How much of PE is just playing musical chairs with the same assets?
IB analyst here so might be off base, but it feels to me like PE currently is just passing around a bunch of companies to other PE firms at higher and higher valuations without any focus on intrinsic value. I’m in tech so maybe this is an industry issue, but it makes me a bit worried about a future career in PE.
In my last deal, a huge focus of the buyer (a big MF/UMM) was their ability to sell the company again in 4 years. They were literally focusing on what firms might buy it instead of improving growth/margins/etc. The play today is clearly buy something, do a bunch of bolt-ons (which again feeds into the whole PE ecosystem), show a ridiculous growth rate from these acquisitions and then sell the thing at an insane multiple. Every deal I’ve been on at my IB job has been this exact playbook.
None of the PE deals I’ve seen are making money off dividends, FCF to pay down debt, financial engineering, or any of the “textbook” PE money making plays. They’re literally just trying to sell the thing for more in 4-6 years. Hire a bunch of sales reps, juice EBITDA margins with some funky accounting, and get a great growth rate. Maybe once in a blue moon a company manages to go public or get acquired by a strategic, but my general take of the PE ecosystem today is KKR makes money selling their port co to Warburg and Warburg makes money selling their port co to KKR. Everyone is taught strategics should pay more due to synergies and so on, but every process I’ve been on PE bids are way higher than strategics, and my MDs often don’t even bother calling strategics because they assume PE will pay more, which just shows how much PE firms are overpaying now. At some point, it feels like the music has to stop and all these firms will be stuck with overvalued assets that no one (public markets/strategics) wants to buy and returns will go to shit, and the current success of the industry is just a cycle of PE firms raise more money -> PE firms deploy capital by buying expensive assets from other PE firms -> PE firms post great returns due to these inflated prices caused by competition among all the PE firms that just raised huge funds and have pressure to deploy -> PE funds use great returns to raise more money and the cycle repeats.
In an age of GP led deals and continuation vehicles, you don't even need other PE funds to trade with anymore
Yeah you pretty much hit the nail on the head, OP.
The fed increases interest rates.
If you want to really have your mind blown—see if your firm tracks multiples paid over the last 10 years. Notice how you could have bought a borderline garbage company and still made an absolute killing due to multiple expansion alone.
The simple truth is private equity and asset allocators believe beta is alpha. Most the returns these firms are getting is due to leverage and multiple expansion, not some unique strategic angle or intrinsic value. If you use leverage and prices go up, you get very wealthy. If the reverse happens, you get underwater very quick. The reverse hasn’t happened in 13 years.
Further, since you have people that are 13 years into their career who have never seen a correction, firms have big decision makers that are fearless (recklessly willing to pay anything) because it has worked throughout their entire career. Also, the field has been so successful as others have mentioned, everyone is just tossing their money in private equity firms and everyone and their monther is raising a fund because they don’t want to miss out. I was on calls as an analyst years ago where people where saying things like, “we know we will overpay, but we have too much capital to put to work” I can’t imagine how they must feel today.
It’s obviously a bubble and when it goes funds are going to be underwater and the industry will see some consolidation, but with this current fed who knows when that will be. Also, it’s not just private equity, you see the same thing in equities where companies like Tesla or really most tech companies out there are being bought because it has only gone up and no one has ever seen the reverse to be true. Despite the fact that anyone with a pulse recognizes the valuations of these public companies is so warped a 8 year old would say, “yeah, that doesn’t make sense”
Should have bought amc, Bitcoin, and invested in a private equity fund 10 years ago.
I get in this argument all the time. I tend to agree with you, looking at private equity as an asset class.
There still exist pockets of private equity that are alpha creators. When the GP applies unique, specialized knowledge or efforts that alter the course of the business such that the business's future cash flows grow, are de-risked, or both, then the GP has created value and should be rewarded for it. (A GP can still apply knowledge or efforts that aren't particularly unique - the "blocking and tackling" argument - and get paid for it, but then there's a fair argument about whether or not that's truly alpha-creating or if it's just regressing the earning potential of the asset back to the mean.)
"Gee, thanks, Layne," most of you are saying. No surprises in the above paragraph. The surprise, if there is one, is that those conditions are really rare in today's private equity marketplace, and even less so as you get into the middle market and up. The more that smart people with similar skillsets are chasing the same assets, the more the market bends to efficiency, and the less alpha is available to be captured by any one actor.
Inefficiencies still exist in the lower middle market, because the opacity of information about business performance and about risks can create information asymmetries that a GP can monetize. Unfortunately to me, it seems like often in this end of the market the information asymmetry is around value / purchase price, and a sponsor can end up paying an artificially low price for a business because the prior owner lacked the context of the market's view on value. When that happens, I would argue that the GP isn't really finding alpha, they're monetizing another party's information deficit and capturing an outsized portion of it for themselves (and their LPs).
I find that it's more rewarding to effect real changes in a business such that value has been created, and the asset is better as a result, and that additional value is what the GP gets paid for. It's certainly harder than the above scenario, but I get more intrinsic satisfaction from it.
OP you’re not wrong - this environment basically is a function of the last 10yrs where we’ve had a continuous bull market and insanely low interest rates.
Myself I work in PE (associate at a MM shop) but fortunately we’ve walked away from any ridiculously overpriced deals. However I have a number of ex-IB colleagues at mega funds who have worked on/been responsible for acquisitions over the last 5-6 years which I’ve thought were insanely overvalued. As much as I wanted them to do well, I kept thinking that as soon as rates started rising the value of these investments would get vaporised - and it was only a matter of time.
But that didn’t happen - in fact even some of the most overpriced acquisitions they made in 2016-2019 have since sold for huge multiples. These guys are now all VPs or Principals at mega funds and making close to $1m+ annually in their early 30s.
Don’t get me wrong, these guys are very smart and hardworking - but also they’ve definitely been in the right place at the right time (same for guys who made millions in the run-up to 2007). And not to discourage you/give bad news - but while I’m sure PE will continue to be a lucrative career for many years to come, I certainly wouldn’t bank on making the same $$ that guys (who are probably no smarter/hardworking than you) have made over the past few years. Especially if rates do finally start to go up.
I used to play musical chairs in PE class in high school
Now I'm on CVC Capital's sports investment deals