Friday Letter Candian envy

Just two years ago, “$5.2 billion” and “large deal” wouldn’t have been placed in the same sentence, or even the same article. But times have changed dramatically, and the proposed take-private of pharmaceutical information provider IMS Health, revealed yesterday, has bolstered a feeling of recovering momentum among private equity market participants. It is the largest in a series of multibillion deals agreed since KKR unveiled its $1.8 billion purchase of Oriental Brewery in May.

Possibly more closely watched than the size of the IMS transaction, however, is the equity duo backing it – TPG Capital and the Canada Pension Plan Investment Board. The partner with the less famous brand is most often called an “LP” by private equity industry participants, given its affiliation with one of Canada’s largest pensions. But, as yesterday’s announcement shows, CPPIB has been increasingly active as a direct investor. According to CPPIB, it has invested some C$4 billion (€2.5 billion; $3.7 billion) in direct equity alongside its GPs. This compares with some C$17 billion put to work through third-party funds.

The IMS transaction is the kind of deal structure that seems ideal for both parties: TPG is able to round up the required equity for this deal without going to a rival private equity firm, while also forging closer ties with an important institutional investor. CPPIB, for its part, is able to put significant equity to work with the involvement a strongly resourced investment manager like TPG, but without the erosive fees that would be charged if the equity were deployed through a fund.

It’s a model of private equity investing that many other LPs envy and are studying. Fellow Canadian pensions the Ontario Municipal Employees’ Retirement System and the Alberta Investment Management Corporation recently said they would move away from investing in funds and pursue more direct deals. Other large pools of capital, including sovereign wealth funds in Asia and the Middle East, are building or considering building internal direct investment teams.

But it’s not easy, market sources are quick to warn. CPPIB, for example, employs dozens of experienced and competitively compensated investment specialists to conduct due diligence on and monitor direct investments. Its independent structure has allowed it to sidestep political slug-fests that usually break out when public pensions employ well-paid professionals. The creation of a CPPIB-type organisation in, say, California, isn’t even a twinkle in the eye of local legislators. And in any case, simply hiring expensive deal guys is no guarantee of good results. Depending on how their employment is structured, it might be a recipe for excessive risk-taking.

Certainly many other LPs have routinely co-invested alongside their fund managers, but not often at the level of CPPIB (or that other bellwether pension-affiliated Canadian firm – Teachers’ Private Capital).  Most LPs simply don’t and can’t have the resources of CPPIB and Teachers’, and would do well to focus their energies primarily on continuing to push better alignments of interests into the conventional but sturdy limited partnership format. Just as the buyout isn’t dead, the private equity fund isn’t dead either – but its shape will have to be adapted and improved to meet new opportunities and new realities.