What does $1.8 billion of private equity “dry powder” mean for public markets?
The recent cash bonanza in private markets could lead to more privatizations of publicly traded companies as private equity and infrastructure funds seek to create value in evergreen assets.
Private equity funds, in particular, are teeming with cash, with levels of unspent money in the asset class hitting new highs of around $1.8 trillion this year, according to the company’s latest estimates. research Preqin.
Some of this money is now funneled to the public markets, in a context of rising interest rates that could make the modus operandi of private equity, the management buy-out, more expensive.
On Monday, San Francisco-based hedge fund Inclusive Capital Partners made a £1.5bn bid to take homebuilder Countryside Partnerships PLC (LSE:CSP) private, showing that real estate and inland transport have rich choices for private investors.
Following the bid, Countryside shares jumped 20% on Monday morning to 288.8p.
This month, private investors rushed to buy two publicly listed transport operators, Stagecoach Group PLC and FirstGroup PLC, which will later be delisted from the London Stock Exchange.
While international air travel has declined following the Covid-19 pandemic, domestic travel has rebounded, making the sector increasingly attractive to buyers.
Stagecoach founder Brian Souter announced this week that the bus and coach operator will drop from the list by June 27.
Meanwhile, FirstGroup shares jumped on news that private equity firm I Squared Capital has made an offer for the company valuing it at £1.23billion, following ongoing tensions with investors. activists who effectively ousted its chief executive Matthew Gregory last July.
Its shares soared almost 19% last week to 135.3p after the takeover bid.
Other transport companies that could also become targets for private equity include Go-Ahead Group PLC (LSE:GOG), which has seen its share price rise 51% in the past six months, to 1,030p Friday.
National Express Group PLC (LSE:NEX), which has a market capitalization of around £1.7bn, could also become a possible target for private investors, with its profits expected to rise this year due to a recent change. of strategy, according to analysts.
The company said in its annual results that it was aiming to reposition itself in the shared mobility space, a move that is expected to drive £1 billion in revenue growth over the next five years (to 2027).
The impending takeover of Stagecoach means National Express Group will no longer partner with the company, it said in a statement.
Other national transport operators that could become attractive assets for private equity include Redde Northgate PLC (LSE:REDD), a car rental service operating in the UK and Europe.
The company’s projected revenue growth this year could help redress its stock price’s recent wobble despite its rebound from the pandemic.
The car rental business forecasts revenue growth of 12% in 2022 as it expects growth in demand for used vehicles.
Private equity works for itself
Private equity firms have historically had a poor reputation for creating shareholder value.
This can be partly attributed to the high amount of leverage (debt to assets) used in management buyouts, which can leave target companies struggling with borrowings on their balance sheets and vulnerable to interest rate hikes. interest.
Commercial space, for example, suffered a wave of bankruptcies, ten years after the financial crisis, among companies that were overleveraged during the heady days of the market crash in 2008.
Private equity firms have earned a reputation, justified or not, for stripping management teams and leaving little value for public investors.
However, the recent strong performance of Pets at Home Group PLC (LSE:PETS), which was listed by private equity firm Bridgepoint in 2014, may yet be proof that the asset class’s reputation for not generating lasting value must be taken with some caution. salt if not completely reassessed.
Pets at Home is a success story from private equity to public markets in a flurry of mooted deals that have failed to materialize in recent years as companies sit idle amid market turmoil.
The pet care sector recently posted strong earnings, satisfying public market investors and driving its stock price up 17%.
The company said it increased its revenue by 15.3% to around £1.32bn in the year to March 31, boosting its pre-tax profit.
One swallow per summer?
Its recent growth suggests that the reputation private equity has long had for failing to take companies to public markets may still be unfair.
Indeed, Allianz reported in October that the IPO market hit record highs last year, driven by private equity money.
He said private equity has “turbocharged” public listings, creating significant value in the small cap space relative to other listings.
The financial services firm said that in principle, a private equity firm-backed IPO should “outperform” other listings because of the preliminary research that goes into such investment decisions.
Private equity-backed IPOs are expected to outperform so-called “naked” listings, but much depends on company and asset class performance, according to Allianz.
“The acceleration in the relative performance of a certain sector against the broader market tends to trigger a wave of new IPOs in this booming sector as IPO-ready companies seize the opportunity to get into the market,” Allianz said.
He said private equity-backed companies “have the upper hand” in the $50-500 million small-cap space, outperforming naked IPOs by around 8%, but generally underperforming in the mid-cap space.
If the asset class can once again feel comfortable with the exit value offered by public markets, companies that choose to spend their war chest in the small and mid-cap space could create a pipeline of future shareholding opportunities through IPOs.
The Covid pandemic, lockdowns in China, high energy prices, Russia’s war on Ukraine and associated food shortages, high inflation and the cost of living crisis have all rattled stocks. public markets.
Private equity funds are notoriously conservative and risk averse compared to venture capitalists, activists, or public investors, and will generally bide their time to exit a company through a public market listing when it can achieve a larger market capitalization.
Likewise, for publicly traded companies that have struggled to raise their share price due to pandemic-related pressure, privatization could provide a behind-the-scenes opportunity for growth.
Private equity firms generally recommend that public companies withdraw from public markets to give them the opportunity to invest and grow without pressure on the price of public shares.
This happens both in the case of a management buyout, where the company keeps current management in place after an acquisition, and sometimes when it parachutes into a new management team.
The growing level of unspent capital held by private equity firms, known as “dry powder,” nonetheless remains a double-edged sword for the asset class.
The rising cost of capital has put pressure on the illiquidity premium that typically makes the asset class so attractive to investors.
Booming dry powder has reduced returns for investors, and larger fund commitments usually come with higher investment fees, which are usually calculated as a percentage of the fund’s total capital.
While inflation drives up underlying business costs and post-pandemic operating expenses, rising interest rates drive up the cost of debt typically used to fund management buyouts.
The Bank of England raised its discount rate to 1% in May, from 0.5% in February.
The growing interest backdrop could ultimately make staying or listing on the public markets a potentially more attractive option for many mid-cap companies than a buyout, as the debt required for management buyouts becomes more expensive for long-term businesses, but the temptation of high cash offers and continued pandemic pressure on stocks might be too much.