European PE in 2019: Paying a premium

Denise Ko Genovese: What is your key observation for 2018?

David Ewing: 2018 has been one of the most buoyant years in terms of deals completed. People are using aggressive tactics in processes. Pricing is high, but the big differentiator is how quickly you can complete transactions.

Mark Bulmer: I agree. Pricing is very high. I don’t think I have seen it at these levels before. But it is only when you have a buoyant market that the best companies become available, and when they come to market, everybody wants them. Each process costs us a lot, so you also have to be very selective in choosing whether to take part.

Toni Vainio: From a fundraising perspective, there has been a lot of capital – over 60% - going into funds raising more than $1bn – so there is more competition in the larger end of the market. From a pricing and discipline perspective, the mid-market offers more opportunities and better pricing.

Sam Kay: The first part of 2018 was buoyant on the fundraising side, but we have seen a tail-off in the past few months, with more caution in the sub €1bn space. Other observations would be more GP-led restructurings and changing fund jurisdictions – a move away from the Channel Islands to Europe, Luxembourg, possibly to Ireland as well.

Mounir Guen: The market continues to have record distributions, and investors are trying to figure out how to deploy this excess and keep themselves to their allocated targets. On the debt side – the financing has all been very covenant-lite.

DKG: What are your thoughts on the UK specifically?

DE: We focus on the UK mid-market and it is still very competitive. Brexit is obviously a factor in people’s thinking. I mean, if someone owned a business that was heavily exposed to European revenues, or there was a lot of cross-border trade within it, a complex supply chain, then now would not be the time to bring that business to the market.

MB: We have only got 5% of our assets in the UK, but the way we look at things in general is what we would call beta risk – something that is completely outside your control – whether that is Brexit, or whether it is a commodity price. You get down to the driver of revenue growth in the business and then ask yourself if it is sustainable.

TV: If you are looking at it from an asset allocation perspective, the UK represents around 25-30% of all deals done in Europe. So, not doing any deals in the UK is quite a big call. We have seen GPs increasingly shying away from consumer-driven sectors such as retail or restaurants, with a higher emphasis on tech-enabled services, technology, healthcare – sectors that are potentially less dependent on GDP growth.

MG: At the end of the day, a good manager is a good manager. You cannot stop investing. Over time, there have been players who have felt that the industry was top-ish, took a hold and did not do anything for two years. Their net gross spreads ballooned and they potentially got it wrong also. So, even though we have got this [Brexit] situation going on, there are good companies, there are good managers, and the money needs to be deployed.

SK: Yes. I think when 1 January comes around, people will be thinking about 2019 and actually think that 2018 was a fantastic period – halcyon days – because 2019 is going to be a challenge.

DKG: Entry multiples are high right now. Do you think things have stabilised around the 10-12x mark and why are prices so high at the moment?

DE: There is a lot of money out there and GPs are paid to deploy capital. The increase of funds under management is growing faster than the availability of high-quality businesses, which is driving pricing up. Pricing is not driven by debt. We are heavily equitising the transactions we do and although leverage still goes into them, it is not the kind of leverage levels that were present in 2007.

MB: I think people generalise on entry multiples and I think it is a mistake, because if you say 10x to 12x and then you see a business that is valued at 9x, it sounds cheap, but that is not necessarily the case. Likewise, if you see something that is valued at 30x, that might seem expensive, but it depends on the business and its capacity for future growth. We bought a quite expensive business earlier this year in the financial services sector and there has been a significant increase in EBITDA over the past six months. So, what price do you pay for that? Is EBITDA multiple the right way of looking at it? The best and highest prices are only paid for the best businesses. There are a finite number of good businesses. So, once those good businesses have been sold, people are not going to pay the same multiple for a less attractive business just because the money is out there.

MG: Maybe entry multiples are the wrong focus. One of the patterns I am seeing, especially with the large funds that have massive assets under management (AUM) and budgets, is that they are investing in data and data assessment like never before. For them, it is not necessarily the entry point they are as focused on, but the exit point, and figuring out where they can get the target to when considering how much to pay for a company.

DE: And for some of the smaller deals, it is not necessarily the person that is prepared to pay the highest amount who wins. The founder-owners are asking: ‘Who can help us and who can help us bring onboard a new management team that can take the business to the next level?’

DKG: What has fundraising been like in 2018? It seems that we may see a dip in the numbers by year-end compared to the previous two years.

MB: The slight tail off could be because the investor community is gearing up for the larger funds that are going to be out in the market in Q1. So, over a longer cycle, it will still be seen as a positive three-year period.

MG: Yes, the year is not over yet and there are at least four funds that are coming to market, with
€5-15bn targets, which will account for roughly half of this year’s fund sizes.

TV: It feels like fundraising has increasingly been concentrated in a smaller number of successful funds over the past year. As an LP, you have to be in front of these groups six, 12, 24 months in advance of their fundraise to increase the likelihood of securing an allocation.

SK: There are some very good groups, where fundraising has been very straightforward – whatever they do, they seem to be able to raise cash. But there are plenty of other groups where it is harder. I do not think that is specific for this year. It has been a general trend over the past few years.

DE: We were actually in and out of the market in 80 days, which felt like an incredibly short space of time, but we had a very small number of new investors that came in and, even those, we have had a four- or five-year relationship with.

DKG: What makes a fund a clear winner?

TV: Performance, team, sector expertise. Some sectors and regions are currently more in fashion than others. For instance, some regions, such as the Nordic countries or Benelux, are seeing a higher level of successful fundraising than other markets, such as Italy. Timing your fundraise to favourable market conditions and sentiment is also important.

DE: Certainly, the language we use is about ‘momentum’. Some funds get momentum and some funds don’t, and it is often not exactly clear from the outside as to which ones will and which ones won’t.

TV: Co-investing will continue to be a big driver for LPs. You see a lot of them talk about the gross net spread coming down and you see a lot of the larger investors wanting to go more and more direct, but they do not want to compete with their GPs, so the way you get around that is by co-investing.

DKG: From a GP perspective, do you do co-investment purely for relationships?

MB: No. The reason we do it, and we do a lot, is because we do not want to have a fund in today’s market that is too big with the pressure to deploy €1bn a year. I would rather deploy €700m a year, and then put the other €300m into co-invest. It gives you more discipline when you are looking at the market. It also helps, as Toni was saying, build closer relationships with your LPs so that the attrition rate should then fall.

DE: It needs to be used with caution in an established market such as the UK, which is very well-served in terms of GPs at all different levels of fund size. If we see a deal that would be very large for us, requiring a lot of co-investment, by definition, that is not a sweet-spot deal for us.

DKG: Do you think the trend towards co-invest will lead to more LPs wanting to go direct at the risk of annoying their GPs?

TV: For us, it is very important not to compete with our GPs. Mistakes can happen when investors make a big bet on a co-investment that then goes sour and pollutes the overall portfolio performance.  It is not an easy thing to get right, because you need a good primary platform, you need dedicated resource, you need good portfolio diversification and not everyone is able to do that.

DKG: Do you think we will see more GP-led secondaries in the coming months?

MG: We need to see how the current ones perform. But, in general, the industry is looking to be a lot more solutions orientated in its transactions. A number of these secondary firms are going to private equity firms and coming up with ideas so that the GP can manage their businesses more dynamically.

MB: The secondary market, as a whole, is definitely going to grow as there is a lot of money going in. The way I look at it is, there will be a lot more growth from individual LPs selling to individual LPs than there will be from whole portfolios. I do not think that means there will be no growth from GP-led secondaries but they are very specific, very bespoke, so there is no generalisation at the moment.

SK: It is a really interesting tool for fundraising or managing a portfolio. From a legal perspective, it is an interesting area of growth.

DKG: Isn’t the whole idea of restructuring a fund, or even a single asset in a fund, less taboo?
MG: I think it is great.

TV: It has become more mainstream. When the market saw big brand-name GPs go through GP-led restructurings, it made other mid-market GPs more open-minded to discussing them. But, as an LP, we need to be cautious that it is not taken too far and that these transactions are to the benefit of all parties.

SK: There are going to be some ILPA guidelines coming out in the next few months that will be all about what GPs and LPs should be thinking about on these transactions. From what we hear, it will be a fair amount on transparency, on disclosure and managing conflicts of interest.

DE: A related theme is the rise of patient capital, longer-term vehicles. People are thinking, if we are going to hold this for seven years rather than five years, then you need a 12-year vehicle not a 10-year vehicle, which is a different way to solve the same problem.

DKG: What is your key expectation for next year?

MB: The current market conditions will probably prevail into 2019. The key thing is going to be to choose the right companies to buy and have the right value creation plan to deliver returns.

DE: Mine is a hope rather than an expectation: people that we know and that we work with, as managers or as founders of businesses we invest in, generally have a very positive impression of private equity. Yet, when we go out and meet people that have got limited experience of the industry, they often come with a bit of baggage. So, my hope is that, as an industry, we are able to reduce the baggage that people attach to private equity.

TV: Maybe following on that, I think one of the things that is still finding its voice is diversity and responsible investment. There have been some good developments and hopefully they will continue – more female participation in the industry, more impact funds and ESG focus. Continued progress can only be a good thing and help to drive the long-term growth of the asset class.

MG: I think we will see a lot of the same, but there will be more Asian capital influence. Asian investor bases for groups that we have worked for can be up to 15-20% of a fund. This will increase. We are also seeing Asian private equity firms coming west and buying assets in Europe.

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