PRIVATE EQUITY OUTLOOK REPORT

32Previous Chapter

A PRIVATE EQUITY PANACEA?

A PRIVATE EQUITY PANACEA?

sking whether any asset class is ever a panacea for investors invites a binary answer – usually “no”.

Yet sentiment towards private equity remains both optimistic and loyal and it’s always worth exploring whether such sentiment is justified.

According to EY’s 2015 Global Private Equity Survey, chief financial officers expressed a clear intention to allocate towards private equity, far more than other asset classes such as real estate, infrastructure, natural resources or hedge funds.

Private equity has gained something of a broad-brush reputation for presenting its best-case scenario to suit its objectives – certainly regarding its portfolio companies, and especially approaching exit. But just how reliable are its performance measurements?

Trust in numbers?Andrew Brown, senior investment consultant, manager research at Willis Towers Watson, explains that while the internal rate of return (IRR) and multiple of capital comprise the two industry standard measures in private equity, they are flawed.

He says IRR is “not a real number”, and is easy to manipulate in the early years, so has little meaning in immature funds. It is also not directly comparable to time-weighted returns used in other asset classes, but neither is the multiple, though he says it is more “intuitive” than the IRR.

Private equity managers have discretion over cash flows, so it is easy to “monkey” with the IRR, he says. With both measures, it is only the invested capital that gets accounted for, not what is actually committed, which also leaves margin for discretion.

Timing is also everything, it seems. “It is only really statistically significant for funds near completion,” Brown explains. “It assumes the last day of the year that you sold everything to get that last cash flow, so anything pre-2005 is ‘done’ and anything post is ‘not done’.

“If you look at the J-curve, anything post-2007/08 looks to be still early days, but there is a lot more return potential there. It’s in part all due to the cyclicality of private equity.”

When comparing against other asset classes, there’s always an “apples-with-oranges” argument, which is where public market equivalent (PME) analysis can help, but there are still geographical nuances and vintage year discrepancies of which one needs to be mindful.

Growing companiesAlex Barr, fund manager at Aberdeen Private Equity Managers, suggests two reasons for an upturn in private equity’s performance: a reduction in the holding period on assets and an increase in multiples as the value of companies improves, spurred by rising public markets.

“Private equity managers have also been much more disciplined in building out operational engineering. They are buying a business, adding other assets to it, going in and not just cutting costs but re-engineering strategic advice through their expertise and contacts, to more rapidly grow the core areas of that company,” he says.

Despite a perceived upturn in private equity performance, the ever-changing macro environment means that we are still some way away from confidently being able to call PE a panacea for investors – although that remains the hope for the industry.

Private equity has gained something of a broad-brush reputation for presenting its best-case scenario to suit its objectives

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THE NEXT INVESTMENT OPPORTUNITY?

shareholders’ priority lists.To March 2016, 2,731 funds

comprised the global private equity market with an aggregate target size of $900 billion2, suggesting appetite for the darling of the alternatives space remains healthy.

A wealth of opportunitySo with such a desirable asset class, supplying a bounty of cash to play with, where are LPs thinking of deploying it? LGT Capital Partners’ real passion is for buyouts– particularly in the smaller and mid-market space. Tycho Sneyers, managing partner, explains: “In an environment where pricing is high, we feel that space is still the more attractive segment of the market, relatively speaking. “Even within the secondary market, where pricing also remains at high levels, we are still finding extremely attractive opportunities across all segments and we retain an optimistic outlook.” With a “cautiously contrarian” view – mindful of market cyclicality– he believes if the cycle does turn down it will open up even greater opportunities in secondaries and those small and middle-market buyouts, “especially when you compare with public equity or fixed-income markets”. Conversely, Von Niederhäusern says value creation in plain vanilla buyouts has become too challenging, explaining how her team enjoys the luxury of BlackRock’s scale to “turn over every stone” and cast their net more widely.

Special situations and carveouts are two favored themes, such as the American Express Global Business Travel deal in which BlackRock participated last year. “We like situations where you can buy a platform and consolidate an industry, a country or region,” Von Niederhäusern says. “Otherwise we like corporate carve-outs, where you pay for the skillset and it’s about much more than just the price.” Peripheral Europe is presenting some of the best valuation opportunities for Aberdeen Private Equity Fund manager Alex Barr, but he concedes this might be a popular

ollowing record exits in 2014, private equity investors look primed for another

exceptional year. 2015 was due to deliver

billions back to limited partners (LPs), enjoying the buoyancy from newer entrants to the asset class, demonstrated by the growing interest from sovereign wealth funds.

Private equity deal volume in 2015 totaled $819.2 billion1, a 16.1 percent increase v 2014. The third-quarter volume of $241.1 billion was the highest of any quarter since 2007, when private equity deals reached $372.2 billion. North America volume rose 25.1 percent and Asia 34.5 percent compared with 2014, whereas deals in Europe, the Middle East and Africa (EMEA) fell 11.7 percent. Private equity deals for targets based in the Americas reached their highest levels since 2007, representing 57.5 percent of the global total.

Putting it in context, the financial crisis caused a decline in value creation opportunity as companies – public and private – reined in their development costs, M&A fell off and the corporate world in general tried to keep their noses clean.

“Everyone went into survival mode,” says Nathalie Von Niederhäusern, managing director at BlackRock Private Equity Partners. “That pushed out holding periods and exits were delayed.”

Turning off the liquidity taps and the lack of a need to sell the portfolio companies led to two years without exits of any kind.

Today, with record low interest rates and strategic purchases and industry consolidation gathering traction across a number of sectors, commercial efficiency has stepped to the top of many

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call. Single country-specific European funds – such as those focused on Spain and

Italy – are showing continuing inefficiencies at the lower end and middle market. Barr adds him and his team are long-standing believers in the longevity of the technology supercycle, and will continue to have exposure there. He may also up his allocation to venture capital, which still looks attractive, despite the threat of “unicorn” valuations – tech start-ups valued at £1 billion or more – sounding a bit of a wake-up call to the market. Technology disruption is a popular theme that looks set to continue in spite of that shadow of doubt hanging over the markets.

Wellcome investmentsWellcome Trust says its steady stream of realizations has seen its private equity exposure reduce from a peak 28 percent to just under 24 percent in 2015, with expectations it might fall to around 20 percent as more companies are sold or listed. Through its venture partners, the LP has exposure to 57 of the 154 unicorns and 17 of the largest 20. It says the partners have taken a conservative approach to valuations, with its interests held at a gross total value of $1.1 billion – a significant discount to the value implied by the companies’ latest fundraising rounds. The trust exemplified the widening spread between distributions within the asset class and capital called in its annual results for the year to 30 September 2015.

In its technology and venture funds alone, realizations of £940 million compared with £350 million of drawdowns, which the trust says should allay market concerns that returns have been reliant on revaluations. Confident with its allocation, technology venture funds currently make up 40 percent of its private fund exposure with many of the big names having featured, and have now shifted into its public portfolio. Looking ahead, Wellcome Trust’s recent financial statement says: “Their next challenge will be to continue to build and then release value in companies in the next stage of disruption, especially in the ‘decacorns’ – unicorns with

TOP 10 PRIVATE EQUITY DEALS IN 2015

Targets

1. Cablevision Systems Corp

2. Keurig Green Mountain Inc

3. GE Antares Capital Corp

4. Qihoo 360 Technology Co Ltd

5. SunGard Data Systems Inc

6. Par Pharmaceutical Holdings Inc

7. BioMed Realty Trust Inc

8. Transgrid

9. Postal Savings Bank of China Corp Ltd

10. Oncor Electric Delivery Co LLC

flipped upside down with a lot of gradation, but it will take years to materialize.”

Aversion to co-investments looks to become more commonplace. Coller Capital’s latest Global Private Equity Barometer revealed the proportion of LPs with special accounts has risen from 13 percent of LPs in summer 2012 to 35 percent of LPs today, yet 43 percent of sector participants believe that trend is a negative development for the industry. Coller’s biennial Barometer also reported a planned increase to emerging market exposures with a marginal local bias: 50 percent of LPs based in Asia Pacific believe China will become a greater investment opportunity in five years’ time. But Mercer believes the emerging markets rose has “lost its bloom” for investors, with the risk outweighing reward. Partner Michael Forestner believes a preferable call might be in natural resource-related assets – an obvious choice when seeking out capital scarcity or value dislocation. “There is uncertainty about the length and depth of the downturn, but one can recognize that assets are far cheaper today than two years ago.”

Forestner suggests the next question might be whether to seek access to such assets via new capital – and possibly new managers without legacy portfolios – or through secondary trades.

a valuation in excess of $10 billion – the likes of Uber, Xiaomi, Airbnb, Palantir, Snapchat, Didi Kuaidi [now Didi Chuxing], Flipkart, Pinterest and Dropbox, where strong demand from investors has allowed valuations to expand and permitted these companies to raise new money while remaining private.”

A perfect storm?With an easier private debt market and still-accommodative monetary policy, as even the long-awaited December rate rise by the US Federal Reserve was expectedly feeble, combined with the past three years of record distributions, there is something of a perfect storm for private equity. Bespoke solutions are in a prime position to take advantage of all those while challenging the “two and twenty” fees model. Andrew Brown, senior investment consultant, manager research at Willis Towers Watson, believes optimal conditions are on the horizon to improve alignment of interests between parties and more beneficial fee structures, but also puts the general partners (GPs) in the driving seat. “Everyone is clamoring for co-investments despite very few are able to go through the proper due diligence process because they have no fee, no carry. They would be much better off creating different share classes. I think we will definitely see more of this: the ‘two and twenty’ model getting

Commercial efficiency has stepped to the top of many shareholders’ priority lists

Source: Bloomberg

F

Total private equity deal volume in 2015

$81

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7.7

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CompletedCash Cash and Stock Pending Billions USD

1. Source: Bloomberg for Private Equity

2. Source: Ibid.

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VALUE FOR MONEY?

hat private equity firms levy fees on investors is a fact of life: if they did not,

they would not last long. But do they charge too much? Moreover, do they fleece investors by overbilling and presenting hefty hidden costs as real expenses?

The Securities and Exchange Commission (SEC) thinks so. In May 2014, the US regulator said it was putting buyout firms “on notice” after unearthing “numerous” examples of investors being charged inflated fees and expenses. In June 2015, it fined KKR $28.7 million for failing to disclose the costs it passed on to its limited partners following unsuccessful buyout bids. Blackstone was later penalised $39 million for jacking up the cost of monitoring the firms it owns.

As ever, there are two sides to this coin. Buyout firms or general partners (GPs) create profit through two main sources: the firms they run and eventually exit; and the limited partners (LPs) that entrust GPs with their capital. For years, LPs, typically big institutional investors such as pension funds and insurers, were willing to be quietly fleeced (a recent report by two academics found that GPs charged $20 billion in hidden fees between 1981 and 2003), so long as buyout firms continued to generate outsized returns in a low-yield world.

Rules on rulesYet life is changing for GPs as rules are piled on top of rules, ostensibly to protect the investing world from invisible overbilling. In Europe, the Alternative Investment Fund Managers Directive oversees how buyout groups can market and structure funds. In the

US, more and larger fines can be expected as the SEC delves into the bowels of the asset class. Marc Ponchione, a former SEC staffer who is now a banking regulatory partner at Allen & Overy, says an industry that once flew under the radar is now the target of a “broad and targeted campaign” by sharp-toothed regulators. “The SEC’s view is: ‘There are things going on here that we don’t like’,” he adds. This includes the perception that GPs have long played favorites with bigger institutions, transferring some of their fee burden onto smaller or less influential investors. Not all investors are clamoring for change. “We feel our GPs are acting in a fair and transparent way,” says Robin Winning, head of private equity fund investment and co-investment at SVG Capital, which invests in funds managed by Clayton, Dubilier & Rice, Cinven and Permira. “Transparency is good, disclosure has improved, and we have good insight into how they are being run.” And more oversight in an asset class with longstanding public trust issues may not be a bad thing. When the Institutional Limited Partners Association, a trade body for investors, set out plans in January for a uniform reporting structure for all GPs, the initiative was cautiously welcomed across the market.

With regulation comes costEither way, new legislation will change the industry forever. Private equity once boasted slimline operating structures (nimble management teams, minimal oversight) that kept down costs and allowed GPs and thus investors to generate hefty returns. That’s now changing. “I was speaking recently to the group financial controller of a $10 billion firm,” says Giles Travers, director of alternative investment funds at SEI Investment Managers. “Compliance once occupied 10 percent of his time. Now, that share is more than 50 percent.” Another buyout executive said he was sent a 17-tab Excel spreadsheet by an investor that “had to be mapped and uploaded to suit their in-house software. It’s a nightmare”. For private equity funds everywhere, the cost of doing business has never been higher.

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?TOP 4 SECTORS BY DEAL VOLUME - 2015 PE DEALS

Source: Bloomberg

1. Financial2. Consumer

Non Cyclical3. Communications4. Technology

1 2 3 4

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Value of the fine given to Blackstone by the SEC in 2015

$39

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64%

-16% 5%45%

Volume ($billions) YoY% change

6

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GLOBAL PRIVATE EQUITY TRENDSGLOBAL PRIVATE EQUITY TRENDS

$17.8CablevisionSystems Corp

Consortium including: Canada Pension Plan Investment Board

$12.1Tim Hortons ULC

Burger KingWorldwide Inc

$8.1Par PharmaceuticalHoldings Inc

Endo International PLC

$24.4Alliance Boots GmbH

Walgreens Boots Alliance Inc

$14.1Keurig GreenMountain Inc

Consortium including: Mondelez International Inc

Billions USDTarget Name

Acquirer Name

$10.0Grupo CorporativoONO SA

Vodafone Group PLC

$7.7BioMed RealtyTrust Inc

Blackstone Group LP/The

$18WhatsApp Inc

Facebook Inc

$12.0GE AntaresCapital Corp

Canada Pension Plan Investment Board

$8.6PetSmart Inc

Consortium including: GIC Pte Ltd

$7.4Transgrid

Consortium including: Abu Dhabi Investment Authority

$17.5SinopecMarketing Co Ltd

Consortium including: Industrial & Commercial Bank of China Ltd

$10.0Qihoo 360Technology Co Ltd

Consortium including: Ping An Insurance Group Co of China Ltd

$8.1IndCorProperties Inc

GIC Pte Ltd,Global Logistic Properties Ltd (Fund: CLF Fund I)

$7.0Postal Savings Bankof China Corp Ltd

Consortium including: JPMorgan Chase & Co.

$13.4LVBAcquisition Inc

Zimmer Biomet Holdings Inc

$9.1SunGard DataSystems Inc

Fidelity National InformationServices Inc

$8.0Canary WharfGroup InvestmentHoldings PLC

Qatar Investment Authority,Brookfield Property Partners LP

$6.2Nuveen Investments Inc

Consortium including:Investor Group

$7.0Oncor ElectricDelivery Co LLC

Consortium including: Hunt Consolidated Inc

TOP 10 PRIVATE EQUITY DEALS

TOP 8 COUNTRIES BY DEAL VOLUME AND % OF TOTAL GLOBAL DEAL VOLUMEPrivate Equity deals announced in 2015 and currently completed or pending completion/% is based on $808.5 billion as total for 2015

GLOBAL PRIVATE EQUITY TRENDS

United States Canada

Britain

France

Germany

India

China

Australia

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5

6

3

2

1

1

2

9

10

3456

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8

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CompletedPending

Announced Total Value ($ billion) % of Global Total

15

55% 8%2%

10%

1.5%

2.4%

4%

2.1%

444

78 19

65

29

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Source: Bloomberg

2015

2014

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WHERE NEXT FOR IPOS?

Explaining the numbersCorporate activity is on the rise while private equity value has fallen off. For the four quarters to June 2015, corporate deal value and volume have increased by 9.9 percent and 9.8 percent respectively, while private equity value has declined by 20.3 percent and volume has increased by 15.9 percent.

In terms of share price performance, private equity has long been understood to be a driver of returns following IPO. PwC gives three main reasons for this: private equity firms’ ability to professionally manage companies; modest valuations at IPO enhancing their relative success; and retained shareholdings, which signal confidence to the market. But Robert Boyle, partner at Macfarlanes, says their deals are viewed entirely case by case. “There are arguments for and against. On the one hand private equity houses are often seen by the cynics as the ones who strip out value, financially engineer and refinance balance sheets to earn their carry – all of which could be seen as damaging and indicating that performance may not be as good. “On the other hand, the discipline of having private equity investors involved pre-IPO instils discipline in the issuers and that preparation pre-IPO undoubtedly delivers value.”

Looking at post-IPO exit share price performance, while Western Europe on the whole has experienced a rise in values of $14.7 billion and performance up 9.39 percent, a breakdown by country shows some vastly different fortunes. The Netherlands impressed as

The discipline of having private equity investors involved pre-IPO undoubtedly delivers value

WHERE NEXT FOR IPOS?

$34

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he initial public offering (IPO) market is losing its shine in 2016, with

significantly lower activity so far compared to 2015. Private companies are remaining private for longer, which is clearly having an effect on IPO activity globally. 2014 was a tough act to follow in terms of private equity IPOs with 87 exits and aggregated deal volume reaching $66.2 billion. In 2015, 73 IPO exits were posted globally but their aggregated volume was roughly half that of the previous year’s at just $34.4 billion, according to Bloomberg.

Geographically, the declines appear to be indiscriminate. US IPO proceeds fell 89.8 per cent on the previous year whereas China declined by 82.91 per cent in value terms. However, Europe, The Middle East and Africa saw its localised IPO activity go up by 8.8 per cent year on year, making it the second-most active year on record – so there are silver linings.

In Asia Pacific the numbers were strong. The rise in deal values reported between 2014 and 2015 was $3.57 billion to $8.78 billion, in spite of the deal count remaining static at 17 reported IPO exits.

Most of this increase in value was down to Chinese activity, where volume soared from $878 million to $5.1 billion over the 12-month period.

So what’s happening?

a market, delivering an average 19.9 percent of its $2.07 billion of IPO growth in value terms. The UK also stacked up. With an increase in exit value of $5.96 billion, performance post-IPO was up 19.1 percent. Dragging down the continent’s performance appear to be France and Germany, the two worst performers, showing declines of 26.2 percent and 13.3 percent on their higher deal values of $714.7 million and $748.4 million respectively.

PwC capital markets director Vivienne Maclachlan agrees things should be taken on individual merits: “Generally there is no correlation, as performance is more linked to a sector, or is asset specific.”

Private to publicIn spite of the various headwinds facing issuers, performance has held up. Bloomberg found that, on a weighted-average basis, private equity IPOs returned 18.2 percent on their first day of trading and have posted a 75.2 percent increase versus their offer price to date. But is that enough to entice investors? Alastair Unwin, head of technology research and fund manager at Neptune, isn’t surprised the numbers are waning. The private equity boom years saw many companies overleveraged, and after the market collapsed following the financial crisis, many of those companies are coming back. But he says investors are still nervous.

“You need to ask why they were selling. Could they not find a trade buyer? Some of the valuations for IPOs have not been that high outside of tech and healthcare. You wonder if you’re going to be the last guy to the party.” Unwin says Neptune has eased off its participation in IPOs in the past two years. “There has been hot ones, like Alibaba, but they have been hugely oversubscribed.

We have also got this massive private market that can afford to fund companies that we might be interested in such as Uber or Airbnb – you can name the unicorn. So if you can raise good long-term money in the private market, why go public?”

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Aggregate volume of 73 IPO exits posted globally in 2015

1. Source: Bloomberg for Private Equity

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GUY HANDS: FOUNDER & CEO, TERRA FIRMA: Q&A MIXED FORTUNES FOR PRIVATE EQUITY

GUY HANDS: FOUNDER & CEO, TERRA FIRMA: Q&A

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healthcare, as wealth is further concentrated in the hands of baby boomers. In January, Varsity Healthcare Partners agreed to sell Forefront Management, one of the largest providers of dermatology services in the US, to Canadian pension fund Ontario Municipal Employees Retirement System for more than $450 million. The same week, New York-based mid-market private equity investor Riverside Company bought New Jersey-based Dermatology Group for an undisclosed total. Another notable recent transaction involved the sale by Bain Capital of medical technology firm Physio-Control International, to Michigan-based Stryker for $1.28 billion.

rivate equity is at a crossroads. A once carefree industry, it is increasingly

assailed by regulators and investors demanding lower fees, higher returns and greater financial transparency. Valuations, having risen sharply, may have peaked; the average price paid for assets by US buyout firms in 2015 was 22.4 times earnings, according to data from Bloomberg. The buyout industry had a mixed year globally. In Asia and Europe, private-equity-based firms raised $21.5 billion and $29.6 billion1 respectively via initial public offerings (IPOs), comprising year-on-year increases of 78 percent and 14.8 percent. In North America by contrast, just $20.1 billion was raised on the public markets via IPO exits, a fall of 16 percent on 2014 figures.

Many experts pick out Europe as being a market likely to continue growing into 2016. Innocenzo Cipolletta, chairman of the Italian Private Equity and Venture Capital Association (AIFI), said the region, for all its macro-economic woes, remained “an interesting target, with interesting opportunities”. He added that North America may have another tough year, noting that a “volatile” junk bond market was having “a negative effect on US private-equity-backed IPOs”. Britain and Germany soaked up the majority of big-ticket European deals. These included the April 2015 sale of Virgin Active to South African investment firm Brait, valuing the UK health club chain at £1.3 billion ($1.86 billion). Terra Firma sold its German motorway service station operator Autobahn Tank & Rast to a consortium including Allianz and Borealis Infrastructure Management for $4.4 billion. In October, Bain Capital and Advent International finalized the initial stock sale of Worldpay, which went public in London, valuing the British payments processor at £4.8 billion.

Growth sectorsThe bulk of deals globally emanated from the consumer goods and financial services

Many experts pick out Europe as being a market likely to continue growing into 2016

second was our aircraft leasing business, AWAS. Here, we took advantage of the prevailing market conditions and the nature of the AWAS portfolio to generate value for our investors and sell a portfolio of 90 aircraft for a total consideration of $4 billion.

Q: What do you think the biggest opportunities and challenges/threats are to the industry, now and in the near term?A: Investors increasingly want something different from their private equity investments. This provides a great opportunity for the industry to focus on the relationships firms have with their investors. They are turning away from blind pool funds and putting more money to work into separate accounts, joint ventures, co-investments and direct investments. The industry needs to focus on what investors want: alpha, fee clarity and alignment with their general partner [GP]. Limited partners [LPs] have been vocal about paying fees on committed but uninvested capital, with many large institutions publicly announcing they plan to reduce their number of private equity relationships. LPs also want more alignment from their private equity managers, and they want GPs to have “skin in the game”. How the industry manages investor demand is perhaps the biggest challenge it faces, both now and in the near term.

Q: Finally, what big themes do you see affecting the private equity industry going forward? A: Private equity is diverging along two paths. Large GPs will continue to get larger, and many will become generalist asset managers, though they will not be able to create much alpha when they employ thousands of people. They will remain attractive to investors because they can generate consistent returns. But parallel to this, smaller firms will become more specialized, working with fewer LPs to build closer relationships. At Terra Firma our strategy for deploying capital is to be entrepreneurial and opportunistic, to align strongly with our investors’ interests, to minimize fees and maximize carry, and to go for alpha.

Q: What were the key trends for the global private equity industry in 2015? Which sectors performed well, and which underperformed?A: There were two overarching trends in the private equity industry in 2015. First, there was more than $1 trillion of uninvested dry powder globally, excluding roughly the same amount set aside by sovereign wealth funds and their peers to invest directly or through co-investment vehicles. Second, despite surging M&A, the number of deals completed was the lowest in 13 years. So, the industry is expanding in terms of the number of funds and the amount of capital being raised, the result being more competition for fewer deals. Finally, the private equity industry has been delivering substantially less alpha. This is the big industry challenge going forward, and the deals that stood out over the past year were those based on value-added strategic and operational transformation of businesses.

Our strategic sweet spot remains asset-backed companies in industries that require transformational change

Q: What will be the key trends for the global PE industry in 2016? Where will the activity be, and which regions and industries are set to do well?A: At Terra Firma, we have been looking at the same core areas for the last 20 years. Our focus is transformational private equity, residential real estate, and infrastructure. Within those themes, we think European residential real estate offers good value, while core infrastructure remains very expensive. Within private equity, the real opportunities will lie with those businesses that need operational change. Our strategic sweet spot remains asset-backed companies in industries that require transformational change.

2013 2014 2015 VOLUME ($BILLION)

spaces. Buyout experts tip the two sectors to remain dominant in 2016, along with pharmaceuticals and healthcare, but with energy, utilities and technology likely to struggle for traction. AIFI’s Cipolletta reckons the industry will see “greater investment in the banking sector” this year, with distressed assets set to be a major target for buyout groups.

Charlie Johnstone, an origination partner at ECI in London, which owns brands such as UK-based Evans Cycles, sees deal flow remaining strong in sectors including fintech, business services, legal services and insurance. Restaurants would remain a hot-ticket industry, but investors will need to be “exceptionally selective given how much money has piled in recently”. Another fund executive warned there was “a bubble building” with technology “unicorns”: young firms valued at more than $1 billion. “I would be wary of that end of the market,” he said. “There will be a correction this year.”

Other sectors likely to see greater activity in 2016, experts say, include pharma and

TOP SECTORS FOR PE-BACKED AND PE-EXIT IPOS

Source: Bloomberg

Q: Which emerging markets are likely to do well in 2016?A: The best opportunities remain principally in the UK and continental Europe.

Q: Of which recent Terra Firma transactions are you most proud?A: 2015 was a very good year for Terra Firma, and I would point to two particularly successful exits that allowed us to return substantial cash to our investors. The first was our exit of Tank & Rast, the leading operator of German motorway service stations. We generated an overall 7.5 cash-on-cash multiple, which was an excellent example of how our hands-on operational approach can generate enhanced value for our investors. The

P

1. Source: Bloomberg for Private Equity

3.43 6.88 5.33

Consumer Non Cyclical

5.95 2.32 4.36

Financial

2.48 16.65 4.21

Communications

7.87 4.36 3.20

Consumer Cyclical

2.32 3.01 1.45

Industrial

0.48

1.4 0.44Tech

2.37 1.64

0.19Energy

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PLAYING BY THE RULES: PRIVATE EQUITY UNDER SCRUTINY

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or private equity firms, the world changed in 2012. That year, the

Securities and Exchange Commission (SEC) began to properly scrutinize an industry that, even in the wake of the financial crisis, remained an outlier, a financial sector largely unburdened by regulation. First, the SEC told buyout firms to comply with the 2010 Dodd– Frank Act, a move that gave the regulator legal recourse to begin snooping around in firms’ financial affairs. Each year since, the SEC has heaped more regulation on top of a $3.5 trillion industry that once reveled in its status as a sleek, streamlined operator. General partners (GPs) have opened their books, allowing regulators and investors to peer in and look. What they found hasn’t always been to their liking. In May 2014, the head of the SEC’s Office of Compliance Inspections and Examination, Andrew Bowden, said he discovered “illegal fees or severe compliance shortfalls” in more than half of the 112 buyout firms investigated. The regulator later issued a report titled Spreading Sunshine in Private Equity, in which it accused GPs of using “broad, imprecise language” that resulted in opacity “when transparency is most needed”. It said that limited partners (LPs) often struggled to “adequately monitor” both their investments and the activities of their GPs.

The road to standardization “We are at the beginning of what will be a long road ahead,” says Marc Ponchione, a banking regulatory partner at Allen & Overy. “The US has begun to err on the side of investors. This is just the start of a push to regulate and standardize the industry.” So just as investment

banks are now forced to disclose everything from fee structures to deal pitches, private equity faces a future where everything is open to lawful regulatory and investor scrutiny. In this sense, the US is playing catch-up with Europe, where the Alternative Investment Fund Managers Directive demands that buyout firms register their assets, leverage and investment strategy with national regulators. In January 2016, private equity in the US took another step on the road to standardization, with the unveiling of the Fee Reporting Template by the Institutional Limited Partners Association (ILPA), a trade body for investors.

Designed to demonstrate clearly to investors how GPs collect money, assess costs, offset expenses and carry income sourced from related parties or partners, the template is optional at first, though it has already been signed by 25 GPs including Carlyle Group and TPG. ILPA, says Innocenzo Cipolletta, chairman of the Italian Private Equity and Venture Capital Association (AIFI), represents a long-term systematic move toward a “more standardized and comprehensive ‘one-size-fits-all’” financial reporting structure.

Striking the right balanceThis regulatory push has also emboldened investors, who

are increasingly demanding lower fees, more transparency from their GPs, as well as co-investment rights and offset provisions. Many now demand specific carve-outs when investing in new funds, such as insisting that GPs pay for the cost of SEC supervision.

Some wonder whether the regulatory push will undermine an industry that has its fair share of detractors, yet has never directly sought or needed a bailout. AIFI’s Cipolletta is not alone in voicing his concern that GPs will wind up being crushed by a “disproportionate compliance burden”.

But most hope that a fair and reasonable balance can be found. Robin Winning, head of private equity fund investment and co-investment at SVG Capital, says the bulk of recent changes constitute a “positive trend” forcing the industry to become “more transparent and professional in terms of how it reports data”.

He expects the SEC to focus on a number of factors going forward, including imposing greater transparency on GPs, pushing through a co-investment allocation policy and, assuming co-investors are involved in any given deal at an early stage, ensuring that buyout firms absorb their fair share of so-called “broken-deal” expenses.

Buyout 71 109

Debt 42 55

Venture 21 29

Growth 14 26

Real Estate 36 50

RealAssets 30 66

TARGET FUNDRAISING VOLUMES ACROSS STRATEGIES

Source: Bloomberg

F

Most hope that a fair and reasonable balance can be found

2014 ($ billions) 2015 ($ billions) YoY %

54%

28%

45%

27%

23%

35%

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