Private Equity

Ok, I can't locate any specific thread on this subject so I am going to just start posting. This material might be of interest to some.

Understanding Private Equity (PE)

https://www.avcal.com.au/common/Upl...arks/2020 Q1 Website Australia PEVC - AIC.pdf

https://aic.co/AIC/Research/Special-Reports.aspx

Yearbook

Understand that AVCAL is the Industry's mouthpiece. Although I have an interest that is co-invested with PE I am absolutely not necessarily pro PE vs Public Markets, and I hope to use this to work through my thinking on this.

Contrary view point ;

Private Equity: Overvalued and Overrated? - American Affairs Journal

Dan Rasmussen is also talking his book, Verdad Capital runs a levered Small cap fund. I am sympathetic to what he is saying having seen the multiple and debt expansion over the years (fueling returns)

For those that consider the class still uninvestable outside of large retail / industry super or family office size investments (ie. $5m+ per fund) and of no importance to know about, that is no longer the case. I am aware of a fund of funds focussed on Mid market buy-out / later stage growth that places funds with the large well known players in the space, ie. Quadrant, Champ, Anchorage. They will take min $100k with a 4 year lock up.

Lets see where this goes.

 

Not much discussion here yet it would seem

I don’t have anything of value to add, so I should sit back and listen, but hey that doesn’t generate any discussion.

So, my take when I considered the category.

Couldn’t find any way that I could add value, I was at an information disadvantage to the fee takers marketing and managing the funds and Vendors offloading into the funds.

I don’t buy into the marketing that any real ongoing operational management expertise is bought to the table by the private equity managers, to me it seemed to really be about the in-going transaction, the leverage and optimizing financial structure to take as much cash out before the exit transaction. Even if they did have a good business passing through the model their time frame precludes multi decade full value realization that I prefer.

Lack of a market price to set the underlying asset price, Instant gratification focus, leverage, leverage, leverage, high fees, Information disadvantage to the investors. None of it appeals to me as a hands-on active investor. From a passive point of view, it might warrant consideration from a tilt; alternatives; factors kind of perspective. But I have found my happy place with passive being very simple, low cost and broad. So being a dumb supplier of capital to private equity no matter how geniuses the marketing portrays them to be is a no for me with my current level of insight and approach to investing.

While times are good a few crumbs will be left for the investors but most of the excess return which overwhelmingly is a result of leverage will accrue to the fee takers. When the party stops and the leverage slices the wrong way, investors are left holding the can. Maybe I’m too cynical, cautious or uneducated but currently, I reach for the most important defense in my bag on this one and declare it “not my game”.

I am happy for others to invest though especially on those odd occasions when it serves the purpose of transitioning a good business from private to listed and hence into my field of play.

My opinion is based on pretty shallow understandings and open to change if a more thorough understanding dictates so, as such I am interested in your posts on the subject.


Cheers

 

Cheers @dunno . My interest should be viewed from an asset allocation perspective, rather than through the lens of an active equities practitioner.

My bear case thoughts with regards to buy-out / late stage growth PE, the opposite end of the spectrum from VC which is a total punt imho ;

- Historically, Buy-out PE provided an alternative exit to trade sale for sellers in the $25-200M EV range, bringing cheap capital, and some operational expertise. They often paid a little more than trade buyers (5-6x multiple and levered at about 2.5-3x debt to EBITDA) and gave exiting owners a potential upside story with retained interests...this was still cheap and a good strategy.. The plan ; cost out, ebtida up, flog it at higher multiple to trade or IPO on improved earnings. As half acquisition cost was debt, the ROI was tremendous. I saw this happen with former employer in 2005.

- What i've seen happen over time is that competition has increased, in order to present same ROI to the market when forced to pay more, PE needs to apply more leverage. I look at present employer which PE bought in 2016 at 10x multiple and 5x debt to EBITDA.

- higher multiples and higher debt levels work well for a time, however at some point the music stops. When holding you love the growing multiples, and even when buying its ok as long as they keep going up. A lot of the debt now comes from expensive private credit.....banks wont lend at these levels. guess who runs most of the private credit funds?......and private credit costs a lot more....lots of alarm bells here.

- so that leaves operational performance i suppose.....in reality that is cost out, underfunding longer term growth intitiatives... R&D etc. So, who buys from PE ? Trade buyers are leary.....and AU experience with PE IPO's has been horrendous. So all they can do these days is offload to another PE shop! Value creation must come from operational performance, PE owners typically add little value aside from at exit stage(personal experience).

- the other issue we have is that PE is very opaque....you dont realise a loss until you sell right? anecdotally it seems that PE is stuck holding a lot of stuff that they cant exit, so they kick the can down the road and talk about making operational improvements....and they decide valuation. You cant see what smoke is going on.

- Implementation is problematic...performance dispersal seems to be significant, so you are either punting on the PE shop, or you seek diversification via fund of funds with additional fee overlay......there there is the lock up... min i've seen is 4 years via FoF, but will likely drag on much longer.

 

Ok, the other side to that coin is historical performance ;

https://www.avcal.com.au/common/Upl...arks/2020 Q1 Website Australia PEVC - AIC.pdf

Which could largely be replicated via fund of funds less fees of say 125bps. There is nothing to say that there aren't going to be a few more puffs left in the strategy , and of course some operators will do well.

Though all in all I think the game has changed to where the main driver of return is leverage now, and there is a lot of lipstick on this pig. Applying 1x Leverage on XJO would provide a similar return of 9.4% vs 10.6% over the last 20yrs allowing for deduction Bank bill cost of borrow and FoF fees....if one was that way inclined
@dunno thanks for your input mate.

 

Public to Private Equity in the United States: A Long-Term Look August 4, 2020

https://www.morganstanley.com/im/pu...uityintheusalongtermlook_us.pdf?1596549853128

Introduction

Over the past quarter century there has been a marked shift in U.S. equities from public markets to private markets controlled by buyout and venture capital firms. This change has had reverberations for asset managers,investors,executives, and policy makers. In this report we seek to answer the following questions:
•What have been the major drivers behind the shift from public to private equities in the U.S.?
•Why are there fewer public companies today than there were 25 years ago?•What are the long-term trends in buyouts?
•What are the long-term trends in venture capital?
•Where do we go from here?


Executive Summary
...

 

I’m in a similar situation with a US based employer (Software Company) owned by PE.

Since 2011, we have been majority owned by a retirement fund with another PE firm holding a 25% stake.

My investment started off as employee incentive shares, although over time have invested my own funds, Current value around 12% of our portfolio.

$10k investment in 2011 has produced $22k in distributions and currently worth $41k so ROI been good, although I worry whether it can continue to provide future returns at this level. It is nice to have some skin in the game with the success of your employer.

Debt has been increasingly used to fund acquisitions (currently 5x EBITDA). Transition from perpetual to subscription licensing has been used to increase valuation due to the recurring revenues giving a high multiplier on the valuation.

Quite illiquid, requiring either resignation or a liquidity event out of my control.

I see it as a bit of a punt for a more comfortable retirement. Don’t think I’d invest in PE outside of employment though. Too illiquid and opaque

 

I’m at 16% of net wealth excluding our home exposure to single asset investment, which came about as of business sale. Apparently intention is for liquidity event in 2022. This would likely be another PE sale then set up for IPO in Europe after another 5 years or so.

Meanwhile, the company has just raised more debt capital to fund acquisitions. Gives me some interesting work to do on M&A side but to be honest it’s a high risk punt and I’d rather take my money off the table now but I’m strapped onto the saddle! Just holding my breath.

 

Sounds like we are on a very similar journey. M&A is definitely interesting work, I've been involved directly in a number of them both pre and post transaction.

Only getting a fresh valuation once a year or so takes volatility out of your mind somewhat as well. My employer is highly profitable and quite boring really from an investor standpoint. I could never quite bring myself to put the same cash into something like TSLA instead for a real rollercoaster ride and bigger payoff.

 

We have an internal val twice a year, but it’s all academic until a liquidity event. I’ve got seven figures in this one and all I’m asking for is 2x over 3 years. Hell, I’ll take my money back and be happy as not an investment I would have made without the biz sale.

 

My PE journey has come to a crossroads with a liquidity event created by a PE sale to a new majority shareholder.

Will need to decide whether to take some or all of the return off the table and invest in something more boring and transparent like index funds or to take another spin at the casino with the next liquidity event likely to be an IPO.

I think I’d be more frustrated to take the money, continue working there and miss out on a future windfall than to take another spin and lose.

 

Update, internal revaluation after 12 months ; +32%.
2020 was a good year for the business. Just need to eek out a similar result in 2021 and I think we are looking good for 2022/23.

I’m working on some decent acquisitions locally thst should complete this year - will be 2-3x accretive just on P/E arbitrage...should give us a kick along.

What did you end up doing here mate?

 

As an aside, through family connections I’ve recently got to look at some “friends and family” tranche Private debt / equity opportunities, this is typically subordinated debt or preferred equity for development or buy-out capital for businesses attached to real assets (i.e. Pubs), every deal is different and has to be assessed on merits of lack thereof!

This is pretty interesting stuff ; it’s really small scale, with total deal size often around $5-10m with only around 20-30% as preferred equity, so very much sub Insto level. Usually c.50% of capital is 1st mortgage, typically bank. The key is in the deal structure. I’m finding this pretty interesting and could see allocating 5% of portfolio to it. You are typically looking for 20% IRR on these deals.

 

What did you end up doing HM ?

In our case organic business performance has been outstanding in addition to accretive acquisitions, which means I expect internal valuation to represent 3-4x on Cash over 2 years holding when next revalued in January 2022. To be honest though while the music is still playing I do hope for an exit in 2022 as it feels like the hand is in the fire at the moment!

 

Don't be fooled by private equity returns | The Evidence-Based Investor

This piece talks to something I haven't seen anyone try to quantify. Namely, the reported IRR achieved on deployed funds in an "at call structure" be it Private Equity, or Private Equity type Real Estate deals varies markedly from what is experienced by the investor when the "at call", non deployed cash is factored in.

An understanding of this concept is useful for those that invest tactically in debt instruments, say single asset mortgages as well as single asset real estate. One way to address the issue is to use a LOC as opposed to cash for these type of investments, albeit resulting in higher risk levels. The alternative is to focus on constant exposures rather than tactical. Food for thought perhaps.

 

This and the illiquidity have always put me off. I have friends who have done very very well in pe shops, but its not for me - maybe sour grapes.....

 

Took some off the table and pumped it into non concessional super contributions and SCV ETF's outside super.

Reinvested some back into my employer to continue to have some skin in the game. My role also expanded globally this year so want to have some reward at the end of this. We are getting large enough that the next liquidity event could be IPO. Hoping for this in the next 3-4 years.

 

I don't think this applies to me as an employee investor. This is more about PE funds which hold non deployed cash in search of the next acquisition. Is a SPAC similar?

 

Correct, doesn’t apply to you. My presumption; you are not an investor in a fund, but a co-investor with PE in a holding company that owns your employer. That’s my situation also.

Applies to those considering investing in a PE fund.

Basically it works like this ;

1. Commit to fixed $ amount investment
2. Fund will call on that investment amount in stages (Capital calls)
3. From initial to final call is often 2-4 years but will vary.

 

How’s it traveling HM ?

 

Update ; Job done. 4.32x on January 2020 investment. 2022 exit was impossible due to Ukraine and subsequent inability to raise debt at viable levels.

Have now been offered Management Incentive scheme by new PE owners which is heavily discounted equity package…basically 2.5x return of the institutional (common) equity but investment amount is capped.
Still extremely attractive on risk / return basis.

It’s been amazing seeing how the continuation investment has worked with PE. Example ;

Original Business Sale = 100
Reinvested = 15
15 x 4.32 MoM = 65

85+15x4.32 = 150

Reinvestment 2 promises to be greater MoM return on lower investment amount. If all goes to plan should see a total return from reinvestments 1 and 2 approx equal to what we originally sold the business for in 2020. Didn’t really expect the additional “bites” so I’m pretty happy with how it’s worked out so far to say the least! All the while have been diversifying and derisking. Happy dayz.