Friday Letter: Going for growth

Big buyouts are still on the menu, but some firms have lost their appetite and are turning their attention to smaller, growth investments.

Mega buyouts continue a pace, highlighted by Carlyle’s $8 billion acquisition of Veritas this week, made with other co-investors including Singapore’s GIC. And we can expect more in that vein. The New York firm alone has a $26 billion barrel of dry powder that it must spend.

Europe is keeping up. A steady flow of €1 billion-plus transactions drove €37 billion of deals in the first half of this year, according to the Centre for Management Buyout Research (CMBR).

But further down the buyout food chain, a roaring market for IPOs, waves of liquidity and cheap debt are pushing some firms to rethink.

Hermes GPE, to which the BT Pension Scheme renewed its private equity allocation at £1 billion ($1.6 billion; €1.4 billion) this week, is shifting focus away from ‘plain vanilla PE’ into growth investments having gorged itself on buyouts in the last market cycle.

The co-investment specialist is still looking at sizeable companies, those with an enterprise value of $500 million, but could go as far down as early stage and as low as $100 million, its head of private equity Peter Gale told Private Equity International.

For buyouts, this is already a crowded space. In the UK, which leads European buyout activity, there were 101 transactions totalling £10.5 billion in the first half of the year, according to CMBR.

Multiples are steep. Average buyout purchase price multiples (price/EBITDA) in the first half of the year were 9.88x in Europe and 10.05x in the US, according to S&P Capital IQ LCD.

But, as PEI has noted before, money raised must be deployed. And the race to acquire assets shows no sign of slowing. Competition was apparently hot for UK foreign exchange company Currencies Direct, bought by Corsair Capital and Palamon Capital Partners for more than £200 million this week.

Cheaper debt might ease some of the short-term pricing pain. But borrowing big at low interest rates is a gamble that credit will remain plentiful to support asset prices far into the future.

Perhaps that is why Hermes GPE is also looking beyond its usual hunting ground of Western Europe and the US, and taking its first proper look at ‘growth markets’, such as Africa and Southeast Asia.

They aren’t the only ones. Buyout house TPG, through its growth arm, has also spotted the opening. In June it announced it was partnering with London-based Satya Capital to launch a $1 billion investment platform targeting Africa.

Satya’s chairman is Sudanese billionaire entrepreneur Mo Ibrahim. The team up points to a key requirement for doing deals in emerging markets: local knowledge. Funds also need resources, including people and time, to source the right deals and build a new network of relationships.

In PEI’s forthcoming The Africa Special 2015, we flag other funds that are eyeing the continent, which has had a bullish first half for raising capital, and detail the rising number of investment opportunities.

If a fund can get it right, the cost of deal sourcing, and even the multiples it might have to pay to acquire sought after assets, should be offset by the potential for huge growth and the commensurate returns that come with it.

But what of those deal-craving GPs that either don’t have the capacity or the mandate to make a shift in strategy or geography? These are the majority. If you’re a European mid-market manager or a US buyout fund, growth and emerging markets can’t be part of your solution.

This leave us with the question, what can?