Greek Complexity

PE techniques spill over into public companies

In today's Telegraph is a piece about European public companies imitating the techniques of LBO houses.

Anything you can do, I can do better. That, at least, is the attitude of some European public companies to the headway being made in the deals business by leveraged buyout houses.

It seems some public companies have piled on debt in their pursuit of returns-enhancing deals. The author cautions against this.

But is this something very new? In the M&A class I am taking at grad school, I've already come across a couple of cases where companies had the option to pursue leveraged recapitalisations and acquisitions. These cases weren't particularly recent. The only thing I can think of that might make a difference is that the cases we studied were all US-based.

Link: Public companies ape the private equity houses at their peril

Asian PE growth to continue

A (leading) indicator of growth in Asian private equity points upward -- Asian PE outfits are hiring senior bankers. PrivateEquityOnline:

[PE's] hiring spree is taking place as investors target the fledgling Asian private equity markets in search of higher returns than they could achieve in the US or Europe. Last year, Asian private equity fundraising topped $10 billion, compared with $3.3 billion in 2003.

The only way to go is up: even having tripled in one year, there's plenty of room for growth in Asian fundraising. For some perspective, consider this tidbit from AltAssets:

The Carlyle Group, for example, closed a $7.85bn US fund and a $2.2bn European fund. Goldman Sachs, the global investment banking, securities and investment management firm, has reportedly raised the largest private equity fund to date, with $8.5bn in commitments.

Blackstone and Warburg Pincus are both some way down the line with their latest vehicles, expected to be in the region of $10bn and $8bn respectively.

Although there are bound to be hiccups (regulatory/political ones, for instance) and pockets of slower growth, the overall trend is going to be one of increase.

Watch this space.

Service to rate private equity funds launched

Yet another development towards standardisation in the PE industry (apart from this one, for example).

Cogent Analytics is a new division of Cogent Partners, a Dallas-based investment bank best known for its secondary advisory work. The new group plans on providing institutional investors with standardised reports on existing and proposed private equity funds, ranking each on a scale of one to five, with five being the best.

The ratings system, to be officially announced soon, will include a service that monitors partnership investments for LPs, ascribing a number to funds with regard to historical as well as projected performance. Called CORE Reports, LPs will receive, among other documents, a one-page tear sheet each quarter with standardised historical return analysis on one side and standardised projected return analysis on the other. On the top left corner of each side is a blue number – say, 3.5 – that, claims Cogent, distills more than 20 types of risk and return analysis.

Another service to be launched by Cogent Analytics could also have major implications in the private equity fundraising market. Called GP Screen, the service involves Cogent producing a roughly 50-page write-up on a particular fund in the market. The report, paid for by the LP not the particular GP concerned, assigns quantitative measures to many fund attributes. The group offering the fund is rated on historical performance and partnership terms, but also on “strategy” and “team”. Cogent Analytics asks the same sets of questions of each group: for example, how are the economics distributed among the professionals; how long has the team worked together; how has deal sourcing changed; has strategy shifted over time?

I read the article and thought of investment consultants such as Cambridge Associates, who have been doing similar work for a long time. (CA, for instance, provides endowment funds, trusts, pension funds and other investors with information and advice on choosing money managers.) But there are two main differences between a Cambridge Associates and Cogent Analytics:

• Investment consultants primarily perform custom analysis for each client whereas the Cogent Analytics service seems almost like a Moody's for PE funds.
• Investment consultants have a broad brief of which PE is only one component.

So this is quite interesting. Their website makes no mention of rating venture capital funds. I'm guessing that would be much harder (more subjectivity?). And even if they did rate VC funds, I would imagine that the ratings would be more volatile than those for PE funds.

Link: PrivateEquityOnline.com Newsletter

Private equity for public equities

AltAssets reported last month on a new fund that will apply PE techniques to public companies:

"Our approach within the SVG Advisers' public equity team has been to apply similar due diligence and valuation approaches to investment that has served private equity firms so well in recent years. The performance of [the previous fund] to date has demonstrated the validity of this approach."

I understand how due diligence might be more focused than is traditional but I wonder how PE valuation techniques are different from any other valuation techniques. Also wonder whether these guys exert control/work with the management of companies they buy into. That could be an interesting hybrid model. Wonder which other shops are applying this model.

Link: SVG to launch new fund to apply PE investment techniques to public companies

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

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

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)

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

McKinsey on private equity in China

In The McKinsey Quarterly:

There may be an opportunity for private equity groups to invest in midsize US manufacturing companies because, while they are struggling to keep up with the Chinese competition, they retain substantial brand value, sales channels, and intellectual property. Through investment, private equity funds can inject the management talent to help a company shift operations and sourcing to China—which can lead to substantial cost reductions. Our experience suggests that there is tremendous room for such deals because there is little competition to invest in midsize US manufacturing companies.

The writer says that investing in Chinese companies poses various hazards (which is why he suggests that PEs invest in US companies with an exposure to China). In summary:

• There is an oversupply of capital in China.
• Investors sometimes make the mistake of trying "remote controlled" investing.
• Domestic debt financing is difficult to obtain for both investors and their portfolio companies.
• Exits remain uncertain.

Wonder what he thinks of India.

Link: How private equity firms can play in China (free registration required)