Review of the decade
This year will launch a new decade of PE activity that will extend and reflect significant events that occurred in the past decade. These include a spike on each end of the deal spectrum, the rippling impact of technology on PE, and emergent political activism shifting domain boundaries. While various forces continue to shake up the terrain of PE, each shift marks a window for value creation.
A spike on each end of the deal spectrum
The decade ended with a record year for deal making activity, including the largest private real estate deal in history occurring with Blackstone’s purchase of U.S. logistics asset GLP for $18.7 billion. Several other $10 billion dollar plus deals occurred, including EQT’s purchase of a Nestlé skincare unit for $10.1 billion and Digital Colony Partners and EQT’s purchase of services provider Zayo Group for $14.3 billion.
PE deals below $500 million also increased, making up nearly a third of deal volume. Why is there an uptick on this end of the spectrum? The large volume of deals at the $10 billion plus mark has had its fair share of failed deals. Several deals, including a bid for Arconic by Apollo, fell through negotiation talks. Large deals seem to have been most successful with instances of PE sponsor building on a portfolio company or when potential competing bids failed to materialize. Deals below the $500 million mark materialize as a strategy to avoid the risk of failure found with megadeals, by acquiring a series of small companies within a given sector and exiting through a rolled-up listing or sale.
The rippling impact of technology on private equity
In the past decade, technology has matured into the domain of PE. While many technology companies turned to venture capitalists willing to onboard the risk of many early-stage companies, the disruptive value of technology has become evident as companies like Apple, Facebook, and Alphabet have matured into the most valuable companies in the world. Technology companies seeking to exit are now commonly considering PE as an attractive option to maintain some distance from public scrutiny and maintain private share distributions.
This shift towards PE as an exit option has had an impact on the frequency of IPOs, acquisitions, and secondary buyouts – all down at all-time lows at the close of the decade. The handling of the WeWork IPO was met with industry-wide scrutiny and distaste. This prompted a wane in speculated demand. Endeavor, a U.S.-based talent agency, pulled its IPO ahead of the planned launch date due to perceived lack of demand. With M&A, some PE firms have displayed stronger interest in taking stock of publicly traded acquirors to promote liquidity in their investments.
Acquisitions, while also at an all-time low at the close of the decade, saw a rising trend in direct lending emerging as a category to compete with syndicated financing. While the customary syndicated financing is still a primary source of financing for large-scale leveraged acquisitions, the direct lending market grew quickly for several reasons. While debt provided by direct lenders is not necessarily cheaper than syndicated financing, it has emerged as a viable alternative because of its increased certainty of terms, structural flexibility and optionality, and elimination of the debt marketing process. The debt markets were generally strong, though borrowers rated single B or lower were met with a more discerning credit market towards the end of the decade. Sponsor-backed borrowers responded with revised structures, agreements, and pricing to respond to these challenges, an ever-continuing cycle that will continue on in the next decade and worth keeping note of for trends in the metadata.
Technology continued to impact PE firms by prompting structural transformation. Following updated S&P index rules that no longer permit the inclusion of dual-class companies in the S&P 500, several major firms converted from partnerships to C corporations. This trend compounds on changes in tax laws that further incentivize the formation of and conversion to a C corporation. Of note is the change in U.S. tax law lowering the highest tier corporate tax rate from 35% to 21%. This shift away from partnerships will enable a broader group of investors to participate in the returns found in PE.
At the end of 2019, nearly 40% of U.S. PE deal value came from acquiring innovations that have the potential to disrupt entire industries. Tech-specific dry powder doubled in the last five years of the decade, a trend that is likely to continue as dry powder accumulates in PE. Over $1.5 trillion of dry powder has built up in supply. While this has triggered mild concern from some observers, viewing it as an incentive for firms to pursue overvalued deals, others meet the capital supply with optimism. At the close of the decade, PE returned more than 13% per year on average compared to approximately 9% for the S&P 500, signaling that the reserves of dry powder will continue to promote strong returns and outperformance.
Global PE fundraising hit an all-time record in 2017, then steadily declined through the end of the decade. Much of the activity was concentrated in a collective few comprised of mega-funds raised by established firms. Vista Equity Partners raised the largest-ever tech fund at $16 billion and Blackstone Capital Partners closed the largest-ever buyout fund at $26 billion.
Front office tools are yet to emerge in a meaningful way, but sourcing and secondary liquidity platforms are two large and growing categories that look to solve a meaningful pain point for private equity funds.
Emergent political activism shifting domain boundaries
While hedge funds and PE funds hold different attitudes towards publicity and organizational change in portfolio companies, hedge fund-style activism has had increasing overlap with PE. Some activist hedge funds have begun bidding for companies and several PE funds have explored this style of investing and engagement with public companies, including Starboard Value’s $200 million investment in Papa John’s, Elliott’s PE affiliate, Evergreen, taking Travelport private in partnership with Siris Capital, and KKR taking a minority ownership position in Dave & Buster’s. While hedge funds and PE funds remain distinct, the overlap in attitude in some limited instances will likely continue to go on in the coming years.
A landmark 2013 legal case found investment funds liable to obligations to pension funds in the event of a bankrupt portfolio company in which its funds are invested. The case tracked New England Teamsters’ pension fund challenging Sun Capital Partners’ claims that it was not liable in this event. Heard in the First Circuit, the case was decided in favor of New England Teamsters.
In a related vein, the U.S. presidential elections have shifted attention towards financial sponsors. Elizabeth Warren, former U.S. Senator of Massachusetts and current Democratic presidential candidate, has put PE in the political crosshairs by introducing the “Stop Wall Street Looting Act”. The U.S. Congress also held a hearing focused on the costs produced by PE ownership and felt by employees, shareholders, and unsecured creditors. Public figures have taken up this targeting of PE and extending messages of public outcry. In the coming decade, particularly as the 2020 U.S. presidential election ramps up, there will be a need for financial sponsors to establish their voice in Washington to share the benefits produced for investors, employees, pension funds, and other stakeholders across the U.S. and world.
Emerging on the horizon
A global economic slowdown, political volatility, trade tensions, and recessionary fears will no doubt have an impact on deal activity. However, given the above outlined trends of adaptation to emerging windows of opportunity, financial sponsors will continue to find strategies and execute to create value.