Pricing, recruitment top list of challenges for PE in 2016

In late-November, unquote" brought together a group of leading private equity practitioners from various corners of the market to discuss industry developments in 2015 in order to assess the outlook for the new year. Following previous instalments focusing on exits, deal financing and fundraising, this final edition looks at key challenges to be faced by private equity in the coming year. 

Participants

• Farah Buckley, Adveq 
• David Burns, Phoenix Equity Partners
• Lars Eriksson, Riverside Partners
• Mounir Guen, MVision 
• Graeme Gunn, SL Capital Partners
• Richard Sanders, Catalyst Corporate Finance
• David Whileman, Inflexion Private Equity 
• Tim Wright, DLA Piper
• Moderator: Alice Murray, unquote"

Alice Murray: What are the main challenges the industry will face in 2016?

David Whileman: The biggest challenge for the industry is obtaining new talent. We're heavily recruiting and by talking to my competitor peers we are all now suffering from the result of post 2008 when many in the industry paused and placed recruitment on hold. I think the challenge over the next five years is more around attracting, training, and retaining talent.

Richard Sanders: Recruitment in the UK has been different to that in the US, because in the US it has been about the MBA programme, consulting networks, rather than the advisory community, which has been a breeding ground for PE here. Maybe that will change in the UK.

Mounir Guen: Universities, such as the London Business School are doing a lot to train people in PE and to get them up to speed. When I lecture my classes, there are 80 or more people in there but only five or six people from the UK and the rest are international and hungry for jobs.

Graeme Gunn: But the challenge is to find enough of those people who have done deals, who have sourced and executed.

MG: One thing that becomes important is to have a programme like Goldman Sachs where you bring in groups of people and they move through various stages. To create a training ground.

Pricing predicament

AM: Recruitment seems to be a much more recent issue for the industry, but one major challenge faced in 2015 has been pricing. Corporate buyers are speeding up their transactions, is this making the market more competitive and therefore expensive?

Tim Wright: Trade is quicker, but not as quick as PE – it's still a comfortable distance behind. And, if you're a manager you might fancy another turn with PE.

RS: One thing trade has learnt is looking at structures more flexibly. You can call it protection in terms of wanting some vested interest in the asset they're buying but equally they are prepared to see some upside sharing in terms of management commitment, so we're seeing some fascinating structures you wouldn't have seen five or six years ago. They're almost replicating PE structures.

TW: Economically yes, but psychologically no. Really successful managers are those that want to do their own thing. They are entrepreneurs and so they still find PE deeply attractive.

RS: They want to make a success out of what they do. We are now seeing trade has got a mechanism for doing that – and we are seeing a different umbrella under which they can do that and then go on and do something else.

TW: But a CEO wants to be a CEO rather than a divisional manager – and that's a massive difference. And trade is still not there on deal terms. Legal terms do not make the deal but they can kill it. And there is a significant difference between what trade accepts and what PE does. PE is very good seller, and when it's a buyer it's very flexible. So PE buyers will accept locked box, warranties with management only, no tax deed; trade really struggles with that.

MG: PE has skills so this question of competition and market valuation – I don't think there is much competition. The only competition is who is liquid at what time. If everyone becomes liquid in a certain segment – like the large-cap end of the market at the moment – they'll all go looking for deals at the same time. And if they're all wrapping up funds to do the last investment to launch their next fund then they're all trying to buy something today. But these are all competent managers with huge teams so paying fair value price doesn't make a difference because it's all about skills and talent – what you can do. If you have huge teams and a lot of experience you can make very attractive returns because they have good management; good business plans, and the companies are growing.

David Burns: I think the mid-market has more flexibility. Commentators tend to focus on the 100 or so deals completed each year by PE and those that are auctioned are typically commanding higher prices. In reality, however, there are probably 20,000 businesses out there of the right size and many need capital to grow. It's about widening the lens and finding them with the adequate origination approach.

Once the investment has been made, it's about how you create value. In today's market we are focusing much more on buy-and-build and roll-outs where the initial capital is only a small part of the final capital invested. In short, you can work your way around the around the high initial headline prices.

GG: From our experience, high pricing means the margin for error is a lot less. Yes, we would all love to buy cheaply but we recognise that's never going to happen in this competitive market. So managers must have the operational skill set to drive performance. Our major concern is always around high debt multiples creeping back up. That's what we saw last time – high prices combined with high debt killed companies. But, to be honest, the market today feels more disciplined around debt exposures and tends to correct within a band to keep the lid on this.

TW: Yes, everyone is rolling back. Look over the last month, certainly in the US, there's been the Veritas debt syndication failure, but debt markets aren't quite as healthy as they were even four weeks ago.

GG: We don't see a correlation between entry multiples and return outcomes. It's a very interesting dynamic.

Wishful thinking: Our panel's hopes for the year ahead

Richard Sanders: Steady as she goes. I think it has been a reasonably robust market recently; you can get some stresses and strains if you move to far but things feels on an even keel at the moment.

Farah Buckley: I would echo that sentiment; 2015 has been an excellent year from an investor's point of view, but has also been strong for fundraising too, so if we can continue with that for next year I'd be very pleased.

Lars Eriksson: I'm hoping for stability, more growth, less volatility in exchange rates, which is a headache for businesses that are growing outside of their home markets. And no major geo-political crisis, that's what I hope for.

David Whileman: I echo that; more of the same would be fantastic; stability is great.

Mounir Guen: I have a lot of confidence in the skillsets of the individuals in the industry. I think they've gone through an interesting cycle from 2008 onwards. I would like to see some form of constructive disruption to keep them at an edge and staying crunchy.

Graeme Gunn: I want to see GPs continuing to innovate and develop their investment models to cope with the current environment. Deployment has lagged over the past few years so we also want to see an increase in volume of deals, which would ease some of the pressure on capital raised. Perhaps trade buyers retrenching is the catalyst, but there will have to be perhaps some kind of external market shock to bring that volume back.

David Burns: We've been painfully reminded how major shocks can disrupt a market so stability would be good.

Tim Wright: Lawyers do well out of disruption but for the sake of our clients – more of the same!

 

unquote" would like to thank MVision, Catalyst Corporate Finance and DLA Piper for making this event possible.

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