Friday Letter: The rise of the multinationals

What’s the future of the buyout industry? Easy. Currently the most widespread view of the industry’s evolution is this:  private equity is going where investment banking has gone before it. As a result, a very small number of very large, global LBO players are set to dominate, attracting the vast majority of institutional capital being allocated to the asset class.  

In time (and we’re not talking decades), upwards of 80 cents in every dollar put into private equity will go to members of this elite club. This view was recently propounded by Edmund Truell, boss of UK buyout group Duke Street Capital in a speech delivered at sister publication Private Equity International’s 3rd Annual Private Equity CFO and COO Forum in London. Bobbing in the wake of these super tankers would be a flotilla of much smaller firms (measured by capital under management, number of personnel or offices) who will specialise in niche strategies differentiated by investment style, industry sector, geography or any combination thereof.

Tellingly, nobody in the room questioned Truell’s vision, and you didn’t get the impression that this was simply down to mute-delegate syndrome – or because the proposed scenario was too preposterous to warrant engagement. The fact that Truell himself is shifting his personal focus from vanilla buyouts to a diversified structured product fund might also be regarded as a case of putting your money where your mouth is.

The reason why in the LBO business capital should gravitate more and more towards the bulkiest groups is simple. The biggest firms in the business today already have the wherewithal to attract the best investment talent, buy the best services from intermediaries, employ the most able company operators, fundraise most effectively, invest heavily in their brand and marketing capabilities and in doing all of these things add to the already existing blue water between themselves and their less potent competitors. Because the process is self-perpetuating, the outcome appears inevitable – which is why so few practitioners seriously challenge the notion that much of private equity’s future belongs to the giants of the business.

What is also difficult to refute is the fact that in the race for LBO domination, the US contenders are leading from the front. Not only do they raise the largest funds; they also move around the globe faster and more effectively than their European rivals. With the exception of CVC Capital Partners, which already has a sizeable franchise in Asia, and to a lesser extent Apax, which has a presence in the US and is in the process of executing a merger with New York-based mid-market firm Saunders, Karp & Megrue, Europe’s best houses haven’t extended their deal-making reach much beyond the continent’s borders. Permira recently confirmed plans to open an office in Tokyo, but if you compare these forays with the multi-office, multi-fund entities already created by the likes of Blackstone, Carlyle or Texas Pacific, the conclusion has to be that the big European firms have much to do if they want to take truly leading roles on the world LBO stage.

It isn’t obvious that even Europe’s finest will be able to close this gap. US buyout groups have been a fixture in many landmark buyout transactions in Europe for many years. And in Asia, first-mover advantage lies firmly with the Americans. On either continent, more immediate than the competition for capital is the competition for talent, and so the most promising LBO upcomers will be able to choose between joining a regional champion or a US-headquartered private equity multinational with greater reach and – seemingly – deeper pockets. Which of the two is the better bet is the $60,000 question.

The battle shaping between the two camps promises to be a fascinating one. The evolution of the investment banking industry provides relevant indicators here. Ten years ago the hegemony of the bulge-bracket US firms (Goldman Sachs, Morgan Stanley et al) seemed irrefutable. Fast forward to today and it’s clear that dominance should never be considered permanent: look, for example, at how Britain’s Barclays Capital and RBS have grown (and how Morgan Stanley presently appears to have two left feet).

As for the rest of the buyout industry, comfort lies in the fact that life in the shadows of the largest houses has by no means got to be boring. Hate the idea of being a small cog in a vast, fully institutionalised private equity machine? No problem, go join a niche firm – or raise your own specialist buyout fund even. Private equity’s innate entrepreneurial spirit should ensure that self-starting individuals with a dislike for working within an increasingly rigid corporate structure will find plenty to do.