Private Equity: Perspective on the Link Between PE Firms and Investors

Transcription

1 Private Equity: Perspective on the Link Between PE Firms and Investors EY Global Private Equity March 2015 Page 1 EY Global Private Equity

2 Current market conditions Page 2 EY Global Private Equity

3 Executive summary PE fundraising saw another strong year in 2014, driven by record levels of exits; fundraising increased 11% versus There continues to exist a growing bifurcation in the market, between the large established funds that offer multiple asset classes and smaller pure-play managers that are in many cases are struggling to attract capital. Average fund sizes grew to a record US$647m in PE acquisition activity showed continued strength in 2014; PE investments climbed 1.1% to US$277.6b. Excluding the two US$20b-plus investments of 2013 (Dell Inc. and H.J. Heinz Co.), PE investment rose 23% in 2014 by value. Exits were the big driver of activity last year was a record years for PE exits, which were up 13% in terms of the number of deals last year, and up almost 70% by value. Despite a global rebalancing between developed/emerging markets, PE firms and their investors remain focused on the long-term EM opportunity. The first two months of 2015 have seen a dramatic drop-off in investment. Valuations have trended higher over the last 7 years; this is clearly among the most significant challenges facing PE firms right now. Page 3

4 Fundraising seeing continued strength, driven by record levels of exits Fundraising up 11% versus saw PE firms benefit from a continued economic recovery and a strong exit market. PE fund-raising rose 11% in 2014 to US$$444.7b. Value has risen for four straight years. Global PE fund-raising by year (in US$b) Commitments (US$b) No. of Funds $700 1,200 $600 $500 $400 $300 $200 $100 1, $0 Source: Preqin Page 4

5 Average fund sizes are increasing Large investors are consolidating relationships Average fund sizes grew to a record US$647m in The trend is due in large part to investors consolidating relationships with fewer fund managers in order to streamline monitoring and reduce fees. There is a growing bifurcation in the market between the large established funds and smaller pure-play managers $700 Average fund sizes by year (in US$m) $600 $500 $400 $300 $200 $100 $ Source: Preqin Page 5

6 Dry powder continues to increase Highest concentration remains in North America As a result of increased fundraising, coupled with a flat market for new deals, dry powder continues to increase. The industry currently has US$1.2t in dry powder at the end of 2014 across all platforms. PE buyout dry powder (in US$b) North America US$690b Europe US$296b Asia-Pacific and the rest of world US$256b Source: Preqin Page 6

7 PE acquisition activity shows continued strength 2014 value and volume flat versus 2013 PE acquisition activity showed continued strength in Investments climbed 1.1% to US$277.6b. Deal volume was flat, at 2,107 transactions. Excluding the two US$20b-plus investments of 2013 (Dell Inc. and H.J. Heinz Co.), PE investment rose 23% in 2014 by value. PE acquisitions by year (in US$b) $800 $700 $600 $500 $400 $300 $200 $100 Value (US$b) Volume 4,000 3,500 3,000 2,500 2,000 1,500 1, $0 Source: Dealogic Page 7

8 Exits remain strong, see record year in 2014 Up 70% by value Exits were the big driver of activity last year as IPOs showed continued strength and M&A activity increased was a record year for PE exits, which were up 13% in terms of the number of deals last year, and up almost 70% by value. Overall PE exit activity (in US$b) Value (US$b) Volume $500 $450 $400 $350 $300 $250 $200 $150 $100 $50 $ Source: Dealogic Page 8

9 Corporate acquirors driving exit activity Value of trade sales jumps 84% as strategic acquirors bid aggressively for PE-backed assets In 2013, the IPO market was very strong, but sales to strategics were flat. However, in 2014, strategics began to bid aggressively for PE assets. As a result, the value of trade sales was up 84% versus Our most recent Capital Confidence Barometer (Oct 2014) showed 40% of corporate dealmakers intend to pursue an acquisition over next twelve months, up from 31% in April. PE M&A exits by year (in US$b) Value (US$b) Volume $400 $350 $300 $250 $200 $150 $100 $50 $0 Source: Dealogic Page 9

10 IPOs follow up a busy 2013 by setting a new record PE firms took 211 companies public; value up 88% from a year ago 2014 was another record year for PE IPOs. PE firms took 211 companies public, raising US$109.9b, up 88% from PE deals are accounting for an increasing share of the overall IPO market 42% in 2014 PE IPO exits by year (in US$b) PE as a percentage of all IPOs 45% $ % $ % $80.0 $60.0 $ Alibaba PE-backed IPO proceeds Number 30% 25% 20% 15% PE as percentage of total proceeds PE as percentage of total number $ % 5% $ % Source: Dealogic Page 10

11 Emerging markets continue to attract capital, despite macro worries EM PE on track to close out 2014 up 10% for fundraising, 30% for investment activity Emerging markets remain important for PE, despite the macro downturn in some markets. Through the end of 2014, fundraising closed out the year up 16% from the year prior. Investment activity closed out 2014 up 8%. Local funds are becoming increasingly sophisticated. Unproven exit track record. Emerging market fundraising (in US$b) Emerging market investment (in US$b) $44.00 $45.00 $44.72 $33.76 $39.00 $29.00 $30.00 $26.00 $26.00 $26.00 $21.00 $ Source: Emerging Markets Private Equity Association Page 11

12 Key trends impacting the market Page 12 EY Global Private Equity

13 Secular trends are driving assets to PE Page 13 EY Global Private Equity

14 Evolution of the industry the mainstreaming of PE The PE industry remains well in its youth. Over the last decade, PE has evolved significantly, from a very deal-oriented model towards a diversified multi-asset approach Build-up: Recovery period and build up post-2001 recession. The boom years: Unsustainable deal volumes, with extreme focus on transactions. Portfolio stabilization: Focus on portfolio credit quality and refinancing. Institutionalization: Sustainable deal flow and institutionalization of the franchise. Mainstreaming: The mainstreaming of PE broadening of industry s role and economic impact. PE deal value (US$b) Number of PE deals $800 $700 The boom years 4,000 3,500 $600 $500 $400 $300 Build up Portfolio stabilization Institutionalization Main- streaming 3,000 2,500 2,000 1,500 $200 1,000 $ Source: Dealogic $ and beyond 0 Page 14

15 Global PE assets under management are rising Global PE assets under management (US$3.8 trillion) have risen at an annual rate of 11.7% per year since 2000 Private capital is the largest repository of the world s wealth. Accounts for 56% of global capital. PE firms manage approximately US$3.8t in capital. US$1.2t is available for investment. Global capital (US$ trillions) Govt debt and SOEs, $45 $4,000 $3,500 $3,000 $2,500 PE total AUM (US$ trillions) $2,000 Dry powder Private capital, $161 Public capital markets, $81 $1,500 $1,000 $500 Portfolio $0 Source: Private Equity Research Consortium; Preqin Page 15

16 However, there remains significant headroom for growth Despite most investors increasing their allocations to PE, they remain underallocated to the asset class Investors are currently underallocated to PE. For US pensions, allocations continue to rise. Average allocations to PE 15.5% 14.3% 12.8% 11.5% 9.0% 8.0% 7.0% Allocations over time to PE US pension funds 7.3% 7.3% 8.2% 8.3% 8.4% 8.4% 7.0% 7.2% 6.1% Avg current allocation Avg target allocation 6.0% 5.0% 4.0% 3.0% Avg target allocation 2.0% US public pension funds All US PE investors Global public pensions Global PE investors 1.0% 0.0% Source: Preqin Page 16

17 Investors favor PE over other alternatives Institutional investors looking to alternatives, and increasingly PE in particular, to bridge the funding gap. Since 2005, alternative investments have grown twice as fast as traditional asset classes. PE is emerging as the go-to alternative for LPs. To what asset class are institutional investors most and least likely to allocate capital? Least likely Most likely Private equity 3% 46% Real estate 3% 26% Infrastructure 10% 10% Natural resources 13% 30% Hedge funds 5% 54% Source: Positioning to win, EY 2015 global private equity survey Page 17

18 Investors attracted to consistently strong returns that are largely uncorrelated with other asset classes Larger universe of investable assets and ability to actively influence outcomes the key differentiator Institutional investors are attracted to: Consistently strong returns driven by PE s larger investible universe and its ability to influence outcomes via active involvement in the company. PE returns are largely uncorrelated with other asset classes. 5-year PE returns versus other asset classes; correlations of PE returns versus other asset classes 5-year performance Correlation to PE returns 20.0% 15.0% 10.0% 5.0% 0.0% 1.8% 2.7% 3.3% 8.7% 9.2% 10.9% 15.6% 16.5% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% -5.0% -10.0% -5.5% Commodities Emerging markets equities Investment grade fixed income Hedge funds High yield Global equities REITs US equities Private equity 0.0% -10.0% Source: Morgan Stanley Page 18

19 Actively managed traditional investments have historically been asset management s growth driver Source: Global Asset Management 2014: Steering The Course To Growth, The Boston Consulting Group, July 2014 Page 19

20 .however, growth is now coming from two spaces passive products and actively managed alternative investments Bifurcation in the market - movement towards low-cost, low-margin ETFs/index and high-margin alternatives Source: Global Asset Management 2014: Steering The Course To Growth, The Boston Consulting Group, July 2014 Page 20

21 Changes within the industry Page 21 EY Global Private Equity

22 PE firms are positioning themselves for a larger share of the alternatives space PE firms of all sizes continue to grow beyond the traditional buyout model PE firms are accelerating their efforts to expand the buyout model. PE becoming one-stop-shop for asset management solutions ranging from private equity, credit, hedge funds, advisory, capital markets and solutions for retail investors/ HNI. Private Equity Hedge Funds Infrastructure Real estate Distressed/credit Fund-of-funds Venture Advisory Capital Markets Page 22

23 As a result, buyout assets are falling as a percentage of the total Trend at the largest firms is most pronounced PE firms are increasingly moving into a wider range of alternative asset classes. In 2003, buyout assets accounted for 46% of all PE dollars; now, it represents 37%. At the largest firms, the trend is more pronounced. Buyout dry powder as a % of all PE assets Buyout Non-buyout 61% 63% 63% 63% 54% 56% 54% 52% 56% 55% 55% 57% 46% 44% 46% 48% 44% 45% 45% 43% 39% 37% 37% 37% Source: Preqin Page 23

24 Consolidation is accelerating: towards a winner-take-all market Recent CalPERS announcement the clearest indicator yet of LP consolidation CalPERS as a leading indicator: Consolidating the number of PE managers in which it invests from almost 400 to 120 or less. CalPERS currently has about 400 managers The purpose of the move is twofold. Streamline diligence and oversight and monitoring of investments. Achieve cost savings through larger allocations to fewer managers. Creates model of large full-line generalists versus niche strategy participants Expected to consolidate to managers Page 24

25 Mainstreaming of PE towards greater acceptance Regulators, business owners seeing PE as a critical tool to close the funding gap Policymakers are increasingly looking to PE to close the funding gap for SMEs. How can jurisdictions create an environment that encourages PE investment? Access to debt financing; reducing regulatory barriers; increasing exit opportunities Harnessing trend towards financial disintermediation Emerging markets Regulatory acceptance is increasing Unmet growth capital need European Commission Seeking ways to make EU more amendable to PE Building a Capital Markets Union white paper Page 25

26 Blurring the lines between GP and LP Shadow fundraising accounting for a larger share of the overall market as LPs pursue separate account; the largest becoming more involved in co-investing and directs LPs have moved towards putting more assets into separate accounts. They have also increased their co-investment activity. As a result, there is the emergence of a growing shadow fundraising market, which is accounting for a larger share of aggregate fundraising. Currently, it is estimated that there is between US$60b-US$85b sitting in separate accounts. Co-investment dollars are conservatively estimated at 1/3 of total annual fundraising. Outlook of LPs currently investing in separate accounts Proportion of LPs PE exposure that is/will be direct Now Five years from now Will consider making separate accounts a permanent feature, 32% Separate accounts will be a permanent feature, 68% 45% 21% 41% 32% 21% 12% 12% 7% 4% 5% 0%-9% 10%-24% 25%-49% 50%-74% 75%-100% Source: Preqin Source: Coller Capital Page 26

27 Decline of defined benefit plans leads to search for new funding The decline of defined benefit pensions is leading firms to explore new avenues for asset growth key among them: 401(k)s and HNW individuals The decline in define benefit plans is leading PE firms to search for new sources of capital. PE firms are relying less on pensions as a funding source. Funds are looking to defined contribution plans, high-net worth individuals, and retail investors as sources of future funding the democratization of PE. Experimentation with different structures Innovative thinking around liquidity is required to push the ball forward. Examples: CPG Carlyle Private Equity Fund LLC ($50k min) Carlyle Private Equity Access 2014 ($250k min) Blackstone Total Alternative Solution Advisors ($10m min) Page 27

28 LP expectations are changing LPs seeking lower fees, increased co-investment opportunities Amid an environment of reduced returns expectations, LP demands are increasing: Lower fees Increased co-investment opportunities More direct investments Transparency and reporting According to EY CFO survey, 66% said PE firms could improve investor reporting Value creation plans Page 28

29 What keeps investors up at night? As allocations to private equity have increased, so has investors desire to mitigate their risks Source: Positioning to win, EY 2015 global private equity survey Page 29

30 How is PE responding Page 30 EY Global Private Equity

31 Clearly, the industry is maturing and continues to evolve Rough winds some cyclical, others secular driving significant changes across the industry and naming new winners and losers Underwriting reduced returns expectations Increased competition Regulatory constraints on lending Increased pressure on value creation as returns driver Forced consolidation via fundraising dropouts Interest returning to the US Transparency and efficiency as high as ever Segregating the haves and the have-nots Largest funds to be key beneficiaries Page 31

32 Hybrid Shift to operational improvement as value driver PE firms continue to build out infrastructure designed to maximize operational efficiencies and pursue growth opportunities Adding value through operational improvement has long been a part of the PE playbook. PE firms continue to build up teams of operational executives and now employ a range of models to maximize operational efficiencies and growth opportunities. Operational models Management-centric Limited or no in-house operational capabilities. Focus is on selecting the right management team to execute on the vision. Senior advisor Often a senior advisor with deep industry experience assumes a board-level role. Can also include senior external advisors with specific skill sets brought in for longer term engagements with the company, distinct from consulting arrangement In-house generalists Represents dedicated in-house capabilities on the PE firm s payroll, assigned to portfolio investments for longer-term engagements. Assume a generalist function of working closely with senior management on a range of initiatives In-house specialists Represents dedicated in-house capabilities of specialists in a particular function - HR, marketing and sales, supply chain, or information technology. Many firms have evolved to using hybrid strategies on a case-by-case basis. Page 32

33 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Have valuations reached an inflection point? The first two months of 2015 have seen a dramatic decline in PE activity, the lowest monthly levels since Valuations may be the issue one widespread metric, cyclically adjusted PE ratios, have been this high just twice in the last 150 years 2000; and Disciplined buyers taking a pause? Monthly PE deal value and US public market valuations $60.0 Monthly PE deal value S&P 500 PE ratio (cyclically adjusted - CAPE 10) $50.0 $40.0 $30.0 $20.0 $10.0 $0.0 Page 33

34 Moving from inefficiencies to dislocations as the driver Given increased competitiveness in core buyout business, many firms looking to a contrarian stance what we ve heard from our clients Identifying dislocations as opposed to exploiting inefficiencies When everyone else goes left, we want to go right We have to look under a lot of rocks Simple intermediated transactions can t be good PE deals there has to be an angle Find situations where the perceived risk is greater than actual risk. Use illiquidity to create longer term returns Page 34

35 Sectors seeing current market disruption Rising market efficiency and increased transparency is leading to a more challenging environment for sourcing; firms looking to broader market dislocations for inspiration Wherein lie the future disruptions? PE firms increasing exposure to tech across deal size ranges. Also integrating disruptive technologies into non-tech businesses. What industries will attract PE interest? What challenges can be overcome by bringing capital to bear? Technology Energy Lower prices and an increasing number of distressed operators leading to opportunities to develop complex capital structures - debt, preferred equity. Interdisciplinary teams to identify opportunities. Ageing populations across the developed markets, a changing regulatory environment, and increased affluence in EMs signalling opportunity for PE. Healthcare Page 35

36 How PE plays a sector disruption strategy Oil & Gas case study Dislocation in Oil & Gas market biggest current opportunity Parallels to 1986 supply shock Key question when will prices stabilize? Motivating factors Key OPEC producers trying to protect market share Shale operating costs falling rapidly Energy has become 30% of HY market Why letting price decline? Trying to raise cost of capital for E&P companies Improve competitiveness of OPEC oil producers Oversupply will eventually cause drilling slowdown Take position that the long-term structural equilibrium price is in the $70-$75/bbl range Page 36

37 How PE plays a sector disruption strategy Oil & Gas case study, cont. Based on price target $70-$75/bbl view, how do you exploit the opportunity? Short term: credit opportunities in hydrocarbon producers - buy par value assets at $0.70/dollar. Medium term: buy mid-quality operating companies with good asset coverage Longer term: buy distressed companies (bankruptcies, restructurings, break-ups) or enter through distressed debt markets Page 37

38 Themes, not companies capitalizing on disruption PE looks to place its bets on the right investible themes ESG Cross-border deals Changing tax landscape Offshoring / onshoring Commodities Water Lending Secondaries Infrastructure Distressed real estate debt Eurozone Digital disruption Strength / impact of USD Data analytics Page 38

39 How are PE firms responding? Startups / Greenfield Greenfield/start-up investments Opportunity to bridge ideas with capital Significant growth aspect Focus on: Strategy Competition New lines of business Lines of equity Example: Bain partnering with Richard Branson to launch Virgin Cruises Page 39

40 How are PE firms responding? Building out businesses Building out the business Taking a franchise and making it grow Geographic expansion, new markets, new product lines Operational value add Example: Berkshire Partners investment in Portillo s Page 40

41 How are PE firms responding? Minority stake investments Increased focus on minority / growth capital Partnership with entrepreneurs and business owners Need for operational discipline Driving transformational changes and improving operational effectiveness through influence vs control Examples: Carlyle investment in Beats TPG investment in Chobani Carlyle investment in Vogue International Page 41

42 How are PE firms responding? Distressed and special situations Identification of the opportunity Focus on creative deal structures Perceived risk exceeds actual risk Examples: Blackstone investment in Linn Energy WL Ross investments in BankUnited / Navigator Holdings Page 42

43 Page 43 A new day for PE

44 Outlook PE activity to continue to drive the market as PE firms exit many of their boom-year portfolio companies. Knock-on effects in fundraising market as LPs reinvest in the asset class. Competition for assets is currently the biggest challenge for PE funds as dry powder rises and corporates target M&A as a source of growth. Ebitda multiples currently at their highest since Potential to limit deal activity upside. Financing markets to remain favorable, despite increasing regulatory scrutiny. Fuels increased pricing levels and delivers refinancing opportunities. Continued experimentation with fee structures, new fund structures, and bringing new investor classes (HNW, direct contribution plans) to PE. Continued push towards institutionalization and professionalization at the firm level focus on back office operations, IT infrastructure, and data harvesting. Opportunistic capital looking for arbitrage combining with capital-starved businesses; growth capital, minority stakes, buy and build, and special situations. Page 44

45 Thank you! Mike Rogers EY Global Deputy Private Equity Leader Page 45