GPs must re-invent, LPs must invest

There was a noticeable uptick in mood at this year's event, Richard Burton, partner and private equity leader at PricewaterhouseCoopers, reported in his opening remarks, but he also added that "it is not clear yet whether this is due to a real change or the impossibility to remain depressed all the time." Only time will tell whether there is truly a material change underlying this improved sentiment.

Keynote speaker Jorg Kramer, chief economist and co-head of research for Commerzbank, examined the question of what comes after the end of the recession. He expects strong growth in the second half of the year, with a normalisation in 2010.

Even more optimistically, Kramer added that corporate Germany would resume its "substantial outperformance" of the rest of Europe due to advantages in price competitiveness and productivity. He ended by cautioning against expecting more than moderate reforms from the new CDU/CSU/FDP government.

New Opportunities and Challenges

The next panel agreed that there a host of opportunities await investors, and that private equity can benefit from the demise of much of the hedge fund industry. "Investors like Germany's small and mid-cap companies, and we are beginning to see investors coming back to the market," explained Katrin Brokelmann, partner at Pinova Capital.

Hanspeter Bader, managing director of fund-of-funds Unigestion, was more critical of the situation: "German pension providers and insurance companies are currently investing cyclically, and not deploying capital, which means they risk missing out on a lifetime opportunity."

Jurgen von Wendorff, board member of Hannover Finanz, said that opportunities will also increasingly come from the secondary market: "In my view, the secondaries market hasn't even started yet. Many Landesbanken will have to sell in 2010 and 2011, leading to a situation not unlike 2003/2004, when good deals were made."

Another topic raised was whether the industry has to lower its IRR expectations. Ingo Krocke, partner at Auctus, highlighted that an increase in growth capital means deploying more equity with less leverage. This inevitably lowers average IRRs, and so there should be a risk adjustment in IRR expectations, with IRRs of 20% for less risky and less profitable growth investments. This, he stressed, needs to be communicated back to LPs.

Adapt to survive

A major discussion point was that the current situation means the industry has to re-invent itself and find new deal structures, such as 'private debt' funds in addition to private equity, to replace elusive banks, and also take a much more active role than banks.

"We tell our portfolio companies to cut their staff, work longer hours and innovate endlessly. But we ourselves do very little to improve as an industry," Krocke stressed. "GPs now often say they don't have time to invest in new deals because they are too busy managing their current portfolio, but that is not good enough. It is a good time to be investing and so GPs must look to set up dedicated deal origination centres if that is what it takes to make this work."

This view was bolstered by Louis Elson, managing partner at Palamon Capital Partners: "The industry has had a nice run, but it must now focus on what it will extract from this market to survive going forward."

The re-invention theory was backed by less than a quarter of the UK mid-market in a recent poll conducted by unquote" for the British Private Equity Awards. In it, just 24% felt that the industry needed to change to survive.

LPs also came under the spotlight, since without their support GPs cannot do much in this market. "We used to believe that institutional investors should not time the market, that they should instead deploy capital regularly and allow their GPs to utilise investing expertise to do this," said Bader, pointing out the vast sums of capital that poured into the market between 2006 and 2008 and comparing it with today's dearth.

"This is not true. GP teams are paid to invest, and so investors need to help them with the timing," Bader continued, indicating that now is not the time to withhold money but to deploy it.

Restructuring and secondaries

With restructuring high on the agenda in most portfolios, the next panel discussed the challenges that investors face in the case of a restructuring or when a covenant breach is imminent.

While many banks demand an equity injection as first measure, investors need to be cautious as it is far from a cure-all, stated Guy Semmens, partner at Argos Soditic, "especially as there was little visibility and the investors had to forecast whether the company can survive over the next nine months."

The importance, he stated, was to have cash, which shifts power to the investor rather than the banks.

Rainer Effinger, member of the management board of Nord Holding, stressed the importance of having a solution before sitting down at the negotiating table with the banks. He said that much depended on which banks were involved, as many expect that a few of Germany's wounded Landesbanken might still collapse.

Following this, the panel on secondaries highlighted that while the dealflow has increased dramatically, the conversion rate has decreased. "We expected a global volume of up to $30bn, but so far, we estimate only about $4-5bn has actually been done," illustrates Bernhard Engelien, managing director of Cogent Partners.

However, many distressed sellers have now sold what needed selling and are no longer in the market, and Andre Aubert, principal for LGT Captital Partners, noted that portfolio mergers are coming back.

Hampering more transactions being closed is a continuing insecurity and demand for discounts, as many don't know where the market is going; others resign in the face of the complexity of certain deals, which makes write-offs a tempting alternative. A positive development was highlighted by Pekka Maki, managing partner at 3TS Capital Partners, who remarked that GPs were much more open to secondaries and communication between GPs and secondaries investors is actually increasing, slowly countering a still strong culture of guilt over failed investments.

The industry widely expects that the return of capital calls will increase the pressure on LPs to sell their stakes on the secondaries market to free up liquidity.

The legal dimension

Christian Schatz, partner at SJ Berwin, highlighted the current legal issues in the German market. While Germany is a comparatively low-regulated country regarding private equity funds, this environment will significantly change due to the proposed Alternative Investment Fund Manager directive.

According to this directive, all managers of private equity funds managing assets of more than EUR500m would become regulated. The current draft directive does not provide for a grandfathering, so all funds - not just new ones - will be impacted. The draft has been out since April 2009 with a version likely to pass in 2010 and enforcement likely to take place in 2012.

SJ Berwin's partner Sonya Pauls added that in 2009's challenging environment, the balance of power has shifted to the LPs, and that negotiations about terms and conditions with current investors are a common occurrence. She also indicated that new fund managers are entering the market in force, some of which are already backed by a cornerstone investor, and many expect a first close by the end of this year or early next year. By type, cleantech, infrastructure and turnaround funds are the most popular.

The view ahead

Through all discussions, industry representatives stressed that the next years will be driven by operational improvement and discipline, but that the industry was well-positioned to help fight the dangers to the economy that are caused by too little liquidity from banks.

As Burton put it in the closing remarks: "Private equity has a role to play in the recovery because after unprecedented fundraising in the last years, it has an estimated $1tn in financial firepower, which makes it one of the largest pools of uninvested capital ready to be deployed."

Unquote" would like to thank PricewaterhouseCoopers, Greenpark Capital and SJ Berwin for sponsoring the event.

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