Wanted to see what you guys think on where the PE industry is going given we have an interest rate again, maybe for longer than just a few quarters.
Seems like from the early days of pure leverage based returns, we have now been in a 5-10yr trend of returns driven across industries by add-ons and multiple arbitrage.
Buy and build is harder and more execution risk with a 4-5% rate and lower organic growth.
So more competition for the comparatively fewer assets that can actually support LBO on a more organic basis without acquiring their weight in gold each year? Funds closing down? Or what do you guys think? Hear there is a string of defaults coming in various sponsor platforms.
Here's my $0.02:
Entry multiples have started to cool. This implies a greater return, but nobody knows when this period of tumult and high rates will last. Interest rate inflections generally last ~10 years, this one is expected to only be 4-6 more months. I think the market will open for capital deployment, but nobody wants to mark down in such a high rate environment. The whole reason we had a secondaries boom is because a target 25-30% IRR is totally possible, even when paying intermediaries to unload your "slice of the pie" a few month or years early. So fund vintages from the last year and next two years will be lower than at present. The whole scale of returns will be determined by how hard the imminent recession will hit. On that note - I am not feeling too great for traditional buyout deal flow but there has never been a better time to be in turnaround, credit, or other low-sharpe segments of the business. Enterprise Software, Healthcare, and FinTech are mostly unscathed on the opportunistic "growth" side.
End Result: Cannot just use financial engineering, roll-up, or growth strategies on their own any more to raise large funds, and will have to get very scrappy to lock up money or risk having LP's determine their terms (EG: University of California taking BREIT for a ride). The cash flow of private equity is far from the most appealing and we will hopefully see some innovation to make up for it.
"this one is expected for only 4-6 more months" says who....?
Check out Page 4 https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20221214.pdf
Thanks for providing your thoughts.
CF of private equity meaning the CF profile of levered portcos?
I think you’ll see a lot of longer hold periods for sure. Already are seeing that and secondaries and continuation vehicles as you mention for partial liquidity.
What are you talking about with your point on secondaries? Maybe I just don’t follow your terminology. Can you explain the paying an intermediary for your slice of the pie sooner piece? Like running a sale process / giving up equity to a third party in exchange for partial exit?
You already have the warren buffet model of just becoming a company that owns cash generative businesses propagating through the PE industry, especially in smaller start up funds. Might be a mode of operation for the MFs and UMMs in a rate environment.
And true - many expect rates to drop in the second half of the year. We’ll have to see ultimately, here’s definitely hoping.
Yes, the cash flows and liquidity optionality of Private Equity are not sexy compared to absolute return vehicles, but the total returns are.
As for secondaries, my reasoning is that the option of using a secondary process or rushed exit in this market inherently waters down your return as you are typically repaid a lower multiple for the privilege of a shorter holding period to spread your gains across [EG: We'll take a certain 25% IRR now as opposed to an 30%(+/-)10% IRR later]. That "exit door" no longer exists, and the liquidity that was snapping all of those assets up (EG: institutional LP's) is scared and in hiding.
I've seen the "Buffet / holding company" model take off recently at LMM and MM firms near me. Not a ton of growth op's in those "cash machine" style businesses as far as I can tell, but if you've got a portco and can't unload, might as well send it to work instead of getting murdered on exit.
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