PE Firms With an "Moat"

Question for all the PE guys and gals out there. We spend our day looking at industries / companies, trying to identify companies with 'competitive moats' in attractive industries that have sustainable edges that allow them to preserve or grow their earnings power over time. Clear examples are tech companies that directly benefit from 'network effects' - Google, Facebook. It will quite literally take an act of the United States government to break up the de facto monopoly that is Google because the business model and the nature of network effects in the tech industry is extremely difficult to overcome.

So let's look at the PE industry. There is literally mountains of capital out there - and many new funds. Barriers to entry - while not as low as the HF world - aren't particularly high either. So my question is this - what are the firms with actual competitive moats? A lot will market their executive network, proprietary deals, sector expertise, but at the end of the day the majority of these firms are participating in wide auction processes where definitionally winning a deal means you decided it was a good idea to top the bids of 10 other highly savvy buyers at the high point in an extremely long bull run. 

What does a real competitive moat look like in PE world? Some thoughts to get things started:

  1. Actual deep sector expertise / network / sourcing - Silver Lake (tech) / Vista (tech) / Thoma Bravo (tech) / Leonard Green (consumer) / TSG (consumer) / Welsh Carson (HC) -? 

  2. Investment strategy not focused on broad auction / buyouts - Apollo 

  3. AUM scale to the degree where literally only a handful of funds can compete based on deal size / equity check being too big - Blackstone, KKR, Carlyle, H&F, EQT, Cinven, Advent - ?

What have you guys and gals seen out there in terms of sustainable competitive differentiation among buyout investment funds? 

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Comments (29)

  • Intern in IB - Restr
Oct 6, 2021 - 1:25am

Interesting thread. Could you elaborate on #2 and why you think Apollo is not focused on broad auction / buyouts? What are they focused on?

Oct 6, 2021 - 8:57am

Because Apollo is a value oriented / sometimes distressed investor. And you are not getting "value" in a broad auction process most of the time unless it's a busted process. Apollo tends to manufacture its own deals - that can be proprietary relationships, willingness to wade into hairy situations / companies / industries, or do public to private take-privates. In each of these, there is significantly less competition - if any which allows them to potentially get bargains. On the flip side, it can also take more work to generate a profit and there's always the risk what you're buying is a value trap (i.e., the asset you're buying is cheap because basically it sucks and is a secular decliner). They can overlay structure into the investment to mitigate that risk. 

Oct 8, 2021 - 8:36am

This is correct. Apollo doesn't usually participate in broad auctions given they don't get value from being in a competitive process where values are being driven up by various bidders.

  • 1
Oct 6, 2021 - 1:44am

Geographic focus on a niche market: Building local expertise can be hard, especially in emerging markets. There are many "local" PE firms that operate only within their home country and generate good returns.

Specialized ops teams: Having an ops team with good track record can go a long way when bidding, especially if its specialized (enterprise tech, lean, etc).

Data science: This is probably not quite realized yet for 99% of firms, but the ones that find ways to bring in alternative data (besides what you get in the data room) and perform unique analyses could have an edge in coming years.

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  • Principal in PE - Other
Oct 6, 2021 - 10:12am

1) Yes, but you can make such a long list of specialist firms with deep sector expertise and great networks that theoretically lead to great sourcing. In healthcare, for example, the list of "specialist" investors is a mile long. 1315 Ventures, Consonance, Cressey, Linden, NovaQuest, Orbimed, Questa, and Sheridan are all examples of healthcare-only GPs before you get to the GPs that have funds that only do healthcare (separate from other strategies that they have). On the consumer side, you can add Sycamore to the list and there are others I'm not thinking of right now. Veritas is tops in government services. 

2) Yes - but I've never heard a GP tell me in a meeting that they are focused on broad auctions. Everyone claims to have proprietary sourcing pipelines and says "only X percent of our deals came from auctions". That's of course part of what LPs diligence, but it can be difficult to fully evaluate those claims.

3) Most MF returns are the least exciting segment of the PE market. If you're a really huge LP, you're going to have exposure here because these firms can handle the size check you want to write, but if you're an LP that can avoid committing to MF GPs, you probably do.

I'd add a few other points where there can be a little differentiation:

4) Region, as somebody pointed out above. Every now and then I come across a LMM firm in the South or Midwest (outside Chicago) that has done really nicely by playing in its sandbox and never leaving. The partners there have solid deal flow because they hang out at the same country club as the guys who own regional businesses and when those family-owned businesses are ready to sell, the GP says "hey, how about you just sell to me instead of having to deal with some Wall Street finance shark with slicked-back hair who's just going to fire everyone who's worked for you for the last 20 years?"

5) Region also, but in emerging markets. Latin America, Asia... you want people who have the relationships on the ground, who understand the environment, etc. Since the markets there are less saturated with PE firms, you don't have to be quite as differentiated as you do in the U.S. or Western Europe.

6) I think true operating expertise is a differentiator and that's hard to build. I don't mean just having a couple operating partners, I mean something like Vista Consulting Group, TH Lee's Strategic Resource Group, New Mountain's various operating networks etc. It takes a lot of investment and a lot of time to build what's basically an in-house McKinsey, but if you do it successfully you align everyone's incentives much better which leads to more consistently good results.

7) People who develop an actual sector thesis. You don't have to necessarily be an industry expert like the firms in #1 but the firms that I've seen do top-down research, identify what they like about an industry, and then go try to buy companies based on criteria which comes from that research have had pretty good success. Kohlberg is a good example of this.

All of that said, there are so, so many undifferentiated middle-market buyout firms out there. I think Goldman hands them out to partners when they leave the firm instead of a more traditional retirement gift like gold watches.

Oct 6, 2021 - 11:04am

The operating moat is incredibly difficult to maintain with scale, especially once moving out of the initial/core specialty. 

It's what makes KPS so impressive IMO.

  • Associate 1 in IB - Cov
Oct 7, 2021 - 12:56am

Came in here to post KPS.  One of the few firms with an actual competitive advantage.  Would mention Strategic Partners on the secondaries side too.

Oct 7, 2021 - 1:08am

Yes their reputation is so good even unions love them. Pretty hard to do as a PE firm focused on turnaround lol

Oct 6, 2021 - 10:20pm

Blackstone uses data from across all of their portfolios to find insights and opportunities for their individual portcos.

That's something only the larger alternative asset managers can leverage (compared to the majority of PE firms that have a small handful of investments at any given time) and that's a big selling point for management teams that are rolling/receiving equity.

  • Investment Analyst in RE - Comm
Oct 6, 2021 - 11:24pm

PE firms that can facilitate large purchases of the target company's product by another department. I read about Brookfield investing in a few proptech businesses and rolling them out across their massive RE portfolio.

  • Associate 2 in PE - LBOs
Oct 8, 2021 - 3:10pm

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