4 minute read 3 Jul 2018

Six ways private equity will help drive value in M&A

By

Andrew Wollaston

EY Global Restructuring and TAS Private Equity Leader

Seasoned financial advisor and restructuring professional who has been with EY for over 30 years. Proud father of three. Poor golfer. Lover of animals and the outdoors. Interested in family history.

4 minute read 3 Jul 2018

Rising cash reserves and new investment models are making PE firms among the most impactful players in the 2018 M&A landscape.

Private equity (PE) is one of the biggest topics in M&A this year, with corporates being challenged for acquisition targets more than at any time during the past five years. In the 18th edition of EY Global Capital Confidence Barometer, 80% of executives surveyed expected increasing competition for assets over the next 12 months, with 68% indicating that this would be from PE and other funds.

The past decade has seen PE build up substantial war chests, but high valuations mean it remains a struggle to put that capital to work effectively, and in turn, requires a more creative approach to investing money. Funds are increasingly looking to deploy different pockets of capital for different purposes, and as a result, transforming relationships with companies.

 “PE capital is becoming a lot more flexible. Not just in terms of how much is invested and the sectors involved, but also where in the capital structure the capital will be put to work and what kind of return profiles are expected,” says Andrew Wollaston, EY Global Leader, PE Transaction Advisory Services.

1. Investing for the long term

PE firms are increasingly using investment vehicles with time frames of five, seven and even more than ten years. Longer-term capital gives investment managers the opportunity to engage in deals that require a transformational change to drive investment returns.
For example, in March 2017 it was reported that Blackstone had raised US$5b for its Core Equity fund, which has a 20-year life-span and envisions holding companies for twice the average of a typical PE investment.

  • KKR announced on a recent earnings call that it had raised US$8.5b for its Core Investment strategy, which expects to hold companies for 15 years or more.
  • And in 2018, news broke that BlackRock, the world’s largest asset manager, has plans to raise more than US$10b to invest in companies to be held for more than 10 years.

In aggregate, over the last three years, PE firms have closed or announced long-life funds valued at more than US$40b.

2. Looking at less than control

Funds are increasingly willing to take minority positions alongside existing owners, sometimes as a bridge to full control or as a pre-IPO strategy.

While such arrangements do not give PE firms full control over purchased assets, they give the portfolio company capital to grow their operations, enabling PE to potentially return that value to investors at a later date via public listings.

“Assuming a non-controlling stake also allows PE firms to gain visibility into a target company’s operations in ways that can pave the way for an acquisition at a later date,” says Chris Le Roy, US Leader, PE Transaction Advisory Services, Ernst & Young LLP. This includes building relationships with key stakeholders within that organization, learning how an acquisition would fit into overall portfolio strategy and influencing corporate decision-making in a way that supports these strategies.

3. Counting on credit

From global multi-asset managers to smaller boutique funds, credit platforms are becoming increasingly prevalent, providing nonbank lending across a company’s capital structure. These alternate credit lines include long-/short-term loans, senior down to subordinated or mezzanine (a hybrid of debt and equity funded) loans and even distressed lending.

Such flexible credit provides new opportunities to both the fund and the borrowing business, giving the latter access to new capital and the former a fixed income return with the potential to take a stake in a growing business.

4. Increasing corporate-PE collaboration

PE firms are also finding new ways to work with non-PE, or even nonfinancial services firms, with funds increasingly building institutional relationships with conglomerate businesses in order to participate in carve-out transactions.

For example, by partnering with corporates, PE firms can leverage the synergy benefits of their partners to gain access to higher-valued assets, from which they may otherwise be priced out.

Increasing competition for opportunities is also leading some funds to move downmarket into the growth capital space — typically the preserve of venture capital (VC) investors. Similarly, there has also been a rise in pre-IPO funding, which gives PE firms access to growth opportunities that aren’t complicated by high barriers to entry, like rising corporate valuations.

5. Co-investing with limited partners

PE firms are also increasingly teaming up with limited partners independently of managed portfolios — to pool resources, invest in bigger deals and access greater levels of debt financing.

For the limited partners, this means cheaper access to larger investments, as they don’t have to pay the management fees to an intermediary private equity firm. It also gives them the opportunity to earn higher returns and greater freedom in deal selection.

For private equity firms, co-investing with an LP may cost them slightly in lost fees and a reduced degree of control, but it allows them access to deals that would otherwise be beyond their available capital, while strengthening the LP and general partner relationship.

However, legislation in the US regarding investment could impact this trend. The Committee on Foreign Investment in the US (CFIUS) is an interagency committee of the US government that reviews financial transactions to determine if they will result in a foreign individual or organization controlling a US business. CFIUS’s current review of US-China investment ties, particularly in high-tech industries, could set new limitations on global PE-LP co-investments moving forward.

6. Building your own business

A number of parties are now creating platforms as startup businesses. Increasingly, PE firms are using their cash reserves, sector knowledge and human capital to build their own startup businesses with their own bespoke management teams, to take advantage of perceived market opportunities.

For example, PE firm Oaktree Capital Management used its sector knowledge and resources to build a substantial portfolio of student accommodations. And The Carlyle Group has backed a new company building the next generation of high performance chip technology designed to support the movement of business to the cloud. In these scenarios, PE firms don’t just manage and add value to existing organizations, they directly create their own strategic players in the marketplace.

Conclusion

PE firms that were once focused on generating value from a limited range of activities now have a much wider variety of strategic options. From assuming minority interest, to starting their own companies, today’s PE firms are far from just asset management entities.

For PE funds, this is an exciting time. For non-PE funds, new competition can mean new challenges in the M&A marketplace — but perhaps also new opportunities for value creation. One way or another, 2018 is the year of the PE acquirer, and parties on both sides of the equation should take steps to prepare for the realities of a transformed marketplace.

Summary

Today’s PE firms are far from just asset management entities; they have an opportunity to create value through investment, collaboration and building their own businesses.

About this article

By

Andrew Wollaston

EY Global Restructuring and TAS Private Equity Leader

Seasoned financial advisor and restructuring professional who has been with EY for over 30 years. Proud father of three. Poor golfer. Lover of animals and the outdoors. Interested in family history.