"Team Europe" gaining momentum in global PE game, says Carlyle's Youngkin

Carlyle managing director and COO Glenn Youngkin, speaking at the EVCA Investor Forum, likened European private equity's current status against the rest of the world to the Fifa World Cup. And, despite a dismal first half it appears that Europe seems set to win the global game.

Delegates at the forum were asked what is the best private equity "team" when looking at continental regions. The poll revealed that Europe was by far the winning destination, accounting for 54.2% of the vote, against 32.7% for the US and just 9.3% for Asia.

Youngkin agreed with the voters, which comprised an even split of GPs and LPs. "Team Europe, in the global private equity world cup, is truly gaining momentum and the squad is looking awfully good for the second half."

Attractive pricing and scope for operational improvement create positive momentum

Youngkin equated the last five years to a 90-minute football game, with the 2009-2011 period similar to the first 22 minutes of the game. By this point in the match, team Europe was losing to the US and Asia by two goals. "While GDP growth in Europe was not too dissimilar to that of the US, the future expectations for the US looked much better, while Europe's outlook was cloudy." Indeed, during this challenging time, fundraising efforts by European buyout houses clearly highlighted investor's fading appetite for European private equity funds.

However, by half time (the end of 2013), Europe's recovery was clear: threats of a eurozone collapse had been removed and the forecast appeared brighter. Youngkin reckons that at this point in the game, Europe had managed to score two goals, while the US and Asia were winning by three.

A lot of the positivity for European private equity in 2013 stemmed from the belief that the economy had reached bottom, while realities of the continent's prowess were shining through: Europe accounts for a quarter of the global economy; Spain was no longer the sick man of the continent; and Germany reported the largest account surplus in the world. Furthermore, in terms of dealflow, European transaction volume grew 2.5x faster than in the US. And, this uptick in deals was despite the UK's drop of 24% – every other European market reported impressive increases.

So, in 2014, as we enter the second half of the game, momentum is shifting to Europe. "As of today, Europe has more upside than any other region in the world," announced Youngkin.

Pricing perfection
Carlyle's view is that Europe's economy is improving but crucially, pricing, especially in relation to the US, is attractive. Furthermore, Youngkin believes the region offers the most material opportunity for operational improvements. Carlyle's European portfolio companies have reported an average growth rate of 12.5% compared to Europe's GDP growth rate of 1%, highlighting that despite the lingering economic challenges, private equity houses can and are significantly developing their assets.

"European GDP has reached its inflexion point and this will do more than bring investor confidence; it will bring corporate confidence to sell non-core divisions and create better primary dealflow," said Youngkin. He pointed out that of the last six deals Carlyle has executed in the region, four were corporate divestments.

Valuations in Europe remain at a meaningful discount, down 23% compared to US average valuations. And attractive pricing is clearly reflected in stock markets performance – the recovery has been driven entirely by the view that asset pricing is cheap, rather than by profit increases. Indeed, while the S&P Index grew substantially, corporate performance was flat to negative.

Regulation relegations
However, as usual, it is not all good news. The dark cloud of regulation still looms over Europe. The AIFMD has caused many US-based houses to turn away from the region, while individual countries are threatening restrictions and caps on the asset class. Another poll of the audience revealed the majority of delegates believed regulation to be the region's biggest threat, accounting for 35.6% of the vote, against the continent's economic outlook and specific investment issues (pricing, opportunities and financing). And when compared to regulation changes in Asia, the picture is even gloomier, as authorities in the east are doing all they can to encourage the industry.

Speaking in the following panel, EQT managing partner Thomas von Koch pointed out how resource-intensive compliance is today: "Two-thirds of EQT's staff is focused on support and compliance, this is killing the smaller mid-market houses." For mega-firms, the cost and resources required to handle the ever-increasing requirements of new regulations is burdensome but, for the smaller players the expense is crippling, and in some cases life-threatening.

Looking ahead to the final score, European private equity is winning from a momentum perspective; the feeling is that the benefits of the recovery will reward those who invest now. Meanwhile pricing has peaked in the US and valuations are making private equity investing tough work, while Asia in more general terms is a much smaller market.

For those preparing a road trip this year, the journey is expected to be the smoothest since the financial downturn as investor confidence towards Europe, and the continent's economic outlook grow in equal measures. Many LPs are realising that now is the time to return to Europe.

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