Cashed-up private equity firms warned on overpaying

It means competition is fierce. And the funds are at risk of hunting for the same assets with stable earnings streams, a fixed cost base and motivated sellers.

Funds and their investment banking advisers say the challenge in the coming year will be to come up with innovative structures that play to each fund’s specific mandate, which are becoming more niche as the market matures.

“Having that differentiated insight or capability can be the real difference between paying the extra 1 per cent to win a deal. Everyone is very competitive,” TPG’s Australian boss Joel Thickins said. Mr Thickins is finalising the purchase of listed pets and vets business Greencross.

TPG had previously invested inPetco, the largest pet care retailer in the US, where it doubled store numbersand lifted earnings four-fold.

Pacific Equity Partners co-founder Tim Sims says private equity is increasingly differentiating its performance on strategy.  Louie Douvis

Maturing market

In 2018, there were 58 completed PE deals at a total value of $6.9 billion, according to the Australian Private Equity and Venture Capital Association Limited (AVCAL).

The top five announced sponsor-related transactions were worth $US10 billion compared to less than $US6 billion the previous year. The figure excludes the$US9.5 billion WestConnex transaction led by Transurban.

In deploying their capital, private equity firms were poised to increase pressure on corporate boards, often by buying more stock in the target company or employing innovative deal structures.

Funds such as KKR outlaid nearly $400 million to buy a stake in MYOB before making a takeover offer, while Ben Gray’s new fund BGH capital teamed up with AustralianSuper to bid forprivate hospital operator Healthscopeandeducation business Navitasin a controversial structure that prevented the super fund from accepting any rival deal.

Mr Thickins said private equity has moved on from the traditional model of leveraging up, stripping out costs and flipping assets. He said the local market is in what he calls “PE 3.0” where performance is “driven by strategic investing around themes, operational value add, or international expansion”.

Pacific Equity Partners’ Tim Sims agreed funds were more targeted, saying it was proof of a maturing market.

“Typically, as PE markets develop over cycles and over time; different strategies are tested and refined,” he said.

“This testing process tends to bring increasingly well-defined and stable segments in the market with individual players that tend to outperform others in their chosen space.”

Testing the boundaries

Globally, the local market is under-represented in terms of private equity activity, typically accounting for about 15 per cent of M&A activity compared to 30 per cent in more established markets.

One reason may be because the so-called secondary markets – where private equity firms sell assets to another private equity firm – are shallow in Australia. Although that is expected to change.

Private equity funds are expected to invest with their own investors, including super funds, which are also seeking to deploy large volumes of capital.

“Increasingly large and powerful super funds … are naturally and properly motivated to test the boundaries of their business model,” PEP’s Mr Sims said.

That may reduce the need for “club deals”, where private equity investors team up with each other to buy bigger businesses.

“I think that’s more unlikely than likely. The more probable outcome is PE firms bringing in their investors into the deal,” said Mr Thickins.

Industry shedding past image

But as recently as December 20, PEP and Carlyle were understood to be teaming up tobid for Campbell International.

“Firms are looking at creative ways of deploying capital and increasing deal protection. It should be an interesting year in that regard,” said Tim Freeman, Goldman Sachs’ head of financial and strategic investors.

Add-on investments, teaming up with corporates, and structural flexibility measures such as minority investments and longer investments were some examples.

“I’d expect investment activity to really accelerate. There’s a pipeline of investable businesses,” AVCAL chief executive Yasser El-Ansary said.

But at this golden hour, when private equity seems poised to play a bigger role in capital markets, has the industry shed its image as barbarians at the gate?

Mr Thickins said that stereotype is gone. “Sophisticated boards understand that each private equity company is different, and each person they are dealing with is unique.”

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