When Private equity goes public
In our pursuit of establishing industry enablement in private capital markets, Orpheus Capital is poised to seize opportunities that may emerge in global markets, thereby creating local opportunities for our partners. The transition of private capital to public markets, be it in the US, Africa, or South Africa, holds promise. While the size and liquidity of these markets may pose challenges for PE listings, we draw lessons from history where listed PE hybrids like Remgro have traded at a significant discount to NAV. To address this, Orpheus Capital offers PE and VC securitisation solutions which promises to be a potential game-changer!
Basel III and Capital markets
Since the publication of the most recent Basel III draft regulation, industry participants in the US financial sector have raised concerns about the potentially far-reaching implications for the formal banking sectors in the US. In short, without wanting to elucidate all the fine print, the eventual outcome as proposed, will see a sharp rise in the Tier 1 Capital adequacy requirements for banks potentially increasing the base cost for banks to hold liquid capital. The consequences are expected to be far-reaching as most participants in the formal financial sector will see a material cost to funding their business activities. As always, there will be winners and losers when the draft regulations are formally enacted as suggested. Big banks will increase the cost of doing business, and smaller marginal banks will be squeezed out of the financial system as they will not be able to compete. This indicates reduced competition among major banks, potentially leading to an increase in bank mergers, reminiscent of the “too big to fail” scenario. Conversely, reduced competition among top players also poses concentration risk, unfavorable for borrowers, who may face a situation of paying up or being shut out.
Another intriguing trend set to reshape global financial markets, influenced by developments in the US, is the strategic shift of major private equity and venture capital market players. These players are now exploring the formal savings market (investors) for more permanent pools of capital. Carlyle Venture Capital Group, with a substantial $380bn AUM, has announced its intention to tap into this more permanent capital through an IPO, as part of a defensive strategy. This follows the successful IPOs by Blackstone and KKR, which raised over $1bn each. A key insight is that the initial COVID-related business slowdown, followed by the steepest rate hike cycle in the US in decades, led to a halt in payouts to Limited Partners, who had to endure poor capital returns.
Electing to list around 10-15% of Carlyle’s shares on Euronext in Amsterdam implies a market value of approximately €13 billion to €15 billion for the company. This comes shortly after Carlyle raised €26 billion, marking the largest buyout fund ever (CVC Capital Partners Fund IX).
Our second observation is the extended duration of the new funds relative to the traditional 5-7-year periods. Carlyle raised the fund with capital committed for 10-15 years, bringing some permanency to the funding structure. The more permanent pool of “dry powder” will result in less reliance on LP partners for funding should markets enter a period of “difficulty”.
Valuable lessons were learned from the previous market crises, i.e., the dot-com bubble in the 2000s, saw an almost 30% decline in US buy-out activity, and LP capital calls dropped off by c.23%. During the GFC in 2008, PE funding declined by a staggering 40% and the time to close fund went out to c.18 months versus a historic six months. The last dry spell was during the COVID period when average funding went from $250m (Q4/2019) to $100m for 2Q20.
In PE, timing is everything, and someone once said: “Never waste a good crisis”, this was particularly true during the COVID period when asset values declined to “bargain basement” values as deal multiples shrank to low single digits.
Longer-term investors such as Sovereign Wealth Funds like PE because they want the long-term exposure. This makes strategic sense given the sharp increase in AUM for the latter. SWFs seek less volatility in their PortCo. In contrast to PE funds, private debt funds or leveraged debt managers are under pressure to return capital faster to avoid overturn.
Long-term capital commitments come at a price and with conditions as LP must reconsider its terms and options which may result in funds being less aligned to LP expectations and objectives.
The jury is out on whether interest rates in the US will come off as forecast a few months ago as US macro drivers remain buoyant for jobs, the labour market, forward rates, and sticky inflation. LPs remain starved for contributions and new capital commitments from this source are by no means certain. Unless there is another crisis at hand (read geopolitics) the outlook for PE and their LPs is likely to improve, be it more gradual or less sudden, as current conditions are almost GFC like.
GP’s need to shift PortCos out of their portfolios, which is not easy in the current market, yes industry deal activity is hotting up as larger players take advantage of their balance sheets to acquire the casualties of the last rate cycle; this is particularly evident in the fast-food FMCG and space and technology sectors.
At current rates, term funding remains expensive although NPVs should be more depressed than at the lower end of the interest rate curve. Interest cover ratios are at 2007 lows and for some, debt covenants are close to being breached.
The $1.3 trillion sitting as “dry powder” on buy-out firm balance sheets will provide longevity to the next buy-out cycle. GPs need to guard against overpaying and should always remain mandate-driven.
In our next Industry Insight, we look at Private credit and private debt markets as the new normal.