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An Ocean of Capital: Saturation in Private Equity
 

SanityCheck's picture
PE
(Gorilla, 633
 
Points)
 on 11/29/12 at 11:42am
Ocean of money

First it was rumors. The grapevine of talk from other private equity associates and friends from the BB where I did my banking stint. Of course, gossip is one thing we’re all used to from our investment banking days and just like at our old jobs ,there was no shortage of juicy gossip. However, I brushed a lot of it off as standard ex-banker complaining. After all, everyone loves to complain in finance.

But then came the calls. Headhunters that I haven’t talked to for a year were suddenly emailing me and calling me to “catch up”. Was this a new hiring boom in a new vertical of finance? Unfortunately no, it was open PE positions that were looking for laterals. Complaints of a saturated market and the inability to get deals done were no longer just harmless complaints from overworked associates. Apparently the rumors were true. PE associates were leaving their jobs for business school, startups, hedge funds, corp dev, etc.

The private equity (and any investment related industry in general) was oversaturated. There was too much capital in the world. This may be hard to believe, but according to a very recent Bain & Co. research report, total financial assets are nearly 10 times the value of global output of all goods and services. Let that sink in for a moment...

What’s worse is that a major emerging market, China, which was thought to be an investment sink, is actually generating more capital than they are absorbing. What you will see by 2020 is the global world of capital turned upside down as there is too much capital and not enough attractive investment opportunities.

Now we can discuss the implications of this all day, but what does this mean for YOU, the junior member of the private equity or investment team? Well, not a whole lot except for the fact that you’ll do more bitch work and less deal execution. However, is private equity still a good place to be in the future? Is it still worth it to get that costly MBA and return?

My answer is, yes, but with a caveat. One major problem with illiquid assets and too much capital is the inevitable creation and likelihood of bubbles. The housing bubble would be nothing compared to a future bubble as capital grows and the stakes get higher. And yes, maybe you can still make those great returns if you can find a bigger fool to buy it from you, but that is a reliance on the bubble and timing the market, which no good investor should rely on.

However, the same research report lists solutions around this capital saturation problem. One solution is to aim for the long term. Game changers. Things like cheap renewable energy, nanotechnology and robotics. It’s going to be harder and harder to achieve an attractive short term return (traditional 3-5 year LBO model) so you really do need a platform that will last. Another solution is a focus on operations and real value add / expertise. Good management teams will be very important for realizing value. For most of you, this may be a great time to start a business and prove your worth.

Finally, emerging markets still hold ample opportunity. Even though their financial systems often lack liquidity, depth and breadth, regulatory consistency and transparency, this “bottleneck” may eventually subside over the next few years and allow for new investment opportunities for literally billions of eager consumers.

Everyone hates change, but of course change is inevitable. I’m actually quite optimistic about the future of private equity and consequently, the future of investors in general. We might be over the traditional LBO models and financial engineering of the past, but that’s not necessarily a bad thing. With the death of the old comes a new era of operational improvement, entrepreneurial focus and of course, a truly global financial community as we shift our focus towards the emerging markets.

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Comments

m2's picture

Great post. Any chance you

VC
 
Points)
 on 11/29/12 at 11:44am

Great post. Any chance you can share the Bain study on this?

SanityCheck's picture

Given you're a certified user

PE
(Gorilla, 633
 
Points)
 on 11/29/12 at 1:04pm

Given you're a certified user I think that's fine. PM me your email address and I'll send it over when I catch a breather at work :)

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BTbanker's picture

So total financial assets are

IB
 
Points)
 on 11/29/12 at 1:33pm

So total financial assets are ~$700 Trillion? Is that right?

"A man generally has two reasons for doing anything. One that sounds good, and the real one." - J.P. Morgan

johnwayne7's picture

SanityCheck: This may be hard

 
Points)
 on 11/29/12 at 2:04pm
SanityCheck:

This may be hard to believe, but according to a very recent Bain & Co. research report, total financial assets are nearly 10 times the value of global output of all goods and services. Let that sink in for a moment...

I would like to see that report as well. Wouldn't this be somewhat logical due to derivatives?

I'm struggling to see how you arrive at the conclusion that this directly relates to oversatuation of PE. Thanks.

expenseaccounts's picture

SanityCheck: Given you're a

(Baboon, 102
 
Points)
 on 11/29/12 at 2:12pm
SanityCheck:

Given you're a certified user I think that's fine. PM me your email address and I'll send it over when I catch a breather at work :)

The Certified User comment is bullshit.

You can just go to the following link to download it:

http://www.bain.com/publications/articles/global-p...

AstonMartin's picture

We've heard of private equity

ST
 
Points)
 on 11/29/12 at 2:26pm

We've heard of private equity with too much dry powder, are hedge funds facing a similar problem?

prospie's picture

AstonMartin: We've heard of

(King Kong, 1,682
 
Points)
 on 11/29/12 at 2:49pm
AstonMartin:

We've heard of private equity with too much dry powder, are hedge funds facing a similar problem?

yes.

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DontMakeMeShortYou's picture

prospie: AstonMartin: We've

HF
(King Kong, 1,964
 
Points)
 on 11/29/12 at 3:02pm
prospie:
AstonMartin:

We've heard of private equity with too much dry powder, are hedge funds facing a similar problem?

yes.

False. Hedge funds are tiny in comparison to other investment vehicles. Also, note that HFs have a much broader set of investment opportunities than PE.

http://imgur.com/xvZOO

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SanityCheck's picture

Agreed with above. Hedge

PE
(Gorilla, 633
 
Points)
 on 11/29/12 at 3:31pm

Agreed with above. Hedge funds have a different mandate, but in my opinion finding good investments in the future will be tough for any investor with a large AUM.

Expenseaccounts: Apologies, I was forwarded the report along with a bunch of others as a bundle from our consultants so wasn't sure if it was public or not. For those that PM'd me though, I'll email it out since it saves you the hassle of having to register on that site.

Johnwayne: Arriving at the fact that PE is saturated is separate from what any report says. I found it cool that someone else had arrived to the same conclusion but were using actual numbers / research through their day job of consulting.

Ask anyone working in PE, it's just not the same anymore. Most of my friends at the larger shops are a bit jaded from their experiences as every deal is looked at and passed around by more and more people and there simply is a lack of attractive investments right now (moreso than before).

I also find it interesting that some of the changes are already happening as more funds are looking at smaller deals and "growth" type deals. I was able to participate in some LP calls and basically every large buyout fund is now interested in growth deals (according to these large FoFs).

But of course I only posted this as an opinion piece, feel free to disagree and discuss.

Edit:
PS: Oh, and for those interested, the recent lawsuits against large buyout shops "colluding" on deals is also a pretty interesting indicator that there simply aren't enough good deals out there anymore.

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johnwayne7's picture

I'm not in PE or even IBD

 
Points)
 on 11/29/12 at 3:53pm

I'm not in PE or even IBD yet, but I am currently most interested in getting into PE down the road. I definitely see a lot of talk about PE not being the same in the coming decades and I'm not really sure why.

Since global economic activity in general has slowed to a trickle, it would make sense to me that deal flow is down as well. Unless there is something systemic about the industry that I'm missing because I'm a no0b to the whole PE thing, I'm not really sure why PE would be forever changing. Unless, of course, you think we are approaching a "new normal."

As for financial assets, my comments were mainly about the way they have ballooned in general. The fact that financial assets are so high would seem to suggest that we are coming up with shittons of leverage and creative new investment vehicles. Not necessarily disagreeing with you, just still don't see why that means PE is constricted.

SanityCheck's picture

It's not a matter of

PE
(Gorilla, 633
 
Points)
 on 11/29/12 at 4:27pm

It's not a matter of increased leverage, actually deals nowadays have a lot more equity. As mentioned above, the main issue is dry powder and nowhere to put it. A lot of funds aren't finding deals that are surpass their hurdle rate given the risk attached. It's no fun to participate in an auction of 20 bidders when everyone is using the same valuation techniques.

PE has always adapted in the past, the LBO boom may fade but something will definitely take it's place and hopefully that comes in the form of operational value add rather than just leverage and balance sheets.

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prospie's picture

DontMakeMeShortYou: prospie

(King Kong, 1,682
 
Points)
 on 11/29/12 at 4:35pm
DontMakeMeShortYou:
prospie:
AstonMartin:

We've heard of private equity with too much dry powder, are hedge funds facing a similar problem?

yes.

False. Hedge funds are tiny in comparison to other investment vehicles. Also, note that HFs have a much broader set of investment opportunities than PE.

http://imgur.com/xvZOO

Interesting link. In my defense, it really depends on the kind of fund. Obviously I don't need to tell you about certain funds having to return money to investors.

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DontMakeMeShortYou's picture

SanityCheck: It's not a

HF
(King Kong, 1,964
 
Points)
 on 11/29/12 at 4:42pm
SanityCheck:

It's not a matter of increased leverage, actually deals nowadays have a lot more equity. As mentioned above, the main issue is dry powder and nowhere to put it. A lot of funds aren't finding deals that are surpass their hurdle rate given the risk attached. It's no fun to participate in an auction of 20 bidders when everyone is using the same valuation techniques.

PE has always adapted in the past, the LBO boom may fade but something will definitely take it's place and hopefully that comes in the form of operational value add rather than just leverage and balance sheets.

As far as I'm aware, most of the returns today come from operational improvements and not just leverage. The days of financial alchemy ended in the 90s.

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johnwayne7's picture

SanityCheck: It's not a

 
Points)
 on 11/29/12 at 4:45pm
SanityCheck:

It's not a matter of increased leverage, actually deals nowadays have a lot more equity. As mentioned above, the main issue is dry powder and nowhere to put it. A lot of funds aren't finding deals that are surpass their hurdle rate given the risk attached. It's no fun to participate in an auction of 20 bidders when everyone is using the same valuation techniques.

PE has always adapted in the past, the LBO boom may fade but something will definitely take it's place and hopefully that comes in the form of operational value add rather than just leverage and balance sheets.

Well when I mention leverage, I'm not talking about LBO or even PE, I'm mainly referencing the macro concept of the explosion of derivatives. This phenomenon would explain the 10x stat Bain used. Sorry if I'm not being clear.

SanityCheck's picture

Gotcha. Hopefully that link

PE
(Gorilla, 633
 
Points)
 on 11/29/12 at 4:52pm

Gotcha. Hopefully that link posted above works for everyone but if you'd like a copy of the report I can email you a copy so you skip the registration step.

Dontmakemeshortyou: Yep, agreed. Just misunderstood what Johnwayne was saying in his prior post. The bigger problem nowadays in PE from my experience is the ultra-competitive auctions for any deals we have liked so far. My fingers are crossed for a proprietary deal this year....

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dinendal's picture

great topic. agree w/

IB
 
Points)
 on 11/29/12 at 9:41pm
SanityCheck's picture

Well, I think it's pretty

PE
(Gorilla, 633
 
Points)
 on 11/29/12 at 11:06pm

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ThePenceOfSpence's picture

Also the case in MM... time

 
Points)
 on 11/30/12 at 12:36am
discrete's picture

this is actually a very

PE
(Baboon, 118
 
Points)
 on 11/30/12 at 2:55am
Californicated88's picture

MM and Lower MM all the

PE
 
Points)
 on 11/30/12 at 1:13pm

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Bankn's picture

johnwayne7: SanityCheck: Th

(Orangutan, 286
 
Points)
 on 11/30/12 at 1:07pm
karypto's picture

"Wa wa we wah." -Borat

EN
 
Points)
 on 11/30/12 at 4:10pm
sanjose04's picture

Thanks for opening up this

IB
(Orangutan, 335
 
Points)
 on 12/1/12 at 2:24am
SanityCheck's picture

This is all my opinion but in

PE
(Gorilla, 633
 
Points)
 on 12/1/12 at 3:24pm

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Financier4Hire's picture

PE is facing other problems

PE
(King Kong, 1,112
 
Points)
 on 12/4/12 at 8:42pm

"The future isn't what it used to be "-Yogi Berra

"Perhaps you've failed to take into account my hidden assets"-007


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slowdive's picture

HFs are also having trouble,

HF
 
Points)
 on 12/4/12 at 10:10pm
DontMakeMeShortYou's picture

slowdive: HFs are also having

HF
(King Kong, 1,964
 
Points)
 on 12/5/12 at 9:44am

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Bankn's picture

slowdive: HFs are also having

(Orangutan, 286
 
Points)
 on 12/5/12 at 12:12pm
liquidityaddiction's picture

SanityCheck: This is all my

CF
(Monkey, 50
 
Points)
 on 12/18/12 at 3:45pm
sub0's picture

European banks will have to

(Monkey, 31
 
Points)
 on 2/26/13 at 8:03pm

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