Friday Letter: Predictions for private equity

As the year draws to a close, here are ten things we believe will preoccupy the industry next year

Private equity had a record breaking year in 2014, and by all accounts the industry is on pace for another one in 2015. Here are our predictions for what will make the new year.

1. Mega buyouts make a comeback
2014 was largely dominated by the middle market. However, sources tell us that the prospects for a big year of big-ticket, multibillion dollar buyouts are on the horizon. The recent BC Partners purchase of PetSmart ($8.7 billion) and Thoma Bravo's Riverbed buyout ($3.6 billion) could well be harbingers of what's to come. The market certainly has the liquidity to help fund a surge.

2. Buy and build to the fore
With big deal hunting the exclusive preserve of the largest firms, the name of the game for everyone else will be carve-outs, tuck-ins and platform acquisitions. Fundraising was brisk in 2014, and as such GPs have money to burn. Many believe that carve-outs will be a particularly robust opportunity set, where crafty buyers can capitalise on business units within larger companies than can be backed to make it on their own. Other are staking out plans for platform acquisitions and small tuck-ins to build the next big thing.

3. Strategics assert their power
Much has been made of the exit environment in 2014, but although distributions really have been strong, a large portion of them came from sales between GPs, as well as IPOs. Sources tell us that 2015 will see much more activity from cash-rich strategic buyers looking for everything from the traditional brand buy to the quirky small business add-on.

4. Interest rates? What interest rates?
At its last meeting, the US Federal Reserve opted to remain bullish on the US economy despite recent slowdowns elsewhere. This has given interest rate prognosticators newfound confidence in their predictions that interest rates will rise mid-2015 even if they don't rise anywhere else. Inevitably there is speculation that an end of easy credit will harm private equity. However, neither the managers nor the lenders we've spoken to seem concerned. They say the deal environment is primed for another high volume year and any interest rate rise will have minimal impact. If anything – they say – it could give investors a little more leverage on deal terms, but a rate rise is unlikely to hamper overall deal flow throughout 2015.

5. Energy investments rebound
The recent slowdown in energy projects and the dramatic fall in oil prices have caused widespread consternation in the world economy, but many private equity players are rubbing their hands. Why? Because as prices have fallen and capex has dropped off, entry valuations getting cheaper by the day. For those with patient capital to invest, this is now looking like a perfect storm in the making. Back in Q2, when energy prices hit the peak, many value investors moved to the side lines. Now these firms are back, and often with freshly raised funds. Everyone from Carlyle to the lower middle market firms closed energy funds during the slowdown and are ready to pounce as a veritable buyer’s market opens up before them.

6. Co-investment unabated
It’s hard to find a limited partner these days who doesn’t want to co-invest, and this is not surprising: no fee, no carry, and an opportunity to put additional capital to work in (hopefully) well-conceived transactions led by capable managers – what’s not to like? Unfortunately for those craving LPs, demand for co-investment deals so far has exceeded supply pretty comfortably. Still, many private equity fund investors continue to ramp up their capabilities to be able to act fast and efficiently when the GPs come calling. This trend is likely to continue in 2015.

7. Haves and Have Nots
While the word ‘bifurcation’ has possibly been the most overused word in private equity in recent years, it continues to sum up the prevailing fundraising climate. Expect no change here either: for brand name GPs with stable teams and strong historical performance, fundraising will be like shooting fish in a barrel, whereas anyone with a stain on their record, or a question mark hanging over them, will likely have a different experience altogether.

8. Managing reputational risk
Prejudice against private equity was unfortunately something that the industry continued to endure in 2014. Just think of the furore in the UK when BC Partners-backed Phones4U went into administration. Some GPs have warned this year that a bad reputation will hamper the industry’s ability to source deals, and are calling for more dialogue with other stakeholders to create a better understanding in society of the benefits private equity can bring. Expect this debate to intensify next year, and not just in Britain. GPs best be ready.

9. Off the beaten track
The world at large looks full of risk, and geopolitics has returned as a potent source of much of it. And yet yield-craving institutional capital is once again looking actively for private equity opportunities in less familiar territory. Eastern Europe looks set to remain an acquired taste for many, but Sub-Saharan Africa is one example of a region insiders say is poised for private equity growth.

10. Still everybody’s darling
When did you last see a survey of investors predicting reduced allocations to the asset class? Don’t worry if you can’t remember – neither can we. From an inside-the-industry vantage point, this may be the most important mega-trend of all: for those looking to boost return on capital, and who isn’t, private markets continue to exert near-irresistible pull. People are rightly talking about the dangers of too much money chasing too few deals, but in the overall scheme of things, popularity with investors is not a bad problem to have.

One thing’s for certain: there’s plenty to ponder, and the year ahead is bound to be another taxing one. Until it begins, we wish you a peaceful and refreshing festive break.

But before you go, if you haven’t already: don’t forget to vote in our Annual Awards 2014.