Why Is This Fund Manager Dealing With Ponzi Private Equity?

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Is the outstanding performance of private equity too good to be true? As the global stock market crash forces mutual funds to price their holdings in the market, some are vocal in their skepticism of private markets.

Speaking to reporters last week, Vincent Mortier, Chief Investment Officer of Amundi SA, Europe’s largest asset manager, wondered how private equity firms can maintain their high performance. even as the IPO market crashes:

The vast majority of transactions are currently between private equity players… One private equity player will sell to another who is happy to pay the high price because he has attracted many investors.

When you know you’re able to sell your stake to another private equity firm for a multiple of, say, 20, 25, or 30 times earnings, of course you don’t reduce your book… That’s why I’m talking about a Ponzi because it’s a circular thing.

Intuitively, that makes sense. Last year, with a buoyant US stock market, private equity firms went on an exit frenzy, raking in billions for their investors. But with the IPO market in a dry spell and strategic buyers increasingly cautious, private equity firms are running out of options. These days, to get out, they will have to sell themselves their portfolio companies.

A few recent transactions may have caught Mortier’s attention. In April, KKR & Co. agreed to buy Barracuda Networks Inc. from technology-focused Thoma Bravo LLC in a deal that reportedly valued the cybersecurity company at around $4 billion. Thoma Bravo can probably make a handsome profit – four years ago Barracuda went private for just $1.3 billion.

Meanwhile, over the past two years, private equity firms have been eager for fundraisers. For example, KKR closed a record $19 billion fund in North America in April, more than $5 billion more than the previous fund in 2017. With more than $1 trillion of dry powder in the world, cash-rich private equity firms have enough headroom to buy stakes from each other. Thoma Bravo, for example, this week slashed the $10.7 billion offer he made to enterprise software maker Anaplan Inc.

But looking at recent deal feeds, Mortier’s comments sound more like a warning than a reflection of reality. While about two-thirds of outflows in the first quarter were deals between private equity firms, their actual value of $43 billion is by no means extraordinary by historical standards. The same conclusion applies if we instead look at the number of transactions.

In other words, the conditions are ripe for what Mortier called a “Ponzi” scheme in the PE industry. But so far there is not much evidence.

More likely, the criticisms of traditional asset managers reflect their envy that private equity firms appear to be winners in good times and bad. Over a 1, 3, 5 and 10 year horizon, private equity has generated higher internal rates of return than public markets.

Stock markets took notice and rewarded private equity specialists accordingly. Shares of Blackstone Inc. and KKR outperformed traditional fund managers. like Amundi.

Certainly, there is a lot of room for facade in the world of PE. For example, it is common practice to use public market peers to value unrealized investments, even though there is no guarantee that private equity-backed companies can achieve similar valuations.

And just like investors in the public markets, private equity firms in recent years have largely paid for their investments. In the first quarter, a median buyout was valued at 14.6 times EV/EBITDA, or the ratio of enterprise value to earnings before interest, taxes, depreciation and amortization, up from 11.9 times four years earlier. according to PitchBook.

Nonetheless, that’s the beauty of private equity. It offers investors a safe haven from a bad stock market. With all that dry powder, he can also benefit from a bear market, taking companies private and lowering his average cost of acquisition. Mutual fund and hedge fund managers, who have to worry about investor redemptions, are in the wrong business.

More from this writer and others on Bloomberg Opinion:

• Tiger Global and the Dangers of Crossover Hedge Funds: Shuli Ren

• KKR wins by treating workers more like owners: Brooke Sutherland

• Private equity finds another flight in the UK: Chris Hughes

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. A former investment banker, she was a markets reporter for Barron’s. She holds the CFA charter.

More stories like this are available at bloomberg.com/opinion

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