Читать книгу The Private Equity Toolkit - Tamara Sakovska - Страница 27

Have you ever wondered how a deal actually originates? What factors propel private equity activity? And why do deals come in waves? The reason why I care about these questions is the following: if you understand what emerging trends are likely to spur private equity deal activity in the near future, you can focus your deal sourcing efforts on this arena and position yourself ahead of your competition. In other words, if you are more observant than others, you can try to figure out where deal activity might happen much earlier than anyone else.

One of the intriguing aspects of private equity deals is that they take place in both good and bad market conditions. Theoretically, most private equity deals should happen in a bear market. When the IPO window is closed, the public markets are pessimistic and banks are less willing to provide debt on attractive terms; thus the shareholders of target companies should view private equity as a more appealing financing option. This theoretical argument can be extended further: private equity funds themselves should be able to take contrarian views in a bear market and seek to invest heavily in a down cycle. This will allow them to pay relatively low entry valuations and generate attractive investment returns. Does this happen in reality? Not as often as it should.

My observation is that private equity activity as a whole ends up being quite pro-cyclical. Of course, there are disciplined private equity investors out there who abide by their strict valuation criteria and who avoid investing at the top of the cycle. However, most market participants are human and, therefore, are likely to succumb to hubris when they observe rapid economic expansion and rising stock markets. Valuations are high when the markets are optimistic; however, one can always justify paying a full price for a good business. A deal frenzy begins and eventually swallows the majority of market participants. This explains why deals come in waves.

Since little research exists that links emerging trends to the private equity activity, I found it useful to look at the field adjacent to our industry, namely that of mergers and acquisitions (“M&A”). There is an outstanding book by Bruner (2004) that, in addition to discussing nearly all key areas of applied mergers in impressive detail, addresses precisely this topic. Bruner (2004) looks at what drives the M&A deal activity and identifies areas of “economic turbulence.” Some of these factors provide a good explanation of the private equity deal activity and are useful to keep in mind in your deal sourcing efforts. They are as follows:

 Geopolitical change. Political decisions can radically change the attractiveness of certain markets. Any shifts in policy that affect the prosperity of the economy, taxation, social environment and corporate governance will have profound implications for private equity transactions. For example, I owe thanks (and deals) to the following geopolitical developments that influenced my private equity career: the introduction of the single currency in the Eurozone, the inclusion of certain Central and Eastern European states to the European Union, the admission of China to the World Trade Organization as well as market deregulation reforms that followed the economic liberalization in India.

 Secular trends. Examples of secular trends include long-term shifts in the demographic makeup, the need of labor migrants to sustain economic expansion, vast differences in wealth distribution across generations, rising obesity rates and distinctive preferences of younger consumers, just to name a few. Any sustainable long-term macro shift could provide a fertile ground for investment.

 Changes in regulation. Deregulation is typically very beneficial for businesses, as their growth becomes less constrained and they can play by the rules of the market economy. Companies typically need to rationalize their operations in order to compete. On the other hand, when regulation tightens, businesses often have a need for fresh capital in order to comply with the changes that might be as extensive as having to adapt their entire business model. There are second-order effects too, such as the rise of new entrants providing tools and services that aid compliance in the new regulatory setting.

 Technological change. Do you remember how the world worked 10 years ago? Technological advances can be very disruptive for companies. Apart from requiring additional investments in infrastructure and personnel, technological shifts might compel companies to alter their strategic direction and invest in new capabilities in order to survive.

 Innovation in financial markets. Increasing market sophistication has a direct impact on the private equity industry. Examples of complex transactions that added fresh momentum to the sector include the advent of the LBO and securitization of leveraged loans. The introduction of certain structural features in private equity transactions such as a “sale and leaseback” has been replicated across numerous private equity–backed businesses that own hard assets.

 Changes in capital market conditions. Buoyant markets enhance deal activity. During record market highs, even businesses with no earnings, no revenues and, sometimes, no customers get bought and sold. When the markets are very liquid and are forgiving of corporate shortcomings, hubris takes over the world. As I mentioned earlier, private equity activity, at least theoretically, should abate. It does eventually but, as a rule, a little too late.

There are a couple of other deal factors not mentioned by Bruner (2004) that are important to include in this discussion:

 Industry disruption. Private equity firms are generally enthusiastic about backing industry disruptors. Traditional classroom education providers, retail banks and insurance companies are examples of industries being disintermediated by new entrants backed by private equity investors. However, it would be fair to mention that private equity funds sometimes fail to spot a terminal inflection point in the industry and let disruptors attack companies in their own portfolio. For example, some of the biggest losses in private equity occurred when the business models of music publishing and brick-and-mortar retail companies were completely dismantled by the online competition.

 Sectors with substantial capital requirements. Sometimes there are entire industries that announce large capital expenditures that will need to be incurred by companies operating in that sector. Examples of such capital investments include purchases of new spectrum in telecommunication auctions, the move to hybrid or electric engines in the automotive sector, the development of new techniques to extract fossil fuels and financing the gradual switch to alternative energy sources in power generation.

 Applying successful business strategies to new industries. Private equity excels at identifying proven business models that can be applied to new sectors. On-demand services, asset-light operations, outsourcing, “buy and build” strategies are just a few examples of what has been replicated across industries. Private equity investors look for appropriate business analogies and think: If restaurants operate as a chain, why don't nurseries or schools operate as a chain?

 Replication of successful deal types in new geographical markets. When private equity arrives in a new geography, especially in emerging markets, first deals tend to happen in telecommunications, breweries and branded consumer goods. Why? Because straightforward deals happen first. Private equity funds always seem to be keen to pursue proven investment theses in new countries where there are enough imperfections to warrant a high return.

Is this an exhaustive list? By all means, it is not. You can probably come up with additional factors driving private equity deal flow that are relevant to your industry or geography. It is always worthwhile to keep a close eye on any emerging trends in order to anticipate potential transactions and stay ahead of your competition. As soon as you identify the areas of so-called “economic turbulence” that seem relevant to your investment mandate, rush to your desk to research them so that you can spot future deal flow before anyone else.