PE and the 4th Industrial Revolution: Proceed with caution

Disruption may be the media's buzzword du jour, but there is no question the global economy is facing major structural changes at breakneck pace, and short shrift will be made of any industry – including private equity – that does not adapt.

"The Fourth Industrial Revolution" is a term coined by World Economic Forum founder Klaus Schwab that became the main theme of the 2016 conference in Davos. The term denotes "a fusion of technologies that is blurring the lines between the physical, digital and biological spheres" that builds on the technological and subsequently digital strides made in the "Third Industrial Revolution".

Access to increasingly powerful technology and digital tools at ever-decreasing costs is breaking down barriers to entry and paving the way for nimble and savvy challengers to take on the old-guard incumbents across more sectors.

EQT chief operating officer Johan Bygge believes the adoption of technology is vital: "There are industries where, if companies don't change, the Fourth Industrial Revolution will be negative – if they don't grasp this as an opportunity."

The most likely area for private equity to first feel the effects of the Fourth Industrial Revolution is at portfolio level. In Digital Pulse 2015, a survey of 2,000 C-suite executives by headhunting firm Russell Reynolds, around 50% of executives in 10 of the 13 verticals surveyed were anticipating moderate or massive digital disruptions in the coming 12 months.

There are industries where, if companies don't change, the Fourth Industrial Revolution will be negative – if they don't grasp this as an opportunity" – Johan Bygge, EQT

The industries anticipating the most disruption were predominantly business-to-consumer companies, though 39% of industrial executives said they expected significant digital disruption in the near term.

"It is very trendy to talk about disruption these days, but it is something we face in many of our existing companies," says Jan Johan Kühl, managing partner at Danish mid-market GP Polaris Private Equity.

Private equity has historically had a penchant for industrial assets and the affinity remains, according to Jon Hustler, partner and co-founder of UK corporate finance outfit Clearwater International: "There is good demand for industrial assets. We have definitely seen over recent years what might have been a reasonably unloved sector almost coming back into vogue.

"Industrial assets is a fairly broad church and the sectors under it go in and out of fashion, but if we have an industrial asset to sell we can generally find interest from UK trade buyers, overseas trade buyers and from private equity," says Hustler.

Fearless executives
The fact that industrial-company executives fear disruption in the short-term the least, according to the Russell Reynolds survey, could be seen as a compelling opportunity for low-risk plays by private equity; the risk of fundamental challenges to the business model are either not substantial, or a long way off. Conversely, it could be interpreted as a sign of overconfidence – if all companies are at risk from disruption – and could mean these businesses are caught out when a fast-paced competitor emerges riding a wave of new technology.

While industries such as house building and general manufacturing have typically maintained high barriers to entry, and may not appear to be under immediate threat from new technology, game-changing developments could be on their way. 3D printing technology is evolving fast and 3D-printed industrial components are becoming increasingly popular.

GP Bullhound co-founder and managing partner, Per Roman, sees manufacturing as particularly susceptible: "Industrial production companies are heavily impacted by technology, as you can build more efficient production systems through the use of technology – everything from the Internet of Things (IoT) to software."

Despite the threats facing industrial assets, private equity is unlikely to abandon the asset class, according to Roman: "In a world where technology plays an increasingly important part, technology assets will be a critical component," he says. "That doesn't necessarily mean private equity will stop investing in other sectors where they have a lot of competences."

The best-case scenario for industries facing large-scale disruption is a market where they can successfully compete against new entrants and hold on to market share. As for worst-case scenarios, there are few better examples than Blockbuster's demise at the hands of Netflix – particularly given Blockbuster had the opportunity to acquire Netflix before the company grew into the market leader it is today.

The asset-light global play
While the likes of Uber, AirBnB and Netflix steal headlines as lead disrupters, challengers are making strides in less glamorous industries as well, such as the printing sector.

Norwegian startup Gelato, backed by a group of VCs including London-based Dawn Capital, provides printing services by connecting customers to a network of printing companies across the world, allowing the client to print at whichever location is closest to where the final product needs to go.

"By not having to buy any printers, Gelato doesn't need a huge amount of money," says Dawn Capital founder Haakon Overli. "It has become a business generating $50m a year with essentially just three salespeople. There's no real need for private equity or massive investment to reorganise something huge – it's driven by other factors."

Gelato is a textbook example of a common attribute of Fourth Industrial Revolution companies: asset-light and an expansive geographical reach without multiple local offices. "You can run an asset-light model in a completely different way now, because no one is as bothered about owning things anymore," Overli says. "The sharing economy is very well-understood on the consumer side: AirBnB is now one of the biggest hotel operators in the world but doesn't own a building.

You can run an asset-light model in a completely different way now, because no one is as bothered about owning things anymore" – Haakon Overli, Dawn Capital

"If you go about it cleverly you can construct companies that control a significant number of assets through technology. They make assets available as if they owned them, but without actually doing so," says Overli, citing VC-backed food delivery company Just-Eat as an example.

His view is supported by EQT's Bygge: "You can make traditional service industries and other sectors scalable in a completely different manner – that's an opportunity."

In tomorrow's instalment of our Fourth Industrial Revolution series, unquote" will look at the opportunities this paradigm shift affords GPs

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• EQT
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