factor among their personalities, which spanned the spectrum from engaging to soft-spoken to intellectual. Not one of these people threw his weight around with others. Not one made a big show of his wealth. In fact, I am fairly certain that were I to have a conversation with two people, one an average joe and the other an industry titan, and if the conversation was restricted to the weather, then I would not be able to tell the titan apart from the joe.

So what sets apart some people from others? Is it brains, hard work and some measure of good luck or is there also some special x-factor involved (which I obviously am not capable of seeing!)?

Indian PE maturing fast, says Business Today

The Business Today issue dated March 13, 2005 has a good article on the state of India's PE industry (and an extremely difficult to search/navigate website; but I find this is true of most India-based websites. I digress).

The article starts off with some mind-boggling figures on returns that PEs have booked in India. I have been generally aware that PEs have been getting more and more interested in India. And, of course, the stock market has hit all-time highs. But this is probably the first time I've really looked at the numbers.

The opening paragraph:

If anyone in the venture capital industry needed proof that India is an Asian El Dorado, then it was delivered on the front pages of pink dailies early February. Warburg Pincus, the Big Daddy of private equity industry with $14 billion (Rs 61,600 crore) under management globally, sold a 3.2 per cent stake in Bharti Tele-Ventures for an eye-popping $306 million (Rs 1,346.4 crore). Just six months earlier, it had offloaded a similar stake, but for just $208 million (Rs 915.2 crore). Envious rivals reached for antacids because six years ago when Warburg picked up an 18.5 per cent stake in Bharti, it paid a bargain price of $290 million (Rs 1,276 crore). Already, though, it has raked in more than $500 million (Rs 2,200 crore) by selling 6-odd per cent, and the remaining 12 per cent is still worth a billion dollars. "It's a once-in-a-lifetime kind of deal for any private equity firm anywhere in the world," drools a rival.

And the numbers roll on in similar staggering vein.

I summarise here some trends that the article highlighted:

• Sharper focus: Investors are focusing on a few preferred investment segments.
• Faster exits: Ernst & Young's Country Managing Partner says, "The quality of investment has been good in recent years. So when it took five years to exit earlier, it's not more than three now."
• Increasing PE funds flowing into India
• PIPE (Private Investment in Public Equity) deals are popular
• Buyouts getting more common

The article ends with what I thought was really the most interesting bit of the article, far more interesting than any of the multiples and returns that the writers focus on:

Believe it or not, early stage investing may also come back into fashion, as more and more Silicon Valley investors jump on to the India bandwagon. According to Ranu Vohra, co-founder, Avendus Advisors, there is a major supply of money coming in the $10-million (Rs 44-crore) and below category.

Early-stage VC is where it all begins. Once this gets going, the pie is enlarged for everyone (late-stage PEs, entrepreneurs, etc). This is going to be the next big thing in India.

Link: VC's Pay Day (subscription required)
Thanks to Sameer Wagle for pointing me to this article.

"M&A activity to continue in 2005"

...so said the head of a New York-based hedge fund. I was watching Bloomberg TV and jotted down some quick notes:

• M&A activity at highest levels since 2000
• Will continue in 2005 but may not hit 2000 levels just yet
• PE groups are taking public companies private; lots of money accumulated over the past couple of years; could not use earlier (risk-averse)
• But PE guys probably not overpaying; have good knowledge of their own business and target businesses; for example, the winning bidders for Toys R Us include real estate group Vornado Realty Trust
• M&A likely in banking, financial services, brokerages (because of overcapacity, a prime target of most efficiency-oriented PE shops), healthcare, energy (not much activity so far but likely to see soon, particularly with refiners and oil services companies)

Investing in art

Buttonwood writes in The Economist about new innovations in art investing. It seems that art indices have exhibited returns roughly equivalent to that of the S&P 500 over the past 50 years and hugely outperformed the S%P 500 over the past 5 years. But the main attraction of art is that it is completely uncorrelated with stock prices. Makes for good diversification.

Another point to note is that the market for art is inefficient. So the potential exists for big profits (and big losses).

As I was reading the article, one downside popped into my head. Buttonwood says it better than I could:

Buttonwood is all for diversifying portfolios, and thinks art is at least as jolly as pork bellies. But there are a few worries. One is that no matter how sophisticated the portfolio analysis used, it is simply not possible to discount mathematically the chances that Damien Hirst’s polka dots are going to appeal more in 20 years than Jeff Koons’s dinner plates. And this market, with more than $1 trillion in assets, is virtually unhedgeable.

So perhaps the moral of the story is that one should invest in art for pleasure first and profit a distant second. I don't think this is going to dissuade too many people though. Buttonwood refers to the popping up of funds that securitise art investments to make it accessible to the ordinary investor. The entry fee might be as low as $50,000. That sounds pretty scary.

Link: Economist.com | Buttonwood

Hedge funds target private companies in India

The Economic Times (India):

Hedge funds have realised that with just a handful of private equity investors in India, there are a lot of investment opportunities to be tapped among private companies. Moreover, they feel that the potential or returns could be much larger in the private markets, compared to public ones.

Hedge funds generally do not have partners with operational expertise of running companies — something which most private equity investors have. Instead, hedge funds have people who are capable of identifying new investment options and valuations differences.

Some of the new offerings to investors by hedge funds are positioned as “venture hedge funds”.

These new funds invest in both short and long-term assets, the objective being to leverage the short-term earning in true blue hedge fund style, while gaining from long-term profits from ventures. A balance of short-term and long-term investment means that these funds are able to deliver returns consistently and regularly over their life cycle.

Vinod Sethi, investment advisor to private equity and hedge firms, says, “If hedge fund investors start investing in unlisted companies, then valuations are going to get stretched. I don’t think it will reach a stage where competitive bidding will take place between private equity and hedge funds, as most private equity funds would like to avoid such a situation. I don’t think hedge funds have the skills to invest in unlisted companies.”

Mr Bhasin believes that private equity funds will generally have an advantage over hedge funds. “It is unlikely that hedge funds will lead an investment. At the most, they may ride on the coat tails of private equity investors. Entrepreneurs may also not be so keen on hedge funds leading an investment,” he says.

Competition between PE investors and hedge funds is fairly recent even in Western markets so I am quite impressed at the speed with which these developments have occured in India.

Separately, I wonder what sort of timeframe hedge funds typically seek from investments in private companies.

I also wonder how they realise returns, given that hedge funds' traditional strengths are not in finding exit opportunities such as IPOs or trade sales. Perhaps they are bringing in partners with private equity or investment banking or even operational experience? I do remember reading some months ago that some of the larger PE guys --Carlyle? KKR? I don't remember exactly who-- have set up hedge fund-style units to compete with traditional hedge funds. Won't be surprised to learn that hedge funds have set up their own PE units as well.

Link (courtesy of Sameer Wagle): Hedge funds smell a killing in Indian unlisted firms

Taxes and humour DO mix!

This is a little off-topic compared to my usual posts but saw this funny article on MSN Money that I felt compelled to post about. If today were April 1, I wouldn't even believe the article. It's about techniques people have used to claim tax write-offs in the US. Two of my favourites:

"Several years ago, I was going to owe some tax, so I put an extra deduction on my tax return."

Well, reasoned Lovelett, managing director of Lovelett, Skogen & Assoc. in Casper, it couldn't be that bad. Then the DJ explained: "I put my dog on as a dependent."

And another canine tax-tale:

"I had a guy come in one time wanting to know if he could deduct the cost of his dog food. His reasoning was that his dog was security for his house, therefore the dog food became a security expense," Howard says.

"I kind of liked that one. The IRS loves that stuff."

Lovely!

Link: MSN Money - The 9 weirdest tax write-offs