The private equity (PE) industry continues to see record levels of inflows off the back of strong performance and growing investor demand for yields not available in lower fixed-rate investments and hedge funds. This, in conjunction with inflated asset values, has made deploying capital a real challenge — one that can be quantified by the sheer amount of dry powder available globally — with more than US$600b in buyout funds alone.
Further, increased activity from corporate acquirers pursuing M&A-oriented growth agendas — and a new focus on direct investments by pension funds, sovereign wealth fund (SWFs) and family offices — is creating increased competition for the most attractive assets.
In short, identifying compelling targets that can be acquired at reasonable valuations is a significant challenge right now. Effective origination is, therefore, more important than ever. With limited partners (LPs) seeking to back funds with a differentiated value-add or unique market access, firms are becoming increasingly creative in the ways that they uncover opportunities and identify value.
In today’s market, PE firms need to have a unique angle on a deal, one that is compelling enough to win a highly competitive process. This can include current or historical ownership of an asset in the space, perspectives about the market entry of a company’s products and areas for cost reduction, as well as partnerships with strategic investors.
Some of the ways we are seeing firms uncover value in today’s challenging market include:
Partnering with corporates
Clearly, corporate acquirers often have synergies that allow them to outbid purely financial buyers. To that end, many general partners (GPs) are partnering with corporate acquirers on deals, allowing them to reap the benefits of a strategic partner’s market position, infrastructure, potential synergies and industry experience.
For corporate acquirers, partnering with a PE firm can drive broader deal flows via increased financial firepower, as well as an ability to split up different parts of a complex opportunity. Further, they will have access to the PE firm’s network of operating partners and senior industry executives.
Given a PE firm’s typical holding period, this partnership also often paves the way to full ownership in the future.
Seeking opportunities in disruption and market excess
The “Amazon effect” and other forms of tech-driven disruption are having a dramatic impact across a wide range of industries. Changes in customer buying patterns, demographics and tastes are causing many boards to refocus on and sometimes reshape their portfolio of businesses, yielding carve-out opportunities for PE investors. These opportunities can be lucrative, given their often non-core and under-managed status.
Disruption broadly impacts a sector or subsector, thus making another strategic buyer less likely to compete, and opening a door for PE. In addition, PE can focus on core levers of business improvement and value creation within a private setting compared with public markets, and have the luxury of, at least initially, not worrying about how the acquisition impacts their public story. Disruption also tends to put the spotlight on companies that may have overindulged in M&A during a growth period and now must determine which companies are their long-term businesses of the future. Identifying value in large companies that may be overextended and need to refocus is challenging, but has led to some great deals for PE opportunities.
Casting a wider net
Finally, PE firms are working their networks harder than ever before. While they continue leveraging their traditional relationships with bankers and industry executives to generate some deal flow, firms are now casting an even wider net, working with a range of firms that equally are well positioned to identify and source potential investment targets in this competitive landscape.
At EY, our origination network combines early tactical indications of deal opportunities with bespoke and highly relevant content about complex and cross-border situations. Our value-creation and carve-out teams can help with real numbers, and develop views around asset improvement at an early stage, thus creating the possibility of a proprietary deal and direct dialogue with the management team or owner.
Our Entrepreneur Of The Year® program also connects us with CEOs of high-growth public and privately held businesses across a broad range of industries, many of which are at an earlier stage of development.
Overall, the breadth of our different business lines and corporate relationships gives us critical market knowledge about the impact of new technologies, areas of growth and decline within a sector, and strategic considerations impacting our clients. To better serve our clients, we are constantly exploring new and creative ways to enhance value for them, often via M&A.
In summary, the challenge for sponsors is to stay nimble and adapt to current conditions, with a focus on what may develop ahead, in ways that stay true to their core identity, enabling them to excel despite the high valuations and otherwise challenging conditions.
This article was originally published in 2018 Preqin Global Private Equity & Venture Capital Report.