Outperformance will be the key to success in private equity

The private equity industry is experiencing particularly favourable conditions, with a buoyant economic environment, low interest rates, record-high fundraising and high-quality performance, attracting a growing number of investors to the sector. Too good to last, the situation is influenced and exacerbated by three complex cycles, and we must position ourselves against them.

Today’s growth is a double-edged sword

The first of these three cycles is simply the business cycle. Economic growth is very synchronised at the global level. In the United States there has been uninterrupted growth for nearly 10 years. True, growth is slowing down, but it might be rekindled by Donald Trump’s tax reform. In Europe, the political upheavals caused by Brexit, the election of Emmanuel Macron and the results of the German elections have reversed the attractiveness of various countries in the EU, to France’s advantage. Our business cycle is still in its early stages and growth might accelerate similarly to the way it has in the United States.

As a result, competition has become fierce. Last year, out of nearly 20 transactions of more than €500 million in EV, 11 were carried out by market participants that didn’t even exist in 2016 (Canadian pension funds, European LPs operating directly, etc). The price of all types of assets, particularly their stock market values, have skyrocketed, and the companies we acquire are no exception to the rule.

In this context, the risk for private equity firms is that they will not be able to invest and will be forced to delay the next fundraising, or that they will invest too quickly at high prices, endangering performance and leaving themselves open to accusations that they lack discipline. Not to mention being pushed out of the market by more aggressive competitors. This climate also generates opportunities, in particular being able to sell assets and take advantage of the current enthusiasm to raise funds more quickly. Every team has its own view and its own approach, based on its estimate of the cycle’s remaining lifetime.

Measuring the consequences of the market’s exuberance

[The development of our industry adds to this buoyant economic context and exacerbates its consequences.] I disagree completely with the notion that private equity has become a mature industry. In my opinion, maturity is characterised by the following factors: slow growth, a limited number of competitors, high barriers to entry and stable technology. This is not at all the case for private equity. Fundraising continues to rise – $3 trillion has been raised in the last five years – and so does the number of private equity teams, which now number 8,000 compared with 2,000 18 years ago. New asset subclasses are developing, as are new structures and new business models. The technology of the sector is far from stable.

As it would in any industry, this strong growth phase has led to considerable investment on the part of competitors seeking to establish a position. In the last few years, the largest firms have become asset managers, recruiting new talent and moving from a single-product mentality to a multi-product one. Geographic expansion is now a must, as is strengthening the firm’s skills.

This race to improve customer service and performance exposes private equity firms to the risks of marginalisation, loss of independence, talent flight, lack of differentiation. Firms also risk falling behind in terms of relative performance.

Using digital technology to turn a lag into an opportunity

Digitalisation is the third and last cycle. Digitalisation represents an opportunity to create value by boosting companies’ growth rates, reducing their costs and improving margins, and of course increasing the multiple at which they will be sold. Unfortunately – or maybe fortunately for us – French companies are lagging in this area. The barometer of the digital maturity of mid-sized French companies, which we publish in partnership with EY, shows that much remains to be done, even if the awareness is there. At Apax Partners, we see a real demand and a real need among company executives, who are conscious of the commitment necessary.

Digitalisation requires skills that are not traditionally found in private equity firms. Helping our companies innovate quickly might require that they create ties with the digital ecosystem of European start-ups. Doing nothing means running the risk of being overtaken by the competition and of exiting at lower multiples. The most telling example of this in 2018 was the transfer of value between traditional retailers and Amazon.

In this complex environment we have to maintain high performance while positioning ourselves with respect to these three cycles. Alas, I don’t have a magic formula, but I’m sure that there is a common response to all of these challenges: creating alpha, i.e. creating more operational value in our companies, regardless of the strategic decisions we take. In future, private equity’s winners will be those who outperform, independently of the business cycle.

Eddie Misrahi Chief Executive Officer Contact informations

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Apax Talks is a digital magazine aimed at company managers. It presents growth levers for SMEs, with a focus on TMT, consumer, healthcare and services sectors.