I'd like to revive this discussion from 2012.....
http://www.wallstreetoasis.com/blog/an-ocean-of-c…
It seems particularly pertinent given the PE recruiting cycle. I've attached some charts from a presentation given by the CIO at a firm in the 75th percentile of the PEI 300. The last two slides are from another source and attempt to critique the "conventional wisdom" tenets as to why LBOs produce solid returns as they apply in the current environment.
The LBO private equity industry has become incredibly saturated. The PEI 300 was the PEI 50 in 2007. The abundance of "dry powder", competition from other investment platforms and new LBO shops has driven up LBO purchase price multiples. Can the returns of the past really be replicated in this new, wildly more competitive (and expensive), environment?
I am at a boutique industrials M&A shop and, while my experience may be anecdotal, we are seeing a significant disconnect between the supply and demand for new opportunities. We regularly get inbound requests from shops all across the PEI 300 spectrum (I'm talking like from the very top) to source new opportunities. While M&A activity in my sector, which has historically seen significant LBO activity, remains relatively high (>90 deals closed in 2016), the LBO share of those deals is extremely low (10%). The assets that are being acquired by PE are in the least attractive sub-sectors and likely have very limited upside.
Given this context, are traditional LBO shops really all that attractive for the long term in spite of the competition for spots? Is everyone just chasing the prestige of having worked at KKR, Apollo, etc.? While I understand the appeal of working for an LBO shop (i.e. better pay, better hours, etc.), might it not be better to continue in banking (for more that 2 years) and really get a taste for the hustle required to win business? Even at LBO shops, as competition increases, senior investment professionals have to hustle increasingly harder to source opportunities.
What do you think?
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| Challenges Facing Private Equity 220.85 KB | 220.85 KB |
I think the last slide of the deck has a lot of merit. There's a solid argument for the value components of traditional LBO either getting competed away or priced accurately, either way reducing the upside for those doing the buying.
I was talking with the partners at a middle-market PE shop earlier this week, and I think they're indicative of an investor type that is always going to have a competitive edge. A couple elements have to come into play:
--the target is at a growth stage where some strategy & operations formalization is a value-add (which means the PE firm has to have enough sector & operations expertise to achieve that value over and above what another owner could, and I think that's pretty tough for a generalist to accomplish anymore)
--there's a risk disconnect between ownership & future owners, like when it's a closely held business and the owner wants to cash out to protect the value that's been created
--bonus for buying the asset outside of a process, so you capture the value that would have been auctioned away by using a competent banker
--extra bonus for information asymmetry between this investor and others, where some network of contacts gives them insight into a rollup thesis that someone outside the sector wouldn't or couldn't capitalize on
I think this kind of PE setup is always going to exist to some extent, and it'll always be profitable because participation in it is capped by the scarcity of sector and operational execution expertise. But that's a fairly minor segment of the greater world of PE, and I have a hard time believing that a lot of the bigger generalist shops (especially ones that rely on PE-to-PE handoffs) will continue to exist to the extent they do today.
I am in CF at an acquisitive industrial company and I often wonder how PE companies compete. The short answer is that they likely have different targets than we do, but realistically, if it's even close to any of our markets we'll take a look at the company.
When I look at our models and the synergies that a PE company could never achieve (and a decent chance we won't either), our relatively low cost of capital, our industry knowledge, the growth we're chasing, and the multiples we're ultimately willing to pay, it just doesn't make sense to me.
Obviously, if the PE company gets to an owner before we do and seals the deal, there could be tremendous upside (when they sell to us in 4 years). However, I have to assume that this is fairly rare. Any owner who has thought about selling their business will do some homework and try to maximize their returns.
The other thing that makes me laugh is that rarely does a PE or IB have better information than the people operating in the market. We had a BB in here pitching our president a month or so ago on a few ideas. The ideas weren't bad at all, but we are so far ahead of them and what they think is "coming" that their "insight" was useless. We already know that their biggest pitch to us is useless (for reasons you can imagine).
I truly believe that PE and IB are full of very sharp people and have their place, but the future is contraction rather than expansion. Not exactly the same, but I happen to have similar thoughts for consulting. Companies are getting smarter, cheaper and thus, handling more things in-house. It's just getting less likely that we need a BB to advise us on buying a company for 10x or MBB to tell us how to sell to our distribution network.
That can be the case and that can add value. The 2 F500 companies I've worked at generally didnt get this value from bankers, but I'd assume some should. And while they will definitely have some market knowledge, to assume we wouldn't already have it won't always be true. As I've moved up I've been amazed at how much we know about competitors (and I'm sure vice-versa). These are the things that are top guys stay on top of, either through trade shows or meetings, they know how most relevant companies are positioning themselves.
One of our main sources of information is customers. Almost anything you say or do to a customer you can assume the competition knows about. This is how we get most of our information related to Products and Operations.
I'll keep it very vague, but this is the overview of the last BB pitch we got:
BB item 1: We really think company XYZ would be a great acquisition target for you guys. Given that the owner is aging and pursuing other interests we think he's ready to sell and you could get it for $100,
(Reality is that we've been talking with company XYZ for years and our President who's only been on the job 4 months has already visited 3 times. They won't sell to our main competitors, but he still turned down an offer WELL above the $100).
BB Item 2: There is another PE-backed company in an adjacent space that could be of some interest to you. We have an indication that they'll start looking to sell in ~12 months.
(Our President had a meeting with the PE company at the big trade show last month. They are working on a few strategic items and then plan to sell in about 18 months. Our President will be the first call when they're ready).
The BB asks us what we're interested in and we tell them that we'd look at anything in our space. They agree that they'll call our President whenever anything comes up.
So, the meeting wasn't a total waste and the BB's ideas were good. However, they really didnt tell us anything we didnt already know. IF we were less acquisitive or a smaller player, this probably would have been very useful, but I think at least the major players have a pretty good knowledge of what's going on.