Monte Carlo hadn’t seen a drop of rain in four weeks until the private equity set turned up. The glamorous beachfront home of the Capital Creation conference was pounded by storms for two days. The slate grey sky fit the mood perfectly as many at the event complained of working extremely hard in 2009 but making no traction in deals or fundraising.
Several speakers noted the stickiness of asset prices. Nigel McConnell, managing partner and chairman of the advisory investment committee of Cognetas, blamed the situation on the government support of the banks, arguing that whereas in normal recessions prices take between 12 and 18 months to adjust, public money has artificially kept prices up, meaning company owners are under no pressure to sell.
Combined with the lack of leverage – which McConnell believes will take two to three years to return to traditional levels – this has placed GPs in a position of cost cutting and cash conservation, deciding which portfolio companies to support with follow-on funding and which to sell or write-off.
Of those companies that remain in private equity hands, many are facing operational difficulties, leading to many buyout houses to embark on a hiring programme of senior figures with hands-on experience. In this market, operations-focused firms like Oaktree Capital are doing well. Rick Krens, vice-president of European principal opportunities team, said: “Oaktree stays close to its portfolio managers and is operationally focused, always engaging management. We operate a very clear incentive programme which runs throughout the company from senior to lower level.” Ian Croxford, the group operations director of StockSpirits – one of Oaktree’s portfolio companies, said: “It is useful to have our private equity investor as a sounding board. For example, we recently reviewed our Italian business, downsized and got rid of two thirds of the workforce. It was difficult work but was good to have Oaktree’s support.”
It is certainly a market for operational specialists and that fact hasn’t gone unnoticed by LPs either. Jean-Charles Douin, a principal in the London office of Teacher’s Private Capital, the private investment arm of the C$87.4bin Ontario Teachers’ Pension Plan, said: “Now is the time for us to find the right teams. Some teams grow, some restructure. We are currently identifying managers without the right skills in this market and making sure that they [those with missing skills] hire the right team. We are also working on change management at the GP level, making sure we have the right managers in place.”
The most popular place for LPs to trim and refine the GP teams represented in their portfolios is the secondary market. According to Andrew Sealy, managing partner of Campbell Lutyens, “some funds were trading at a 60% to 80% discount but in the last two months those spreads have narrowed and the discount has narrowed to around 40%. Generally vendor expectations are down and prices are up”.
Christina Pamberg, investor relations manager of KKR, offered some anecdotal evidence that LPs are trimming holdings in the secondary markets in even the largest, brand name funds. Pamberg said: “There has been a huge step up in the granularity of detail in the requests coming from LPs. Today, investors drill down into the financing structures of the companies. They want to know the risks of unfunded money. As a GP we have a fiduciary duty to the selling LP. Legally we must make sure that we have no asymmetries of information for buyers versus current investors.”
Sometimes it is very difficult for a GP to know if the interest in its fund is coming from an LP’s primary or secondary team. Joe Topley, managing director of Parish Capital, said: “Having a primary and secondary business is a huge advantage. Without primary investments you are not going to get access to find out exactly what the covenants are and how close the companies are to breaking them.”
Greg Holden, a partner at Adam Street Partners, is also demanding more information these days. He said: “Run rates and earnings are either flat or down. The real uptick has been driven by public companies. There is no real change or improvements for private companies. The bid-ask spread is widening so there is a real need to dig down into the assets.”
US pension funds are optimistically and opportunistically buying in the secondary market, and secondary funds are pretty much the only private equity players that have been able to have successful fund raisings and closes in 2009. Kirk Beaton, vice-president of Lexington Partners, said: “There is great opportunity now in the secondaries market. It is the countercyclical option. Whenever a secondaries fund raising is announced in this market, investors are interested.”
The Capital Creation event revealed that the market is bleak for those buyout houses that are drudging along with the same old financial engineering ideas, but for those that have embraced operational turnaround at the GP level and secondary investing at the LP level, this market may prove to be very good. Shame about the weather, though…