PE GPs acquiring LPs – what does it suggest?

Recently Carlyle announced the purchase of Dutch asset manager AlpInvest Management from its anchor investors APG and PGGM pension funds. APG and PGGM Agree to Sell AlpInvest Partners to The Carlyle Group and AlpInvest Management

AlpInvest is considered one of the world’s biggest PE fund manager with USD 43.3 billion AUM and these two dutch pension funds as the main investors. Even though these pension funds have given commitments of around USD 13.5 billion till 2015, this divestment signals a new investment philosophy on the LP front.

I believe LPs such as APG and PGGM want to remove the FoF intermediary in future and invest directly or through co-investments. On the other hand GPs such as Carlyle who are integrating backwards through such acquisitions want to have access to bigger cash pools. However to me GP and LP owned by same management would create conflicts of interest and investors would surely like to have these two entities different.

Let’s see how things go around for Carlyle while managing AlpInvest? Time will tell us if they will be able to maintain the trust and commitments from AlpInvest investors?

PE issues today and their implications

Some of the issues the PE world is facing these days and their implications I feel are:

Funds are sitting on a dry powder of around USD 500 bn which is awaiting investments. The investment period deadline of many funds is around 2011-12, so they are left with very less time to invest the uncalled commitments. This is resulting in many funds investing at very high valuations in places like Asia and overheating the already heated market.

Not many IPOs of PE backed companies are happening as a result of this most of the exits are happening through secondary sales. Is this leading to somewhat round robin, where only secondary exits are happening? In that case wouldn’t it be better to have more secondary funds?

In case of buyouts much of the debts used during the 2007 buying spree would be due in 2012-13 and the economic situation of all the funds is not so well that they would be able to payback all the debts. Would this lead to a new market of debt refinancing? If some big repayments do not work out would it lead to new economic problems?

Globally government regulations for alternative asset class especially PE/VC is tightening.PE/VC would no more be as profitable as it used to be. It would no more be a totally unregulated asset class.

Big PE firms have started looking at small deals also.With the big firms trying to take away the pie of small firms who used to specialize in small and medium enterprises, there would be huge competition among the funds. This may inculcate a very favorable environment for entrepreneurs.

Globalization: Japan-India PE perspective (continued)

In the last post I touched the issue of 4 ways of looking at the PE/VC relations between Japan and India. In this post, I would try to elaborate on these 4 ways about how the Japanese PE/VC firms could look to seek a pie of the India story cake.

  1. Invest in Indian Companies – After talking to various PE/VC firms in Japan I noticed that they have very less exposure to the Indian markets. They almost have no Indian company in their portfolio. We need to understand that to capitalize on the emerging economies; companies need to understand the local markets and who can know these markets better than the local Indian companies? I completely agree that to have companies from other country on the portfolio, someone from the investment firm needs to understand the target country’s culture and people. But that should not be an issue for Japan, since many Indian business professionals work in Japan and they are bilingual too. Off-course in the beginning aligning to some new county’s customs and business would be a problem for the investment firm, but that’s fair enough given the better IRRs.
  2. Streamline the Indian companies – Now once the Indian companies are in the portfolio, the Japanese GPs can streamline their operations while restructuring the company. The GPs can then use the knowledge of their world-class quality tools such as TQM, JIT to improve the efficiencies and take the company to new avenues. They can also restructure the company to serve the Japanese markets, like Daiso’s main suppliers are from China and Indonesia, similarly companies in India can also have products catering to Japanese markets, become suppliers to companies such as Uniqlo.
  3. Bring LPs from India on board – As I said in the last post due to not up-to mark performance of the Japanese GPs, some LPs here might have turned a bit unwilling to invest. The unwillingness is but natural because the LPs would always be expecting for much above market returns, which may be high expectation over the short run. However with the recent boom in India, there would be cash-rich LPs in India, looking for fundamentally strong companies in Japan, to invest in. In India basically most of the PE firms, are arms of business conglomerates, Birla, Fortune, Premji and now even Infosys to name a few. These firms would be willing to invest in companies having businesses allied to their business, such as Fortune could invest in a brilliant technology catering to the Retail markets, Premji Capital could invest in some brilliant embedded technology company.
  4. Take the Portfolio company’s products to India – Japan, a technology power has immense potential in terms of technological innovations, the need of the day is to synchronize the applications of these innovations to the needs of emerging economies, and if the GPs can achieve this during the restructuring of portfolio companies, planned to cater to India markets it would be very fruitful. Let’s take an example of this aspect; India has set a target of generating additional 78,500 MW of electricity by 2012, of which Solar and Hydro Power also form a crucial part. India has set an immediate target of 1000 MW of Solar energy by 2013 under the Solar mission and 20,000 MW by 2022. Some days back I was reading in Nikkei Weekly that due to high costs Japan has lost market of photovoltaic cells to Korea and Taiwan, but these days there is some movement for regaining the lost place. If PE firms having such companies in portfolio can have an offering for Indian markets, it would be a right offering at right time. But not to forget, in India cost and durability play a vital role, so due care should be taken of these aspects. Some days back I was looking at a hydropower Japanese product, it is a box, which just needs to be placed in a stream of water, may be river, city sewage drains, industrial drains and it would in turn generate power. Now if this product can be adaptable to Indian needs it would be interesting. Suppose it can generate enough electricity to pump water for a river side farm, than farmers would readily use it, even the government could pitch in with subsidies, because it’s addressing the immediate need of power shortage in India.

Globalization : Japan-India PE perspective

We understand that Globalization means sourcing resources from places, where we get them in the right amount, at the right rate and in the right quantity; this in turn results in efficiencies.

Now let’s analyze India-Japan Private Equity-Venture Capital (PE/VC) viewpoint using this principle. A General Partner invests time, capital, talent and energy in the enterprise and optimizes its performance, if required restructures it. The result is a better enterprise with improved revenues, efficiencies, bottom lines and off course better valuations. Post this they sell their stake in the enterprise through various exit strategies; IPO, sale in secondary markets and sale to a strategic investor to name some. In today’s globalized world the PE transactions need not be limited by boundaries and in many cases it’s happening so, however if we look at the Japan-India PE activities we do not see much happening on this front.

Japan has always been a technology power and being a developed nation and high per capita income has the capital to invest, however due to shrinking domestic markets does not have much promising investment opportunities, if the invested enterprises aim only local consumption. Also the Limited Partners from Japan these days are turning a bit reluctant. India on the other hand has an increasing customer base, incomes, investment opportunities, HNIs, Institutional Investors and companies looking for advanced technologies.

If these two nations can bring about a proper synchronization between all these resources and needs of them, it would be a win-win situation for both the nations. Not to forget India and Japan share a lot common in their cultures and this can help them in doing businesses successfully. However today if we see the portfolio of any big PE/VC firm in Japan or India they have negligible cross investments.

This disparity could be looked in four ways; I would discuss more about it in my next writing.

Implications of the Volcker Rule

Recently the US president proposed a rule “Banks no longer would be allowed to own, invest or sponsor hedge funds, private equity funds or proprietary trading operations for their own profit, unrelated to serving their customers.”

Mr Obama said that “While the financial system is far stronger today than it was one year ago, it’s still operating under the same rules that led to its near collapse”, the new rule named after former Federal Reserve Chairman Paul Volcker (a staunch advocate of prohibiting banks from engaging in proprietary trading solely for their own profit) would prohibit banks from owning or making investments in private-equity and hedge funds that “are unrelated to serving customers.” While financial institutions could still manage the assets on behalf of clients, they wouldn’t be able to invest in their own funds or those run by Private equity firms.

Since the proposal of this rule major banks have seen a fall in their stock prices by around 4% , if this rule is passed by the Congress the possible effects could be:

Private Equity Space:

  1. The industry would see many mergers and acquisitions with banks being forced to sell their private-equity units
  2. New players would be seen in the Private Equity market with the cash rich banks no more being there and a huge market share was occupied by them.
  3. Existing Private Equity firms would grow stronger
  4. Since huge loans were provided for LBOs by banks, this source of loans for LBOs may be interrupted resulting in a bit trouble for LBOs
  5. In a world where already the sources of capital for Private Equity are less, one source of capital would be removed

 Investment Banks:

  1. All major I-Banks may have to sell some private-equity businesses and stop investing in buyouts
  2. Plan to curb proprietary trading will cost all major I-Banks a huge fall in revenue next year. Goldman Sachs alone is estimated to have a $4.67 billion drop in earnings in 2011

Expert’s have various views about this rule:

David Viniar, Goldman’s chief financial officer, while calling the proposal “impractical” said that“You have global institutions around the world who are set up in a certain way and to put rules in place that roll back the financial system by 10 years I think is going to be a very, very hard thing to do”.

Steven Kaplan, a professor at the University Of Chicago Booth School Of Business said “Targeting private-equity investments by banks doesn’t go to the root of the problems that caused the financial meltdown”, “Private-equity investments did not cause the crisis,” Kaplan said. “It was their loans that went bad.”

However from the US Government side Austan Goolsbee, a member of Obama’s Council of Economic Advisers, said that the proposal was “not intended to get rid of asset management as a function.”