THE NEW FACE OF PRIVATE EQUITY
THE ROLE OF SPECIALISTS
September 2010
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| Kristoff Puelinckx, Group Managing Director kpu@deltapartnersgroup.com |
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| Francisco Sosa del Valle, Associate Partner fs@deltapartnersgroup.com |
Is private equity extinct?
The financial system is still trying to work its way out of the abyss. Debt and equity capital markets remain unstable and banks are still beefing-up their capital ratios. A business culture built around leverage is being severely questioned. The prospects of private equity remain unclear.
It seems tempting to claim that the days of the asset class are over. Some LPs are pressing PE firms to reduce fees, commitments, or both; others have elected to circumvent them. The industry is also facing an uphill battle to invest committed but uninvested funds. In addition, investees require more attention than they required in the past. Fund managers’ economics are under pressure; they are expected to remain that way in the foreseeable future.
Despite the prognosis, we still believe there is a future for PE. Leverage, a key industry driver, is temporarily out of the equation. However, PE firms have also succeeded due to their ability to pick industry winners, to align interests of the various constituencies in a transaction, and to marshal resources around investees.
Private equity will emerge out of the crisis. Its value proposition of active ownership to maximize long-term returns for investors remains sound. However, firms that hope to survive must adapt to a new reality – a new norm.
A new industry, a different landscape
The absence of financing has redefined the rules of engagement in PE. Cash-strapped corporations are refining their portfolios and carving-out non-core assets. Buyers are shying away from all-cash deals and increasing seeking alternate sources of financing in the absence of cheap debt. The industry’s focus has shifted from financial engineering to industry know-how.
Table1: Private Equity: Changing Realities
| Old paradigm | New reality |
| Financial engineering | Industry Expertise |
| Build-ups | Carve-outs |
| Cash acqusitions | Equity deals |
| Leverage | Seller financing |
| IPOs and follow-on offerings | Liability management |
| Top-line growth | Earnings quality |
| Recapitalizations | Restructuring |
Source: Delta Partners Analysis.
We think the industry’s landscape has to adapt to the new conditions and that it will move towards a model in which global mega-funds co-exist with niche players that are focused on a specific sector, a region, or both.
Global funds will be industry leaders. They will manage the largest pools of capital, invested across multiple industries and geographies. Sector and geography specialists will not be as large as their mega-peers, but will develop a dominant position in a regional market or a specific sector. We expect them to prevail in emerging markets, and to potentially co-operate with global funds in certain transactions.
The benefits of specialization
Small and mid-sized firms must rethink how they will differentiate going forward. Successful firms will be those that remain selective and that focus on building sector or geographic expertise. A migration towards sector specialization will acquire momentum; its benefits are evident.
Specialization allows fund managers to be in regular contact with key industry players. This provides them access to a vast, focused deal pipeline. More importantly, it allows them to pro-actively originate high-quality deals.
Specialists also have an edge in identifying potential winners thanks to their stringent screening criteria, their discipline and expertise. They are ideally-positioned to reach out to various industry stakeholders which are able to identify shifts in industry trends. In doing so, they develop proprietary insights which make them better prepared, for example, to screen-out less promising opportunities. This gives them a powerful competitive edge during the due diligence phase.
Sector specialists typically identify high-potential sub-sectors in which to zoom-in based on their size, growth potential and profitability, the availability of targets, the existence of potential exit avenues, and based on the firm’s ability to create value in each subsector. Such razor-sharp focus allows successful sector funds to be closer to the ground, better equipped to interpret localized trends and dynamics, and ready to fine-tune their investment thesis based on their observations.
Post-investment, the ability of specialist funds to contribute value to portfolio companies has reinforced their edge over generalist funds. They are better-equipped to create value, and to provide strategic guidance and direction to investees. Additionally, given their broad industry relationships, they can attract the best professional talent to fill crucial positions in their investees. Finally, specialist funds are better skilled to develop relevant KPIs to challenge the investees.
Finally, specialist funds also have an edge as they seek to exit their investments. They can better assess potential buyers’ interest, and are well prepared to present the most compelling case for each of their portfolio companies.
Putting the pieces together
In summary, we strongly believe that the PE industry is far from dead; it is only changing and adapting. In order to survive, small and mid-sized firms must re-think how they position themselves in a new reality. In this battle for survival, specialists have a sustainable competitive edge.
Delta Partners is the leading investment and management advisory firm specializing in telecom, media and technology in emerging markets. We have built our investment business around such focused model and we intend to continue growing and adding value to the TMT industry in emerging markets under the same specialized model.