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The $2.5 Trillion Question | Dry Powder: The Private Equity Podcast - YouTube
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[4]
GRAHAM ROSE: There
are large GPs out
[6]
seeking record amounts of
capital for new fund vehicles.
[9]
HUGH MACARTHUR:
That's Graham Rose,
[11]
a senior partner in our Private
Equity practice at the Boston
[13]
office.
[14]
ROSE: And these
are vehicles that
[15]
both were raising
prior to the downturn
[18]
as well as some
headline GPs who've
[21]
gone to market even in the
midst of the Covid-19 impact.
[25]
MACARTHUR: Today on the
show with Graham Rose,
[27]
we're going to talk about
the state of fund-raising,
[30]
the amount of dry powder
actually in the private equity
[32]
industry right now.
[33]
There's this mountain of
capital, about $2.5 trillion
[37]
with over $800 billion of
that earmarked for buyouts.
[41]
Those are both record
numbers, both twice
[43]
the amount in the
recessionary period
[45]
we entered 11 or 12 years ago.
[48]
I spoke with Graham
Rose to put that
[49]
into context with the
current fund-raising markets.
[52]
ROSE: If you look back at '08,
'09 and think about the early
[55]
stages of that downturn,
today feels like there is more
[60]
latitude to raise.
[63]
MACARTHUR: I'm Hugh MacArthur,
head of Bain's Global Private
[65]
Equity practice, and
this is Dry Powder.
[77]
So Graham, how
has, in your view,
[79]
the fund-raising
environment changed
[82]
since this pandemic started?
[83]
ROSE: The fund-raising market
remains relatively open.
[87]
Certainly, we're
seeing timelines
[90]
be pushed out a little bit
in terms of the raising,
[93]
but the feedback we're
receiving from clients
[95]
is that the capital
is being allocated,
[97]
it's working
remotely, people are
[100]
confident that they'll
get their money.
[102]
And the question ends
up being whether it
[104]
takes a couple of months longer,
or whether they can actually
[109]
hold around the set of timelines
they might have established
[112]
up front.
[113]
Now that's true for, call
it mature funds, or existing
[117]
GPs with strong track records.
[120]
I think as you
start to work down
[122]
towards new entrants or new GPs,
the picture is very different.
[126]
There was a headline,
for example,
[127]
that only a small percent of the
funds being raised in quarter
[131]
one were for new funds.
[133]
So we have seen some impact on
the amount of capital that's
[137]
being allocated to new ideas.
[139]
And in some ways, that's
understandable from the LPs'
[142]
perspective as they
look for confidence
[145]
in the ability of their partners
to deploy, and deploy smartly,
[149]
and are looking
for people who've
[150]
got a track record of investing
across prior disruptions.
[155]
MACARTHUR: So let's unpack
this fund-raising a little bit.
[157]
It seems a little
counterintuitive to me.
[159]
Firstly, we all heard that
there was a denominator problem
[163]
that many LPs faced,
in that the devaluation
[166]
of their public
equities would cause
[168]
them to be overallocated
mathematically
[170]
to private assets.
[172]
We've seen recently a resurgence
in the public markets and also
[175]
obviously some
portfolio markdowns
[177]
on the private asset side.
[178]
Do you see that the denominator
effect is now largely
[180]
not inhibiting LPs from being
able to make new commitments?
[184]
ROSE: I think there are a
series of factors going on, one
[188]
of which is that the LPs
don't want to miss out
[190]
on what they saw as
boom vintages raised
[194]
in the last downturn.
[195]
The LPs looking at
this environment today
[198]
don't want to be on
the wrong side of that.
[200]
So there is a
predisposition to lean
[203]
in in a way perhaps that wasn't
apparent in the last downturn.
[208]
MACARTHUR: But do LPs really
have the ability to lean in?
[211]
I mean, I guess the
denominator effect
[213]
may be ameliorated
by recent marks
[215]
in the public and
private markets.
[217]
Yet, we've also heard there
have been some liquidity
[218]
issues for LPs, as
they've been asked to,
[220]
or, more capital to shore
up portfolio companies.
[224]
So do you think liquidity
is an issue here,
[226]
or is there just enough
dry powder in the market
[229]
to be able to overcome that?
[231]
ROSE: It's a great question.
[232]
I think there are
certainly LPs who
[235]
are having liquidity issues.
[237]
There are family offices in the
tail of institutional investors
[242]
that will have to look hard
at what their expectations are
[245]
in terms of cash flows over
the course of the next 12
[249]
or 18 months.
[250]
There are certainly
also investors
[253]
who are struggling with local
dynamics, such as currency
[257]
exchange rates, the guidance
from their board in terms
[261]
of cash flow demands that
they may need to meet.
[263]
However, I think your
point around the rebound
[265]
in the public markets
is a very good one, even
[268]
as the private markets
have moved down
[271]
and you've seen public
markets rebound.
[274]
A lot of that pressure
has been offset,
[276]
though I think that the
discussions at the LPs,
[280]
and certainly among
clients that we know,
[282]
took place even earlier.
[283]
They were talking
about the potential
[285]
for a disconnect between the
private market valuations
[290]
and public markets coming
back well before it actually
[292]
happened.
[293]
And in many cases, trying very
much to get ahead of that,
[296]
trying to get permission
to maintain a forward foot
[300]
into the marketplace.
[301]
Not everyone could do it.
[302]
But I think that that is one
of the differences between what
[305]
we're seeing today, and perhaps
what we saw in '08, '09 was
[308]
that people were actively trying
to stay ahead of this from
[311]
the LP perspective.
[313]
MACARTHUR: In this moment
of extreme uncertainty,
[316]
you're confident
that LPs are actually
[318]
receptive to funding new
deals, without understanding
[321]
what the virus is going to do?
[322]
Is it going to come back?
[323]
Are we going to have massive
waves of reinfection,
[325]
second waves, third
waves, et cetera?
[327]
Why would that be true?
[328]
ROSE: There is a couple
of reasons, one of which
[330]
is borne in the lessons of their
actual observed cash flows.
[336]
The lessons of prior
downturns would
[338]
suggest they're committing
for cash flows that
[341]
are several quarters,
if not years, away.
[343]
The pace of that demand
will be, in no small part,
[347]
dictated by underlying
deal activity
[350]
and ultimately by that
the shape of the recovery.
[353]
The conversations that
we've had with clients
[355]
suggest that this understanding
that I am committing
[358]
for the next few years.
[360]
Ultimately, I can't
predict what's
[362]
happening with the pandemic.
[363]
I can't predict
what's going to happen
[365]
with the economy
underneath it or around it.
[368]
But what I can say is
that the pace of activity
[371]
and the pace of my
capital deployment
[373]
is likely to move
with the recovery,
[376]
rather than move
through the downturn
[378]
and leave me in a position
where I have just committed
[381]
and can expect rapid cash
draws in a period where
[383]
I can't make those happen.
[385]
MACARTHUR: You've mentioned that
many investors have absorbed
[387]
the lessons of 2008,
2009 and actually those
[390]
were great years to invest.
[392]
It seems this time
around, because of a lot
[394]
of the uncertainty, some
in the investment community
[397]
are thinking that we could
see depressed multiples,
[400]
depressed pricing,
difficulty in earning return
[403]
struggle on for several years.
[405]
Are you seeing a case where
multiples bounce back faster
[408]
than that, or do you
think that we may
[409]
be in for a prolonged downturn?
[411]
ROSE: There is, as
mentioned before,
[414]
a record amount of dry powder.
[416]
And certainly that
suggests that there's
[418]
going to be a lot of competition
for any deal that emerges.
[421]
There are reasons to believe
that any transaction that
[424]
gets priced today will
be priced fully given
[427]
that degree of powder
circling around.
[430]
We've also observed this,
certainly among our clients,
[433]
as the market has
started to see more
[436]
activity in the form of
PIPEs, structured products,
[440]
a lot of different
players and capital
[443]
are trying to put
money to work, pushing
[445]
the multiples and the frothiness
in the transactions themselves.
[449]
There may be a
window of opportunity
[451]
for favorable pricing,
but it's going
[454]
to be favorable pricing in
light of a competitive situation
[458]
with many different bidders
looking at any asset
[461]
that they feel they can
deploy capital against.
[463]
MACARTHUR: I think you're
right that there's a case
[465]
to be made that this could
be an even faster rebound,
[468]
albeit with lots of
uncertainty around it
[470]
than we saw in 2008 and 2009,
because as we talked about
[474]
earlier, I think things are just
fundamentally different now.
[477]
And this is a fundamentally
different downturn.
[479]
When you think about the
downturn of '08, '09, we had
[483]
massive structural problems
in the global economy.
[486]
We had an overleveraged and
undercapitalized banking system
[489]
that made liquidity
difficult to provide.
[492]
We had asset bubbles, like
in real estate in the US,
[495]
that were going to take
years to work through.
[497]
We really don't
have that right now.
[499]
There are instances,
if we continue
[500]
to keep economies shut over
the long period of time, where
[503]
we could cause large
structural amounts of damage
[505]
in the economy.
[506]
And what's happened in
economies is now under debate.
[508]
But it would seem that at
least the financial markets
[511]
are signaling that
if we can come out
[513]
of this crisis in the
relatively short term, that we
[516]
can bounce back to some
kind of a new normal.
[518]
And as you mentioned, assets
will be competed against.
[521]
And I think it's
interesting to observe
[523]
that in the first
weeks of the pandemic,
[527]
we saw a lot of investing
on the distressed side,
[529]
credit, PIPEs, as
you mentioned, even
[531]
some public-to-private activity
that actually was competed.
[535]
We're now rapidly pivoting
towards new processes,
[538]
largely in sync with
where the pandemic started
[541]
and where it's been and
where places are recovering.
[543]
For example, if we used our Bain
book of business as a proxy,
[546]
we are seeing high
levels of activity
[549]
now in China and in parts of
Asia where the virus started.
[552]
We're actually seeing
substantial upticks in business
[555]
also in Europe now,
especially northern Europe,
[558]
and more recently, even
in the United States.
[560]
And this is telling
me that there
[562]
is some type of
resiliency, that the stock
[564]
of dry powder, a belief that
things actually can get done
[568]
and that fundamentally the
virus is the problem, not
[571]
the economy, that potentially
we might see multiples
[574]
and we might see the investment
community bounce back
[577]
a little sooner than some of
the pundits might believe.
[580]
What are you seeing in
your own deal pipelines
[583]
and in your own book
of business that
[585]
might suggest that
that's either true
[587]
or a little bit too optimistic?
[588]
ROSE: No, I think
it's very fair.
[590]
I think the other piece that
I would add to the discussion
[594]
is these sources of capital.
[596]
We have a far more robust set
of private capital to draw upon.
[602]
And if you juxtapose the
prior downturn against today,
[606]
a lot of the bid market
loans and leverage situations
[610]
were financed by the banks
prior to the downturn.
[613]
And then during the course
of the financial crisis,
[616]
they got out of the
business in a large way.
[619]
The capital commitments
that they would have
[621]
had to make to continue
those lines of businesses,
[625]
various strategic decisions,
a host of factors.
[629]
Today, a lot more of the
activity in the leveraged loan
[633]
market is supported
by actors who
[635]
either have closed-end
funds behind them,
[638]
have different pools of capital
in the cases of similar pension
[641]
plans, but don't
necessarily have
[644]
the same degree of constraint,
or are more resilient given
[648]
the fact that, again,
the nature of this crisis
[650]
is different, given the fact
that the pool of capital
[653]
is different.
[654]
And so to your point, yes, my
own deal pipeline back in March
[660]
was very much around
secondary trades
[662]
in the debt market,
people buying debt
[664]
at depressed prices.
[666]
It then shifted towards
more selective opportunities
[670]
in the secondary debt market.
[671]
People starting to take
not just broad-based
[674]
view but zeroing in
on credits, trying
[676]
to figure out within
a given industry
[678]
sector who was mispriced.
[680]
And then started to
move into the solutions,
[683]
the structured debt, the private
investments in public equities
[686]
to build balance sheets,
to build resiliency.
[689]
And right now is
the first real wave
[693]
of processes where you
would classify it almost
[696]
as a traditional
leveraged buyout.
[699]
These are assets
coming to market
[701]
that are very resilient, perhaps
infected on the periphery
[705]
by the pandemic, generally
speaking would have survived
[710]
prior downturns very well.
[712]
But those are things that there
are actually leverage packages
[716]
available against.
[717]
There is a baseline of credit
that you can use and deploy
[720]
against it.
[720]
There is a comfort level
among those sources of credit
[722]
that it will get done.
[724]
And so we are seeing that
shift start to happen.
[727]
Now, how those go and how those
proceed, we will know in July.
[733]
But the fact that people
are trying it, and trying it
[736]
not just in a way that is a
vague process but a process
[739]
that has more firm deadlines,
almost a classic way of getting
[745]
a deal transacted, is a positive
sign for the marketplace.
[750]
And ultimately to your
point, perhaps a harbinger
[753]
of the resiliency of the
model and the set of financing
[758]
through this situation
in a very different way
[762]
than the last time
we were through.
[764]
MACARTHUR: You see, I think
that's a very interesting
[765]
insight that you just
made right there,
[767]
which is that this pandemic,
unlike past downturns,
[771]
certainly '08, '09, is impacting
sectors very differently.
[774]
This is not a
question of customers
[777]
being reluctant to spend.
[778]
This is an issue
of many customers
[779]
not being able to spend.
[781]
And there's a big
difference in that.
[783]
And there are sectors
that are actually
[785]
doing neutral to quite well
during a period of pandemic
[789]
because we don't have a lot of
those structural issues going
[792]
on that are damaging
the entire economy.
[794]
And as I reflect on the industry
segments that were most popular
[798]
for investment in '08 and '09,
they're different over the last
[802]
five years than they were then.
[804]
Right now, tech and healthcare
represent the top two sectors
[808]
in the private equity industry.
[809]
And many elements
of those sectors
[811]
have actually either not
been harmed or actually
[814]
have been accelerated in
terms of revenue growth
[817]
through the pandemic and
through the ways it's now
[819]
forced us to live and
forced us to work over time.
[822]
And so your point about
the industry structure
[825]
is different.
[826]
We're looking at
different assets.
[827]
The pandemic is impacting
different sectors
[830]
in different ways.
[831]
And some of those sectors
are underwrite-able and
[834]
finance-able even by debt,
is an interesting one.
[837]
And so I do think that
there is a case, again,
[839]
not knowing the
future, no one can
[841]
tell the future, that suggests
that in some of the strongest
[844]
areas of the private
equity market,
[846]
we may see a return
to dealmaking sooner
[849]
rather than later.
[850]
ROSE: I think that's right.
[851]
What I am seeing clients
do is pay attention
[855]
not only to the
end market but then
[857]
also within it, the revenue
model and the stress
[860]
test of the revenue model.
[862]
So again, on technology,
the software, the recurring
[865]
revenue, but truly
recurring revenues,
[867]
things that are linked
to ongoing subscriptions
[871]
and perhaps decoupled from
exposure to transaction volume.
[878]
And so being able to actually
work through and say this
[880]
is a resilient model
that we feel good
[883]
about both the industry's
exposure and then
[887]
underneath that, the nature
of the actual revenue and cash
[891]
flow streams.
[892]
And there are sectors
that certainly
[894]
have been much less affected.
[896]
And I think that as
I talk to clients,
[899]
it's this focus on
both how do we think
[902]
about the shape of
the demand curve,
[904]
how do we map our own businesses
against that demand curve,
[908]
and how do we map the models
against that demand curve,
[910]
and what can we take
away from that experience
[912]
in terms of the types of assets
that we would be hunting for.
[917]
MACARTHUR: On the next
episode of Dry Powder --
[919]
ROSE: If nothing else,
in the next five years,
[922]
change will be faster even
than it was over the last five
[924]
years.
[925]
MACARTHUR: Graham Rose and I
will discuss sector expertise
[928]
in a time of great
uncertainty and disruption.
[931]
I'm Hugh MacArthur.
[932]
Thank you for listening.
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