Over its long history, Thomas H Lee Partners honed a strategy of investing in mid-market companies in financial services, healthcare and technology and business solutions.
The Boston private equity firm is today investing in this strategy through funds that have raised more than $6 billion over the past 12 months, co-CEO Scott Sperling told Buyouts. They include a recently launched ninth flagship offering.
Buyouts sat down with Sperling to talk about Thomas H Lee’s strategy, opportunities and pitfalls in the post-covid recovery, and how tech acceleration and vaccine innovation will shape trends. He also shares thoughts on how PE has changed since he got started as an investor in the 1980s.
In what ways has THL’s sector-focused strategy evolved over time?
Our strategy has changed mostly in the intensity and granularity applied to where we invest and how.
We’ve tried to maintain an exclusive focus on our ISOs [identified sector opportunities]. It is in these areas that we have superior domain expertise and can differentiate companies that we think deserve certain levels of pricing from those that are more “sounds alike” but are not really alike.
As part of this, we have built our competitively advantaged knowledge. This involves both developing the experience base of our investment team and constantly attracting individuals who have operated for decades within our ISOs, often in C-suite jobs.
We spend a lot of time upfront accumulating knowledge and relationships in a given sub-sector and we use them to target and find a first deal. We use our operating talent to ensure the deal is successful – that the company is able to accelerate revenue growth, cash flow and profit growth. We then use our success to source the next deal in that ISO and then the next. Good begets good.
By taking this approach, we have gone way beyond sector specialization. We’ve gotten to a point where we are able to very early on identify a sub-sector – like automation or segments of pharma services – with attractive, sustainable growth characteristics and that is large enough to do multiple deals.
If you look back over our history, you will see investments where the commonality is our ability to identify a sub-sector with sustainable growth and then build a company that became a leader. A good example is Fisher Scientific [a provider of lab supplies], which merged in 2006 with Thermo Electron, which went from $1.5 billion of enterprise value to more than $200 billion.
Another is HighTower Advisors [acquired in 2018 and moved into a continuation vehicle last year]. Our team identified wealth management as a place where the dynamics are changing, found HighTower, and saw an opportunity to take a really well-constructed platform and make it a leading industry consolidator.
Other aspects of our strategy have not changed. While we can be flexible, we are predominantly a control investor – one that can be the best possible partner to management teams and minority investors. That is something we feel we have gotten really good at over 20-plus years.
How did THL fare during covid? What is your take on the emerging post-covid market?
In our sectors of focus, the impact of pandemic-related shutdowns was somewhere between neutral to positive.
For example, the acceleration of the digital world, including the move to automation – to deal with everything from labor shortages to taking routine tasks so employees can focus on higher-value tasks – became a more widely recognized opportunity set. As we come out of it [the health crisis], I think we’re continuing to see benefits from both the vulnerabilities and opportunities that covid highlighted.
In today’s environment, as prices continue to go up, our emphasis will be on keeping our head down and investing heavily in capabilities to create our own deal opportunities. This has been a successful formula for us in times of increased competition. It has helped us make rational decisions about the price we pay for businesses based on their estimated growth rates.
There is no doubt we’re seeing more and more things being priced at levels that our analysis tells us exceed where the intrinsic value of a company might be. We’re trying to stick with a discipline of paying a multiple that in an absolute sense may be high, but only for companies that can sustain rates of cash-flow growth that are commensurate with that multiple.
How much money can you put to work maintaining this discipline? That’s why we cap the size of our funds. We want to be highly selective – finding five to seven great deals a year.
We’re primarily micro-economists focused on the sub-sectors in which we invest. We believe the most important thing we’re doing is picking an asset in the right industry we can fundamentally improve. But there are macro-economic issues we have to be mindful of in terms of how they affect specific sectors and also their broader impact on cyclicality, which may alter secular drivers.
So, we’re focused on the effect of interest rates on multiples and the fiscal and monetary expansions that may push interest rates to higher levels. We’re constantly looking at the intersection of these macro issues with decisions we make about where to invest and what to pay.
How will covid-era tech acceleration shape PE dealmaking?
One of the things that happened during the pandemic was our increased use of virtual communications. This sparked a recognition that there were alternatives to traditional ways of doing business. The awareness was helpful and accelerated a series of secular trends in different areas.
Take, for example, healthcare: due to covid restrictions, there was a necessary transition toward digital technologies, such as telehealth, that were known to be available but were not broadly used. This created the opportunity to dramatically reduce healthcare costs by providing a lower-cost modality of care on a primary basis and, over time, by improving compliance.
Issues arising during the health crisis that forced us to use technology – both in our day-to-day work environment and in areas like healthcare – will have a long-term positive impact on private equity’s opportunity set. They will also have a positive impact on society.
We’ve long focused not only on picking the right industries to invest in but also on being on the right side of disruption – technological disruption, in particular. In deciding which sub-sectors to emphasize, it is important for us to pick ones where technological disruption leads to an acceleration in growth that goes well beyond GDP growth.
Our team got ahead of the world in identifying automation as a key enabler of the growth of e-commerce. We developed an early and significant presence as a private equity investor in a space that only had a small number of strategic players. To expand our leadership position, we decided to launch our first-ever, non-flagship fund [THL Automation Fund, closed in 2020 at $900 million].
One of our automation deals is AutoStore [a provider of warehouse robotics, acquired in 2019 and backed this year by SoftBank]. As we’re looking at ways to help automate parts of e-commerce enabling, we are targeting opportunities in attractive sub-sectors. AutoStore was the right vehicle in its area.
Will last year’s big vaccine advances create healthcare deal flow?
The vaccines were the first commercial expression of mRNA technology that had been worked on by several businesses for a range of diseases.
It was enormously beneficial during covid. It also provided a now proven pathway to a much bigger opportunity set by using mRNA as a platform for the delivery of different types of vaccines and therapeutics in oncology.
The technology that has been used involves a lot of complicated processes. So, if you believe there is going to be growth in this mechanism for the delivery of vaccines and therapeutics, I think there will be opportunities for private equity-backed companies to serve the companies that drive the innovation.
Our team is now exploring opportunities that build on the success we’ve already had in pharma services. Our goal is to figure out new ways to invest and identify new sub-sectors – and find the right asset – to help us ride the secular growth that is going to come out of innovation in mRNA, gene therapy and other areas.
There is a world of growth that is going to happen in things that are currently embryonic. We want to be able to get out in front of it if we can.
This is an example of where we’re trying to play for the long haul. Our typical deal takes anywhere from one to three years to put together. We haven’t been that successful at highly competitive auctions and most of what ends up in our portfolio comes about through our proactive deal creation machinery. We’re used to being patient and trying to understand things thematically.
How has the PE market changed over your career?
When I was with Harvard Management Company [manager of Harvard’s endowment fund], there was hardly anyone else investing in alternative assets. During the course of my tenure there [1984-1994], I saw the beginnings of private equity being seen as an attractive and separate asset class.
Since then, this view has become widely accepted. The nature of the tasks in private equity has also evolved over time. The intensity of the effort required to find attractive deals at prices that reflect intrinsic value has become an increasingly difficult enterprise, requiring much more expertise, much more domain-specific experience and a lot more scale.
In today’s market, if you can perform the tasks as I have described them, the ability to drive the kinds of returns we have provided our investors historically still exists. Every element of our business model has required greater and greater investment, but the payoff is every bit as good as what we’ve seen throughout most of the past 30-plus years.