Dealmarket Digest-09

DIGEST

09

SEE WHAT’S NEW AND NOTEWORTHY IN PRIVATE EQUITY THIS WEEK /// ISSUE 09

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Distressed exiting?

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China: living up to expectations

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Brazil: hotspot for PE

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Appetite for tech deals

• Mixed reactions to record exit quarterly data • PE-backed IPOs not up to par

• Mckinsey finds inflated valuations in China • And tells how to fulfill expectations

• The drivers and the risks • No word yet on the rewards

• PE funds target IT companies

Directs planned by several LPs • State-backed CDC, Black Rock, and Alaska Permanent

Making the case for buy and grow • State-backed CDC, Black Rock, and Alaska Permanent

Quote of the Week • Lawrence Schloss, Chief Investment Officer for NYC

May 27, 2011

DISTRESSED EXITING? Before the second quarter is even over, Preqin is reporting record levels of divestiture for private equity funds. The value for the second quarter is USD 4 billion greater than the fourth quarter 2010 and much higher than the first quarter of this year. European deal activity is leading the way representing USD58 billion of the total USD85 billion in transactions, and the majority of these have been trade sales. Fund managers are beginning to divest investment made at the height of the last decade, reports PE News.

However, if one looks at exits by IPO in the US market, the trend does not necessarily mean reliable or predictable returns for LPs, warns a Bloomberg article on Pensions & Investments.

Initial public offerings from U.S. companies backed by private-equity firms are losing money for investors for the first time in at least a decade, making them the worst performers in 2010's IPO market. Thirteen IPOs offered by private-equity funds have fallen two percent in the first month of trading, which is counter to non-PE-backed stocks which made gains subsequent to floatation, according to data compiled by Bloomberg and Renaissance Capital.

The current IPOs have also lagged behind the Standard & Poor's 500 Index. Companies that did not have buyout firms behind them typically have beaten the S&P gauge for US stocks by 5.8 percentage points after their initial sales.

Speaking specifically about US-based exits via IPO, industry insiders speculate that the market is aware that private-equity firms may be trying to „unload“ investments to help pay down excessive debt. And it is not just the public markets that are reacting, one source goes as far as saying that PE-backed trade sales have the label of „distressed exiting“, explaining that when private equity vendor is marketing a deal, the thought is that he is a distress seller, which puts downward pressure on the price. What is more, the article says that auctions are not as common as they should be. The article suggests that now may not be the best time to exit unless a thorough strategy and possibly a strategic alliance is in place. It suggests that private equity houses must be prepared to say no and hold onto their asset for another year to ensure the best return on their investment.

1 www.DealMarket.com/digest

MCKINSEY EYES INFLATED VALUATIONS IN CHINA McKinsey published an in-depth analysis of Chinese public company valuations, this week, and finds them over-valued. The discussion is worth considering because it no doubt has an impact on private equity, both on the buyside and sellside. The report says that Chinese companies are no longer traded at a discount to those in the West, but there is little justification on the balance sheets for a premium of 20 to 30 percent above similar ventures in the United States and the European Union. Looking at the data on an industry-by-industry basis, the gap is even larger, as valuations are between six and 58 percent higher than those of their respective US counterparts. If the Chinese companies are to live up to expectations built into their stock price, they must show more growth, and more discipline on ratios, such as returns on capital, says McKinsey. Several other ways to improve are discusses, such as using divestiture and restructuring to improve returns.

2 www.DealMarket.com

BRAZIL: HOTSPOT FOR PE Brazil’s PE market is set for growth, including the number of deals, the range of sectors targeted, and volumes, according to Bain Insights, the Bain Capital blog. And this despite the early stage of PE in the Brazilian economy. Drivers include, Brazil’s economic growth rates and the greater development of the capital markets. Good bets are companies that benefit from rising middle-class consumption and infrastructure investment, says Bain. For example, housing consumer products, and financial services. And as for infrastructure Brazil is midway through a major infrastructure investment cycle, which will create opportunities in transportation, logistics, energy, sanitation, education and healthcare, among other sectors. Hazards in the market include complicated tax structures and regulations, high interest rates, lack of deep experience in operational management in target companies, partiuclary lacking are the skills to require growth and international expansion, cautions Bain. .

APPETITE FOR TECHNOLOGY DEALS Private equity is showing appetite for technology deals. Thoma Bravo acquired security software company, Tripwire, in a widely report transaction this week, e.g. in PE Hub. Oak Hill Capital acquired cloud computing company Inermedia. But PE’s appetite may not always be satisfied. AOL has reportedly refused to consider a PE-backed acquisition, according to Reuters.

MORE DIRECT DEALS FOR LPS The FT reports that UK state-owned investor CDC has „lost its way“ and needs to refocus and move away from investing via third party private equity funds to focus more on direct investment, co-investment and debt vehicles. The CDC is not the only institutional investor making such moves. As part of its private equity platform expansion, BlackRock said it plans to add direct investments, as has Alaska Permanent Fund Corp, reported in an article on PI Online.

3 www.DealMarket.com

MAKING THE CASE FOR BUY & GROW Buyout returns are on a downward trajectory, new approaches are required suggest a length feature article in strategy+business. Current trends are analyzed with several suggestions on how PE fund managers can outperform their peers.

Two trends have emerged that cause a fund management team to be conflicted. There is the trend to go public and diversity into other asset classes, as Blackstone, KKR and Apollo Management have done, which deflects fund manager’s attention from the business of nurturing growth in acquisitions. And two, there is the fact that returns on leveraged buyouts are down, due to the higher cost of debt and the flagging ability to create profit using financial engineering or even operational engineering.

The author asserts that PE firms will need to enhance their ability to spur organic growth in the companies they own.

It means that PE managers need to pay more attention, rather than less attention, to portfolio companies, to drive organic growth and gain market share. Ways to do this are quite well understood but it takes time, so one result of this strategy could be that fund managers may have to lengthen the time of the contracts with their LPs beyond current ten year cycle.

4 www.DealMarket.com

QUOTE OF THE WEEK Quote of the week: "... perhaps being in the top quartile is not what it used to be..“ Who said it: Lawrence Schloss, chief investment officer of New York City, which has a portfolio value of about USD118 billion.

Context: The institutional investor is interviewed by The Deal about its restructuring and asset allocation plans. About 7 percent of the fund is currently invested in private equity. Schloss is looking to increase that in the coming months. When asked how he picks the best performers, Schloss told the reporter that his team is studying historical performance and track records, which makes it clear to see that not everyone can say they're in the top quartile anymore. “Plus perhaps being in the top quartile is not what it used to be. If you're in the top quartile, that means you made 5%. We're not very happy with that.” He points out that best have taken adversity and made it into opportunity. And those are the funds he wants to be in.

Where we found it: The Deal

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The Dealmarket Digest empowers members of Dealmarket by providing up-to-date and high-quality content. Each week our in-house editor sifts through scores of industry and academic sources to find the most noteworthy news items, scoping trends and currents events in the global private equity sector. The links to the sources are provided, as well as an editorialized abstract that discusses the significance of the articles selected. It is a free service that embodies the values of the Dealmarket platform delivers: Professional, Accessible, Transparent, Simple, Efficient, Effective, and Global.

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Editor: Valerie Thompson, Zurich

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