Private Equity: The Coming of Age

The latest trend analysis of PwC shows: Europe’s financial investors are adopting a much more cooperative approach than five or ten years ago. The European market continues to boom and deal volumes have achieved new heights. Steve Roberts, Head of Private Equity at PwC in Germany, explains why.

One of the main findings of the “Private Equity Trend Report 2018” is that Europe’s private equity companies are increasingly focusing on collaboration rather than confrontation. How precisely do you come to this conclusion?

Steve Roberts: Correct. There are multiple factors behind this. On one hand there are record levels of dry powder, raised funds have grown and the virtually zero interest environment has made the underlying macroeconomic conditions almost perfect for private equity and their operating model. However, there is a scarcity of takeover targets to feed this heightened appetite and this combined with increasing competition, continuing geopolitical uncertainty, unpredictable financial markets as well as increased pressure from LPs has all led to this current dynamic. For example, we asked private equity managers to indicate how the business model of the sector has changed during the past three years. In response to this question, 66 percent answered that they would cooperate with strategic investors much more frequently than was previously the case. In other words: instead of competing for a takeover target, the preferred approach is to adopt a strategy based on common ground. In response to the question about what has changed in doing business with PE’s limited partners, 37 percent stated that they much more frequently co-invest in deals. This is also what I find very interesting. In the past, pension funds or insurers preferred to hide behind private equity. Nowadays, they step aggressively into the public gaze as co-investors and sponsors.

In the past, private equity in Germany has been accused of burdening their portfolio companies with high levels of debt in order to maximize their own return. Are financial investors nowadays also more cooperative in this respect?

Roberts: Definitely. 68 percent of the surveyed PE managers stated that financial engineering has become much less significant – and this for quite some time now. Multiples and valuations are currently very high – on average even higher than before the financial crisis in 2008. However, what we are seeing is that the amount of debt that is taken on to finance transactions has decreased and remained at a significantly lower level than it was in 2007 for example. The results from our survey also support this: when asked what is the most important component of their own business model, 44 percent nowadays state that the primary objective is to “drive forward the operations” of the portfolio companies. Further confirmation in this respect is that, according to another recently published PwC survey, 83 percent of German family-owned middle market companies could imagine a financial investor participating in their company. What we also see in our day to day business is that private equity continues to place more and more emphasis on developing equity stories based on operational value creation as well digitization initiatives. With the factors and market dynamics stated previously, some private equity fund managers who do not have the pressure to invest, have turned to their current portfolio and working on making it bigger, stronger and more robust. Emphasis for many is increasing profitability, while focusing on top-line growth – also with help of new digital channels. On the other hand, this portfolio strategy has also spurred dealmaking - that is why sectors, which are very fragmented and thus ripe for market consolidation are a core focus for private equity – a perfect field for developing buy-and-build strategies.  

But doesn’t this mean lower returns for the private equity sector and inevitably so for limited partners?

Roberts: On the face of it one may think this to be the case, however, the industry is working hard to counteract this through deep value creation and buy-and-build strategies, which are realized through longer holding periods. You must see that times have changed, and with it there has also been a change in the approach of most financial investors. The picture is of a sector which is becoming more and more mature, a sort of coming of age. Private equity has outperformed every other alternative investment class – and significantly so. This is also the reason in this low-yield environment for more and more insurance companies, pension funds and even sovereign wealth funds to be dedicating larger amounts to private equity. It has become more difficult for private equity fund managers to generate these top returns – and now they are not focusing on leverage and multiple arbitrage but have to pull up their sleeves and work deeply together with their portfolios to build better businesses. The sector has achieved a constant high growth on this basis. Accordingly, 48 percent of private equity managers stated that the number of their investments in 2017 has increased compared with the prior year – whereas another 32 percent stated investments remained at the same level as in 2016 – which was already at a very high level.

Is there a link between the cooperative approach and the strong growth rates?

Roberts: That is precisely what I believe. There is a link between the ever increasing operational focus of private equity on their portfolios and the increased cooperation with strategic investors as well as limited partners. Private equity has joined forces and this has proven to be a success.  There is definitely no sign of an end to the private equity boom which has been ongoing for many years now. Even in a slow macroeconomic environment our survey shows that 57 percent stated that they were satisfied with the development of their portfolio companies; only 14 percent were dissatisfied. In addition, 50 percent expect to see even better business this year, while 64 percent expect investments in 2018 to increase further. The private equity sector is not experiencing a temporary upswing; on the contrary, it is in the process of further establishing itself as a permanent and prominent presence in Europe.