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Themes from Q2 2017 PE earnings calls

PE firms improve operations and fundraising

Fundraising robust and evolving

  • Many firms remain confident that the PE fundraising outlook will remain positive for some time because investors want increased exposure to alternative investments like private equity. However, a strong fundraising environment will contribute to asset valuation remaining high.
  • PE firms do not need help raising funds. They want more creative ideas on how they can put dry powder to work. The industry is looking at more minority investments and late-stage venture capital opportunities, not just the traditional buyout model.

The most successful PE firms are getting creative in the way they invest their dry powder ─ and they are increasingly seeking to create more value through operational improvements.  

Mike Rogers,
EY US Private Equity Origination Leader

PE succession planning is critical

  • Many of the industry’s pioneers are looking to the next generation to help ensure the prosperity of the businesses they established. With several PE founders over the age of 70, the transition to the next generation of PE leaders is beginning now.
  • PE founders must make all efforts to ensure the right people and corporate culture are in place to safeguard their legacies and help ensure the continued growth of their firms. Future leaders must act as standard bearers for firm cultures that have evolved over decades.
  • PE firms today are radically different than they were just 10 to 15 years ago. They are bigger, broader and more complex ─ with a wider range of investors and product lines. They’ll require different sets of leadership skills. Digital proficiency is now critical as leaders seek to help their companies navigate an increasingly disrupted and disintermediated commercial landscape.

Low oil prices have hurt some businesses, but PE is upbeat

  • While the deployment of raised capital has been slow since the oil price decline, PE’s deal appetite for the sector has seen a significant improvement starting 2017. Potential targets have relatively cleaner balance sheets since many companies are now emerging out of bankruptcy. Other tailwinds for PE investments are the narrowing of bid-and-ask spread, as well as the overall consensus on oil price outlook.
  • We will probably see a widening in the Brent WTI differential and a spike in gasoline prices due to loss of pipeline/refine capacity as a result of Hurricane Harvey’s landing in Texas, but it should not change long-term fundamentals.

Technological and efficiency gains have reduced the capex needed on a per barrel basis, but the sector is still capital intensive. With more than US$143 billion in dry powder capital (within the natural resources sector) waiting to be deployed, PE is ready to contribute to funding.  

Andy Brogan,
EY Global O&G TAS Leader

Asia is starting to see larger PE deals

  • APAC witnessed a surge in the size of PE-backed deal investments in last two to three years. The average deal size for PE investments in APAC rose to US$295 million in 2Q 2017 from US$152 million two years ago, according to Mergermarket data. China has been the dominant active market, experiencing high volumes in terms of domestic as well as outbound PE-backed deals.
  • At sub-regional level, PE deal activity has remained skewed toward emerging Asia. The economies in ASEAN countries, China and India have been able to generate decent returns of ~5% for the investors, primarily due to the long-term investment theme around the rising middle class.

More than US$50 billion in dry powder may be deployed in the APAC region in next couple of years. However, competition for attractive targets remains a key concern while investing.  

Luke Pais,
EY ASEAN PE Leader

Expect more permanent capital vehicles (PCVs)

  • Large PE groups are meeting demand of institutional investors for longer-term investment by setting up PCVs. Such vehicles allow LPs to commit large amounts of capital for an extended timeframe, earning solid returns and enabling them to better match their assets with their liabilities. For taxable investors in particular, PCVs can be extremely attractive given the fewer number of taxable events. Innovation around the way such funds are structured might allow for periodic liquidity for LPs, decreasing their risk.
  • The challenge will be for PE firms that choose to go with PCVs to stay focused. Firms have to concentrate on their 1- to 3-year plan for an investment, but also have a vision for the business in 10- to 15-years. An effective approach for the long-term alignment of interests is particularly important for long-life funds.

Late cycle sectors is a recent PE investment theme

  • The US economy is progressing into a late cycle phase, a period of moderating economic growth where wages start to rise and inflation starts to pick up. Some investors are looking to strategically shift their sector exposures/allocations to benefit from opportunities arising out of this economic cycle movement.
  • PE firms have spent the last several years building teams and competencies to generate value for investments in consumer staples, energy, health and wellness, minerals and utilities, and other sectors that present opportunities for firms focused on late cycle investing.

Investor base expansion

  • PE executives, who are looking to expand their investor base, still view 401(k) plans on top of the industry’s wish list because of the untapped pool of capital from those plans. Some firms are investing more in technology and product development to position themselves with solutions that will appeal to retail investors - if and when regulatory changes allow individual investors to access exposure to PE investments.
  • PE is searching to find other sources of untapped capital and some are finding new investors through geographic diversification. PE is collecting more capital from different countries than they were at the turn of the century.

PEs still eyeing infrastructure

  • Infrastructure has gained considerable interest among larger PE firms and other alternate asset classes that are seeking investments with stable businesses, predictable cash flows and strong growth prospects.
  • Infrastructure will continue to intrigue large PE firms because of the appeal of government investment. Firms are actively fundraising as they anticipate big-ticket deals in North America in the near- to mid-term period.

What makes the US market difficult to crack is that there are not many large scale infra deals to use as a model in the US, as it is still a municipality-based structure. You see more interesting models in IFC/World Bank projects in Asia and Africa.  

Jude Uzonwanne,
Parthenon-EY Senior Manager

Insurance is starting to see more attention from PE

  • PE’s interest in making sizable investments in the insurance sector has returned after a recent US$4.3 billion PE investment during 2Q 2017. PE had not completed an investment of this size in the sector for the past three years. However, firms may now be viewing the space more positively given the late nature of the current cycle and the industry’s ability to produce stable cash flows at comparatively lower risks.
  • Disruption is driving PE investment in the insurance industry. Insurance companies are facing competitive threats, cost pressure, regulatory requirements and lack luster financial performance, which could mean certain business may be on the block for PE at relatively low valuation.
  • InsurTechs, which are firms that seek to reinvent the insurance industry using technology, also may attract PE. InsurTechs are putting pressure on traditional insurance firms to adapt, which could be another opening for PE to help with value creation.