Friday Letter: Know your sector, get together

The M&A market is poised to continue rocking 'n rolling along, as activity over the last 12 months reached levels not seen since before the global financial crisis took root in 2008. A number of factors have converged to set the stage for another robust year for North American private equity sponsors and strategic acquirers alike. Both groups have access to plenty of credit – whether in the form of syndicated terms loans, subordinated debt or junk bonds. Healthy equity capital markets continue to shore up the purchasing power of public companies, while private equity buyers sit atop an abundant amount of dry powder. And amid a stable economic backdrop, it is in no way surprising that competition for deals is as intense as ever. 

So if your private equity firm is as well capitalised as the rest of them, how can you give yourself an advantage? Become an industry specialist is what you do. This isn't a new theme within the industry. But according to a report issued by Deloitte on the 2015 M&A environment this week, it's continuing to preoccupy GPs a great deal.

Deloitte interviewed 408 financial sponsor professionals and was told by almost three quarters of them that they were making investments to create industry-specific portfolios rather than portfolios comprised of hodgepodge companies from diverse sectors. As trends go, this one looks certain to be here to stay. 

Says Stewart Kohl, Co-CEO of The Riverside Company: “The focus on industry specialisations is a long-term trend which is part of the natural evolution of private equity. In an increasingly competitive environment, it provides you with an edge while also allowing you to be a better buyer, as well as owner.”

It's a philosophy that many limited partners are finding compelling, too. “LPs are also now using [industry knowledge] as a criterion when selecting where to invest,” notes Kohl. 

In light of this, approaching leverage buyouts with a generalist orientation is getting harder. For GPs, the writing on the wall should be clear, especially if the goal is to secure capital for a new fund from the institutional investor community: beef up your industry-specific skill set, or hit the road jack and don't come back. 

It could be that sector expertise is also a booster of GP confidence when it comes to taking on larger acquisition targets. According to the Deloitte survey, 55 percent of those polled expect to be working on transactions with an enterprise value of $500 million or greater.

More tellingly still, there was a big number of survey respondents who predicted an increase on club deals: 71 percent of private equity survey participants foresaw a rise in consortium transactions in 2015, up from 58 percent the previous year.

Limited partners might have mixed feelings about this last data point. At face value, a group of deeply knowledgeable GPs teaming up to buy a larger technology or healthcare company than any of them would be able to acquire on their own might seem appealing. However, club deals are well remembered as a less impressive part of the private equity track record from before Lehman Brothers. If they are now poised to make a comeback, investors must be hoping that the right lessons from last time have been learned.