Friday Letter Mid market turf war

With LP capital flowing in and the erstwhile mega funds pushing downward, the market for mid-size private equity transactions is becoming an uncomfortably competitive environment.  

Limited partners over the past year have been ramping up exposure to the mid-market, the general theory being smaller firms use less leverage, employ more operational expertise and produce better returns than their mega-fund siblings. LPs have preached since the downturn started their desire to get exposure to mid-market players who are not afraid to roll up their sleeves and get their hands dirty.

But by now it is clear that the mid-market is changing, as the larger firms have moved in to find assets on which to deploy capital.

The Blackstone Group, for example, now touts itself as mostly a mid-market investor that only occasionally does some really big deals. Meanwhile Carlyle Group, never slow to add new strings to its bow, recently formed a small-cap investment team to target growth equity opportunities.

No wonder the mid-market is making headlines. Investors, however, should be concerned. Those looking to boost their exposure to middle market private equity are entering an increasingly crowded market, and one in which some of the best opportunities in this fledgling new business cycle may have come and gone already.

It was with this in mind that David Turner, head of private equity at the Guardian Life Insurance Companies of America, recently tempered the enthusiasm for the strategy during a recent presentation at an institutional investor forum in New York.

Turner’s point was that, with mega-funds pursuing smaller companies, and even traditional mid-market players getting into bidding wars over assets, returns in the fabled land of operational excellence and sensible gearing will inevitably fall as well.

“At the smaller end of the buyout market, GPs with good track records and the pretenders are at war right now,” Turner said. “Investors and managers have flocked into the lower end of the market.”

It's not a trend that is likely to change overnight. Estimates vary, but let's assume buyout funds globally have about $500 billion of uninvested capital to spend. With large deals still largely off limits, they are chasing targets all over the spectrum to get their cash into the ground. And with the mid-market now firmly on everybody's radar, it's going to remain a battlefield for some time.

In light of this, limited partners who were betting that mid-size private equity would be a great place to make money will need to reconsider: it's not going to be that simple.