Private equity firms need to diversify and differentiate their businesses through the current period of economic turbulence, according to a new report from PricewaterhouseCoopers that seek
Private equity firms need to diversify and differentiate their businesses through the current period of economic turbulence, according to a new report from PricewaterhouseCoopers that seeks to identify the key challenges the industry must address to respond to an environment of contracted markets.
The report, Seeking Differentiation at a Time of Change, says that larger funds are broadening their investment criteria and geographical horizons. The holding period for portfolio companies is growing longer and private equity managers are demonstrating active portfolio management with this in mind.
‘The private equity industry is witnessing a dramatic downturn in deal activity and is suffering from a lack of leverage caused by the turmoil in the financial markets,’ says Brendan McMahon, global investment management and real estate private equity leader at PricewaterhouseCoopers.
‘This has a major impact on the ability to finance larger transactions, but also creates a lack of buyers for existing portfolio companies. Private equity players will need to adapt to the longer-term holding periods by looking at how they create value for portfolio companies.
‘Private equity managers are now looking at the diversification of their investment strategies and are seeking to differentiate their businesses during this time of change. Without doubt, we will see the industry reshape in order to adapt to the new order.
‘In the current climate of focus on quality, investors are seeking access to alternative investment managers with strong brand recognition that are seizing the opportunities and delivering returns in a transparent way. Uncertain times also bring great opportunities for the patient private equity investor and investments from this vintage are likely to generate high returns.’
The report highlights the need for sustainable growth and diversification and examines the growing pressure on fair value accounting and mounting tax risks. It also looks at the opportunities for private equity in the BRIC economies.
Shifting economic conditions are strengthening the case for building diversified stables of investment strategies but the report argues that this must be accompanied by appropriate controls.
The current market climate means there is even greater logic in a diversified product range, particularly as some asset classes are more suited to generating investment gains through the trough of the cycle than others. Private equity players are considering and implementing the diversification of investment strategies in infrastructure, distressed debt and emerging markets.
Sustainable growth will become critical as earnings growth becomes the primary driver of internal rates of return. The report argues that operational expertise is critical in facilitating ebitda growth and ‘buy and build’ strategies in fragmented industry sectors. Portfolio management teams will require integration expertise, and a recruitment drive will be required to change the resource mix, transferring key performance indicator management trends across industries.
Fair value accounting presents real challenges for the private equity industry at a time when investors, regulators and auditors are demanding robust assessment of valuations, the report says.
While there may be a high degree of internal and external challenges in the valuation of unlisted investments by private equity companies, investors will expect managers to demonstrate transparency in how assets are valued.
As investment portfolios become ever more global, private equity houses are confronted with increasingly complex tax risks and structuring challenges. The new territories in which private equity companies have invested often have relatively undeveloped taxation systems while, in the more developed economies, tax risks are increasing.
Fund managers across the globe need to build and develop robust internal procedures to manage tax risk and to stay abreast of key developments in the territories in which they invest or deploy investment professionals, the report says.
The report says a total of some USD297bn in private equity and venture capital was invested last year, up 26 per cent from USD235bn in 2006. Although the environment has changed dramatically in just a few months, global buyout activity continued to grow in 2007, while expansion capital and high-technology activity stagnated; and investment activity was growing in emerging markets and the US, it was flat in Europe.
