Jeffrey Immelt, succeeding Jack Welch as the head of General Electric, remarked that “private equity funds are the conglomerates of this era”.
Looking at the fortunes of conglomerates in developed economies, and of private equity, we can certainly see those changing fortunes: corporate giants such International Telegraph and Telephone Corp, once with assets of $41 billion in 1970, shrank over the following four decades to around $4 billion. KKR, meanwhile, founded in 1976, has grown to over $200 billion of assets under management.
The conglomerate model still survives to some extent in Asia – take Tata Group, which has enjoyed success over the past decade through acquisitions, and today enjoys a market capitalisation of over $160 billion. It is, however, the exception.
Similarly, many have pondered whether the FAANG companies, Facebook, Apple, Amazon, Netflix and Google, might succeed over longer time horizons where conglomerates have failed; if the stock performance of these diversified tech giants during the covid-19 pandemic is any bellwether of success, following both acquisitive and organic growth, the answer may be yes.
Yet for the many positive attributes of private equity – for example, better governance models for affecting real change at portfolio companies compared with the largest shareholders of most public market companies – there are two fundamental reasons why private equity has struggled to realise Immelt’s vision of being newer and more successful versions of the 70s’ conglomerate.
First, the private equity industry has remained very fragmented – in 2000, there were fewer than 2,000 private equity firms in existence. In 2010, that figure rose to around 5,000, and in 2020, that number approaches 10,000. This increase is significant, and anecdotally we know that given the supply of LP capital chasing double-digit returns, it’s likely that only the very worst performers will be unable to raise capital and be forced to consolidate or wrap up. The rest will survive.
As such, even though there are a growing number of firms with over $10 billion of AUM attracting an increasing share of global capital, consolidation in the industry is limited enough that only a handful of firms have reached and maintained this level of scale.
Second, the average term of a private equity fund is 10 years, meaning that once that period expires, even with two potential single-year extensions, most funds are obligated to sell their remaining portfolio companies. We’ve seen firms seek to solve this time pressure problem by selling so-called “tail end” assets to secondaries buyers in portfolio sales, but the result is the same.
The other solution that the largest firms have been able to pursue is the creation of longer-life fund vehicles of 15 or even 20 years.
This solves the immediate need to sell assets after a maximum of 10 years, but is still subject to the time pressure that gives each private equity firm a sense of impermanence – what solution is there for firms that identify highly-attractive companies from which they can deliver attractive growth and provide compelling long-term returns for investors?
Data from Evercore’s Secondary Market report may provide an insight, indicating the significant growth of single-asset deals from private equity funds.
Private equity firms, recognising the potential in some assets to deliver long-term value both for manager and investor, and following an extended test drive of the asset during a specific fund’s period of ownership, have started to sell certain companies to single-asset vehicles with long or potentially unlimited time horizons. The manager keeps the fee income and any potential upside from distributions.
Over the next decade, this will present an increasingly challenging diligence question for investors in private equity: how should we evaluate the alignment of firms which derive a significant proportion of their income from long-term, single-asset vehicles, as well as regular way funds? Do these firms still risk existential decline if a fund vehicle fails to perform?
For the firms themselves, the prize is compelling – a revenue stream from a series of assets that may realise Immelt’s prediction. Private equity may yet become conglomerates limited not by time, but only by the long-term performance of those single assets.
Ed Stubbings has spent a decade raising private capital for general partners in Europe, North America and Asia. He was formerly a member of the Private Funds Group at Houlihan Lokey.