Pantheon sees rising levels of investor caution

Pantheon partner Brian Buenneke explains to Private Equity International why deal-making activity may take “significant pauses” in 2016 if the current market environment persists.

Pantheon partner Brian Buenneke talked to Private Equity International to discuss the challenges of the current investing environment and what he expects in the year ahead.

Q. What are you seeing in 2016?

A. If we roll everything up between the volatile markets, challenged financing on the larger end of the private equity spectrum, and concerns about earlier stage companies raising capital and their potential future valuation, I wouldn’t be surprised to see lower volumes in the number of deals and deal value this year.

If the environment continues on its current trajectory, there will likely be periods of significant pauses related to this disconnect between buyers and sellers. My expectation is that we’ll see these episodes of caution and pause, which will flatten or lower deal volumes, assuming these current dynamics continue.

But, equally, opportunities for strong exits will remain and alpha-generating assets will be in high demand, so our general assessment would be this: be thoughtful and prudent, but we believe there are good opportunities in each of our markets.

Q. What is the overall investor attitude?

A. At Pantheon, our focus continues to shine on managers that have demonstrated strong operating capability and success in increasing asset prices in the past, often developing sector expertise along the way. 

We’ve seen the financing market become more challenging in the past two to three months in particular, which will put a potential brake on deployment and deal activities. Lenders are more cautious, especially at the larger end of the market.

We’ve definitely seen situations where sellers take longer to adjust expectations of what their businesses are worth, or what the capital raised in venture capital could be valued at; this can often be a six- to 12-month adjustment.

Q. How is Pantheon approaching different regions?

A. Of course there is a tough investment environment in Europe – Central Bank monetary easing hasn’t succeeded in stimulating meaningful growth, low interest rates are driving asset price bubbles and market volatility – but this is an environment where our core mid-market focus can do well. That segment of the market is where we have seen managers successfully innovate and shift into new delivery channels, where technology and healthcare advances can thrive.

So we see strong opportunity for careful, tactical investment in Europe. Meanwhile, in the US, though not out of the woods economically, on a comparative measure, we see the potential for economic outperformance and strong investment opportunities.

In Asia, we’ve been quite cautious for a while in terms of where we focus our investments. We’ve concentrated our activities more on domestic consumption private equity strategies, where, even though China’s growing more slowly than it has and perhaps what the official statistics would suggest, opportunity remains in our view from consumers’ increasing ability to purchase products and the growing middle class.

Q. Which sectors do you expect to find opportunities and which ones are you avoiding?

A. I think from an overall investment area and thesis, tech and healthcare remain two interesting areas and we’ve been pursuing both of those for a long time.

If you look at the public market, the NASDAQ biotech index is down 21 percent year-to-date. Salesforce and Workday, two prominent companies on the tech side, are down double-digits. Whilst our expectation was that we would likely see a moderating of healthcare and tech prices, we still see ample potential.

Overall, our macro view remains quite conservative about the consumer sector, given the slow growth environment globally. It hasn’t been a strong area of focus because it’s so correlated with GDP. I think some valuations in consumer companies were built on the fact that this windfall from lower energy prices would end up in consumers’ pockets and help stimulate the sector. But we really haven’t seen it. These are two headwinds that could decrease valuations.

Q. What are you seeing in other sectors?

A. There are two things we’ve been following in the manufacturing sector. The wage gap between China and the U.S has decreased dramatically; lower energy prices and the lessened labour advantage of China make the U.S quite attractive for manufacturing businesses to bring back operations to the U.S, Canada and Mexico. There have been some pretty significant currency challenges with the higher dollar making exports more difficult. So, generally we’re following the trends of lower energy prices and a smaller wage gap but have caution on exporting businesses.

The energy sector has interesting places for private equity to invest in, especially when a lot of investors are turning away from the sector. Of course, no one can predict the future of energy markets. So for us, we focus less on what’s the current valuation today than looking at where the opportunities are likely to be in the medium term. There’s also been a lot of talk about distressed opportunities, not necessarily taking in entire companies but doing one-off asset sales.